ILS fortifies its position
While catastrophe bond issuance fell in the 12 months to June 30, 2018, this should not be confused with any indication of a weakness in the market, a new insurance-linked securities (ILS) report by Aon, Alternative Capital Fortifies its Position, has argued.
Some $9.7 billion of cat bonds were issued in the period, a decrease of $1.6 billion over the preceding period.
The report, written by Paul Schultz, chief executive of Aon Securities, argues that this dip in issuance should not be confused with a lacklustre performance in the period. It notes that the period included issuance not only from repeat sponsors looking to renew maturing bonds, but also from new sponsors testing the capital markets for the first time. In addition, the capital markets welcomed new perils from new geographies, providing diversification to the broader market.
While there was relatively modest issuance volume in the third and fourth quarters of 2017 there was strong issuance in the first and second quarters of 2018. During this period there was the largest ever sovereign risk transfer and the second largest issuance in the history of the ILS market at $1.4 billion, facilitated by the World Bank on behalf of the Pacific Alliance countries.
The strong first quarter 2018 issuance of $3.6 billion was followed by a stronger second quarter, which brought an additional $4 billion of catastrophe bonds to market.
Resilience when needed
The 12-month period in review is notable for the resilience demonstrated by the investment community as investors reloaded capital bases following the catastrophic events at the tail end of 2017, the report notes.
It explains that a key indication of the health of the sector is that ILS managers were able to “reload” at renewals, and the pricing environment remained healthy despite concern over ILS-related trapped collateral after the 2017 cat losses.
“The volume of transactions remained high while catastrophe bonds continued to both upsize and price at the low end of, if not further below, initial guidance. With both supply and demand remaining strong, total outstanding volume of the market has reached its highest level at $30 billion,” the report says.
Almost immediately after the 2017 hurricane events and during the active wildfire events, new transactions were launched into the market with the catastrophe bond sector seeing approximately $1.4 billion of initial issuance activity immediately following hurricanes Harvey, Irma, and Maria (HIM).
Further, the first issuance post-HIM (Galileo Re 2017-1), expanded coverage from its prior transactions, receiving broad investor interest, while demonstrating the resilience of the market post-event. The final transaction of 2017 (Tailwind Re 2017-1) was broadly syndicated, upsized from $300 million to $400 million, and each class of notes priced below initial guidance.
The report notes that Bermuda continued to be the special purpose insurer (SPI)-preferred domicile for the 12-month period: 19 issuances used the jurisdiction, with the Cayman Islands accounting for five and Ireland two of the 29 new issues. In addition, new legislation passed in the UK has helped two ILS transactions come to market in the jurisdiction.
“Overall, as was the case in the prior year’s review, the expertise in Bermuda continued to attract SPI domiciliation, suggesting a favourable outlook for Bermuda service providers, banks, and the Bermuda Stock Exchange,” the report says.
Enhanced coverage
The report notes that the cumulative coverage offered by the alternative markets once again expanded in the 12 months ending June 30, 2018 with increased issuance sizes (up to $30 million from $25.8 million) and more covered perils.
“This multi-year facet of catastrophe bond coverage allows sponsors to lock in current year pricing and later reset the bonds coverage while pricing moves along the current curve to reflect change in risk,” the report notes.
It adds that many sponsors found catastrophe bond market solutions effective for covering aggregate structures. With 64 percent of the limit of bonds placed using some type of aggregate structure, the 12-month period is the first time the majority of deals were not structured on a per-occurrence basis. This change is further appreciated when compared to the prior 12 months, when aggregate structures accounted for just 30 percent of the year’s issuance.
It also notes that 66 percent of new issuances used indemnity protection versus industry index protection. Only one transaction with four sponsors—the republics of Chile, Colombia, and Peru and the Fund for Natural Disasters—used a parametric solution to secure earthquake catastrophe bond protection.
Additionally, several returning reinsurers came to market with index transactions as a way to complement their retrocessional protection programmes, including XL Catlin (Galileo Re Series 2017-1) and Everest Re (Kilimanjaro Re Series 2018-1 and 2018-2) with $150 million and $525 million transactions, respectively.
Meanwhile, first-time sponsors Validus (Tailwind Re 2017-1) and TransRe (Bowline Re 2018-1) offered three classes of notes for $400 million and one class of notes for $250 million of capacity, respectively.
Private cat bonds
Over the past year, there has been an uptick in private transactions that have come to market. Although potentially harder to place given the more stringent primary and secondary trading requirements, the less comprehensive need for legal review allows for a large decrease in cost for the sponsor, which is essential for smaller limits being placed, the report explains.
In the 12 months under review, private deals have been as small as $5 million; however there is also interest for larger bonds, with the largest private placement being over $424 million. “The decreased need for disclosures can be attractive to sponsors,” it says.
Several platforms have been developed to facilitate these private catastrophe bond transactions. Allianz Risk Transfer secured $14.5 million in notes, covering risks associated with warmer-than-expected winters across Europe. This bond uses a parametric trigger that is measured against temperatures across various weather stations in Europe. Notably, this is only the third catastrophe bond to cover temperature-related weather risks.
Private deals have also covered more standard property catastrophe-linked cat bonds, which can be seen in Alpha Terra Validus II, a renewal transaction issued through Aon Insurance Managers’ White Rock Insurance (SAC) reinsurance company.
This deal stood at $5 million, the smallest catastrophe bond issued in the preceding 12-month period. This deal provides protection against Latin American property catastrophe risks and is structured as a zero-coupon note, which means that the cedant provides the premiums upfront, potentially allowing for better investor returns.
Alt capital grows
In terms of alternative capital overall and across all structures, the report notes that strong 2018 issuance has allowed alternative capital to grow by just over $9 billion to a total of $98 billion for an overall increase of 10.2 percent. This growth came despite the third and fourth quarter events of 2017. However, the period of growth also came with new structural features, risk profiles, perils, and sponsors.
It notes that the ILS market continues to provide investors with an attractive risk-return profile, while maintaining its diversifying benefit to investors. Interest spreads have remained fairly constant despite catastrophic losses in 2017, with an average weighted by size of 5 percent. In turn this allows for additional perils and more favourable bond structures, such as aggregates, to be covered.
The trend of using the World Bank’s International Bank for Reconstruction and Development (IBRD) as collateral continued for the trailing 12 months. This year, 45 percent of the notional amount issued used IBRD notes in the year under review versus 56.8 percent the year prior. This collateral solution offers a way to enhance yield for investors as the IBRD notes generally offer the three-month London Inter-bank Offered Rate minus a spread of 16 to 40 basis points, representing a premium of around 40 to 50 basis points over money market funds.
Sixty-one percent of deal classes experienced upsizing during the process for an average increase of 34 percent of the volume issued or an average increase of $37.6 million per class of notes. Not only did the market experience a significant amount of upsizing but many deals were initially marketed at higher notational levels at the onset of marketing, allowing for the large amount of growth in the catastrophe bond market, the report says.
It also notes that some $2.9 billion in limit was secured through 17 quota share sidecar transactions that came to market since June 30, 2017. “This significant volume demonstrates the opportunity that both sponsors and investors see following catastrophe events,” the report says.
Several sidecars were launched by sponsors that were new to the market. New sponsors included MS Amlin, Fidelis, Neon Syndicate 2468 (Neon), Sompo International, and Oxbridge Re. Chaucer also returned to the market after several years.
“The emergence of new sponsors highlights that sidecars remain an efficient source of collateralised capacity that can be quickly deployed following catastrophe events,” the report says.
It also says that the collateralised reinsurance segment grew by 8 percent in the last 12 months. Although the segment continues to grow, its growth decelerated following the 25 percent expansion during the prior period.
One example of a new solution in this segment is the recently launched Credit Suisse vehicle, Bernina Re. The unrated class 3a insurer is domiciled in Bermuda and is already responsible to manage a significant amount of assets under management.
Further, LGT’s Collateralised Re has transformed itself into Lumen Re and received an “A” rating by AM Best with a stable outlook. Obtaining a AM Best rating and upgrading the vehicle’s Bermuda license to a class 3a reinsurer provides LGT with the opportunity to pursue more diverse investment strategies.
The largest ILS investment fund, Nephila Capital, also further expanded its breadth by making an investment in Volante Global, a newly launched multi-class and multi-territory managing general agent platform. Volante is headquartered in the UK and focused on underwriting specialist portfolios including property and casualty, professional and financial lines, motor, space, aviation, and marine and energy.
This article originally appeared in the November edition of Bermuda:RE+ILS.
