A bumper year ahead for ILS issuance
Catastrophe bond issuance in the insurance-linked securities (ILS) space is typically high during the first and second quarters of the year, and 2020 is set to follow the trend. Retro and European reinsurance purchasing during the January 1 renewal season is typically a key indicator of ILS activity in the quarters that follow, serving as a good barometer of investors’ capacity and pricing expectations.
All indicators from the recent renewal period point to heightened ILS activity in the months ahead.
Similarly, the prominent role of ILS in the retro market has an impact on traditional renewals. This year alternative capital’s impact became more systemic, as many reinsurers developed sophisticated new hedging and capital management strategies, made possible through ILS structures. ILS markets participated on a collateralised basis in excess of loss form, in proportional form through sidecars, and also via direct client participation through reinsurer-managed ILS funds.
End investors reviewed their allocations to ILS following disappointing performance in 2018 and 2019. This created sustained capacity tension, rate increases, less cedant-favourable terms and conditions, and a reduction of the total deployable ILS capital in 2019. To alleviate these tensions during the ramp up to the renewal, multiple reinsurers sponsored cat bonds triggered by an industry loss index: these structures are perceived to be more investor-friendly.
Since Q4 2019, the catastrophe bond market has absorbed an additional $805 million of retro-focused capacity, after $1.67 billion of maturing bonds were offset by $2.48 billion of new issuance. On the sidecar side, a general trend has developed towards greater underwriting discipline on the part of investors. Many have reallocated their capacity towards the best performing sidecars, which emphasises the importance of transparent and robust structures.
We are now observing an overall increase in ILS investment, and a strong 2020 pipeline remains. Improvements in pricing, terms, and conditions are making investment in ILS more attractive. However, investment will likely be much more disciplined than it tended to be in 2018, when an influx of new capital stymied the promise of rate increases.
144A cat bonds
As investors re-evaluate how they gain access to the ILS market, we are observing a greater appreciation of the fully structured 144A catastrophe bond product. Bonds offer greater liquidity and transparency to investors than the alternative methods of accessing the space. Some investors have expressed concerns over more private structures, driven by the lack of standardisation in collateral release and rollover mechanics.
Q1 2020 is off to very strong start for these structures, which are not subject to US Securities and Exchange Commission registration and disclosure requirements for public offerings. With more than $2 billion in 144A bonds issued, including deals currently being marketed, Q1 is already the second-largest first quarter by value in the past 10 years. This trend will continue throughout the year, meaning full year issuance for 2020 could rival the high watermark set in 2017.
The proliferation of ILS into the global property market is increasing, despite increased global catastrophic loss activity. That goes some way to answering questions about the durability of the ILS market.
The current environment provides a significant opportunity for ILS to increase its stake and relevance in global risk transfer markets. Rising rates in the primary insurance market create a further opportunity for ILS capital to expand profitably, while providing valuable capital to the marketplace. Many will respond. Expect a bumper 2020 for ILS issuance.
