Cat bond frenzy unstoppable Q2; can bring other ILS in tow this year: Aon
The cat bond bonanza should roll to another increase in issuance in the second quarter, still fuelled by primary insurers seeking to diversify their reinsurance while reinsurers sit idly on the ILS sidelines, but can only go so long before teasing other market segments into the rally or correcting, something to watch for in the second half of the year, Aon’s chief of ILS operations told Intelligent Insurer.
“We are expecting Q2 to be significantly higher than the comparable period last year,” Paul Schultz, CEO of Aon Securities, told Intelligent Insurer. “We are going to see not only an elevated number of issues, but probably larger deals as well.”
Comments follow a first quarter with $3.87 billion in issuance of the core 144A property cat bond, surpassing Q1 2023's $2.75 billion and the previous Q1 record from 2020 at $3.76 billion, Aon has said. Q1 average deal sizes were roughly flat year on year. The final tally, while record, did not live up to the stack of Q1 2024 maturities, leaving the market down lightly in net outstanding.
Q2 is a harder all-time record to break: Q2 2023 brought $4.86 billion to market, itself down on both the prior year and the Q2 2017 record of $6.38 billion.
The structure of second quarter deals could largely mimic what took the market to its Q1 record and the annual record set in 2023: insurers seeking to diversify their insurance programmes, including a hefty dose from government-related entities like the US flood programme or state-backed residual carriers, often flush with exposures in stressed US jurisdictions.
The visible pipeline suggests that the market can do little else than follow that well-established pattern. Primary insurers will lead, chiefly driven by repeat issuers, but including some smattering of new names. Sums will prove altogether sufficient “to see cat bonds grow as a percent of the risk ceded into the marketplace, for sure.”
“It’s really still coming from insurers driving the market, continuing to hedge or add diversification to their overall reinsurance programme,” Schultz said of a market “putting more limit with capital markets versus the reinsurers.”
Still on the sidelines in the cat bond issuance frenzy: reinsurers who in other times might build heftier retrocession programmes from indexed cat bonds. Schultz’s best guess: they’re happy to take the added net exposure in the good times now that rates have risen and retained earnings have followed suit.
Likewise, collateralised reinsurance volumes have been suppressed while the cat bond records have been set quarter after quarter. Here, Schultz joins the chorus of voices that have blamed trapped capital and the low placement of collateralised reinsurance deals in reinsurance towers that put capital at greater risk.
While “the current rally has legs,” a lopsided rally can only go so far before either correcting or dragging others in its wake, Schultz suggests, and the second half of the year may tell if the imbalance on valuations has tipped too far.
“As we go into the second half, the theme is going to be relative comparison of premium levels, the relative cost of transferring risk into one market versus another,” Schultz said of the market outlook once the current trend-driven pipeline clears somewhat.
Retrocession cat bonds should be the first element to move on any such valuation disparities, Schultz suggested. Spreads on the indexed cat bonds that cornerstone retrocession ILS “have come in pretty significantly,” Schultz noted, “and that should lead to more reinsurer hedging activity.”
Collateralised reinsurance has more to overcome, with structural issues around trapped capital and the negative investor sentiment it created likely to allow for greater valuation disparities before the bravest souls are re-tempted to the market, Schultz suggested.
Ultimately, cedant frustrations from the 2023 property cat market reset may even be put to rest and the pricing gap to traditional reinsurance will also come back into play.
“I think it is going to continue for a while,” Schultz said of the cat bond rally, with caveat for the outer limits of differences in valuations.
“As we go into the second half of the year, it will be interesting to watch the dynamic between ILS and traditional reinsurance and if that spread widens,” Schultz said. By year-end and the lead up to the next 1.1 “it will be pretty clear if that delta has remained the same, tightened or widened.”
“The dynamic has to hold,” Schultz said. “If it doesn’t, … some deals at the margin could go back.”
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