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Despite firming prices further supply growth is indicated for the cat bond market Analysis


In its latest report Aon said it expects the cat bond market momentum through H2 this year to set record issuance levels in 2021.

In the broker’s ILS Annual Report 2022, Aon Securities President and CEO Paul Schultz referred to this momentum as “an impressive achievement given the headwinds experienced in the space at times in the first half of 2022.”

Cat bond issuance reached a record issuance level of $12bn from July 1 last year to June 30 this year. It had reached a record level of $13bn in the previous year.

“We expect the orderly market to continue and gain momentum in 2023,” Schultz added.

Geopolitical factors such as the Russia-Ukraine conflict, rising global inflation, rising interest rates and currency volatility were headwinds in the first half of 2022, as spreads for cat bonds widened.

Sedant demand for the product “remained robust,” however, Aon noted.

“While the cat bond market has seen rate hardening, it continues to diversify and attract new and repeat sponsors, with relatively large increases in traditional (re)insurance pricing placing the ILS market in a more competitive position year-on-year,” the report said. observed.

In the year ended 30 June 2022, Bermuda was the largest issuer domicile with 41 transactions out of a total of 54 transactions globally, followed by five from Singapore and three from Cayman.

“Quest” for greater potential

Investors have turned to CAT bonds as an ILS product type that provides diversification to their portfolio. Given the moderate disaster frequency and severity, this asset class offers relatively attractive conditions.

And “the overall theme remains that diversification is doing well compared to the previous ‘bull years’ of the broader financial markets,” said Richard Pennay, CEO at Ion Securities.

“With the space continuing to demonstrate its ability to provide a source of diversification from the volatility observed so far in the broader capital markets this year – more capital can reasonably be expected to benefit from this attribute,” he said.

“The discovery of more capacity from the ILS markets is well underway” for products such as proportional-based sidecars or cat bonds or non-proportional reinsurance through collateralized reinsurance, Pennay noted.


In the first half of this year, ILS capital markets capacity was estimated at $95bn, down nearly 2 per cent compared to the same period last year.

But Aon noted that as a resilient and robust market, ILS capacity is in a strong position for the rest of the year.

“As we now see the demand for ILS capacity in the market exceed the supply of ILS capital, and this leads to higher prices and tighter terms and conditions, regular sponsors of ILS products are more appreciative of this alternative source of capital, forming stronger relationships with the capital markets in the process,” added Pennay.

Separately, reinsurers are increasingly relying on cat bonds and sidecars for retro protection, Moody’s said, as collateral aggregate capacity contracted last year with the re-emergence of trapped capital. According to the rating agency, the reinsurer has sponsored 15 CAT bonds from June 2021 to access retro capability, providing a $2.85bn cap.

Increased cat bonds

In its latest update on the ILS market, AM Best reported that overall asset casualty cat bond issuance in the first half of this year was $8.1bn from 35 transactions, compared to $8.5bn from 29 transactions in the first half of 2021.

The $5.0bn placed in the second quarter of 2022 is down from $5.9bn in Q2 2021.

However, the report said 23 of the 35 144A Cat bond transactions in the first half – or 66 percent – exceeded their initial guidance levels for a total of $1.6 billion more and an average increase of 36 percent.

Overall, the amount awarded in the first half of 2022 is 23 percent higher than initial guidance.

The report noted that 23 CAT bonds were priced above the midpoint of initial price guidance, while 13 were priced above the upper limit of initial guidance.

“Pricing in the first half of 2022 contrasts with pricing results in the first half of 2021, where none of the 29 CAT bonds issued during that period were priced above the upper limit of the initial price guidance, while 20 of the 29 were below the lower limit,” the report said.

It added: “More cat bond tranches were not placed in the first half of 2022 than in previous years – in some cases, entire deals were not placed. Fifteen tranches of eight transactions were sold to investors but were pulled in the first half. The target amount for these parts has come in at over $500mn.

AM Best commented that the reasons for pulling a cat bond vary but the inability to place some cat bonds “seems to be connected to a broader theme of market hardening.” The rating agency indicated that most sponsors never had enough to sell a cat bond because they perceived the price and conditions would not be favorable.

Cat bond CAGR sustained in H1

Meanwhile, Swiss Re Capital Markets (SRCM) noted that the ILS market offered sponsors an alternative source of risk transfer capacity in a tightening reinsurance market.

“Some reinsurers have reduced capacity in peak sectors or closed their natural catastrophe portfolios altogether, leading to greater opportunities in the ILS market,” the report said. “Given the need for more overall reinsurance capacity, we expect the trend of increased new issuance volume to continue and lead to further growth.”

The SRCM cat bond market is on track to maintain its compound annual growth rate of 8.96 percent since 2012. At mid-2022 there was only $36.2bn of notional outstanding.

ILS market released vs best hypothetical

Net cash flow (new issuance minus maturities) into the market from early 2021 to the first half of 2022 was about $4.9bn, SRCM said, which helps explain the spread seen this year.

Net cash flow is affected by loss payments to sponsors. Payments in H1 2022 from loss events in previous years reached around $230mn, while loss payments in the past four and a half years reached $2.0bn.

In 2022 the CAT bond market paid out recoveries for prior year events including Hurricane Ida, Hurricane Florence and Hurricane Michael.

Despite the decline in CAT bond issuance in the first half, a handful of new sponsors emerged, with $805mn of debut CAT bonds issued during the period. New sponsors are Inigo Insurance, Kin, SureChoice Underwriters Reciprocal Exchange, Core Specialty, Peak Re and The Hanover.

Different strategies of ILS managers

AM Best said in its report that as investors evaluate their options, the financial landscape is in flux.

“Asset catastrophe ILS is often touted for its diversification benefits, but investors are willing to forgo benefits if expected returns on another asset are higher to compensate for the lack of diversification,” the report said. “For this reason, there is a 6 percent to 7 percent floor for cat bond spreads, regardless of the level of expected loss, the quality of the sponsor, the type of coverage, or other aspects of the transaction.”

AM Best commented that ILS managers are using different strategies to improve results – “some are emphasizing price increases, while others are focused on optimizing contract structures and terms and conditions”.

ILS managers believe that results can be improved by moving toward intensity-based rather than frequency-based contracts. This is leading them to word contracts to focus only on named risks and to write counter-occurrence contracts rather than blanket contracts.

“For aggregate deals, ILS managers are more inclined to include per-event caps that allow any one loss to contribute to erosion of the overall deductible. In some cases, per-event caps are set so that the aggregate attachment is not breached until three to four events occur,” the report said.

AM Best believes that investor skepticism about the catastrophe risk model may prevent them from allocating additional capital even when prices rise to attractive levels.

In the first half, the cat saw losses from floods in Australia, storms in Europe, earthquakes in Japan and convective storms in the US, the rating agency noted. But ILS managers believe the underwriting tightening measures taken over the past year should mitigate the impact of these events on ILS investments.

ILS investors are more optimistic about avoiding losses from Winter Storm Uri in 2021, which is estimated to cost the industry $15bn.

More than 130 insurers are jointly suing the Electric Reliability Council of Texas and dozens of power-generating entities over the grid failure, raising confidence that a successful lawsuit or settlement could significantly reduce insurer losses.

“Some market participants believe that, if significant subrogation recoveries result from this litigation, the overall contracts will ultimately not attach to the coverage layers,” AM Best said.

ILS gives slight negativity in H1

SRCM’s report highlighted that broader financial markets navigated volatility in the first half as a result of rising inflation, the Russia-Ukraine war and interest rate fluctuations.

“Despite these factors, ILS markets performed relatively well in the first half of 2022, with year-to-date returns slightly negative year-on-year and the third most active H1 for new issuance on record,” it said.

The Swiss Re Global Cat Bond Total Return Index showed an investor return of -0.35 percent year-to-date, with negative gains from spreads as a result of a tightening reinsurance market.

SRCM said this indicated an improved outlook for returns in the coming years. “Barring any major natural disasters that cause major losses, we expect performance to recover strongly in the second half of the year,” the report said.

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