Catastrophe bonds look set to be the winners of the current market dynamics in insurance-linked securities (ILS), with strong demand expected for their protection and as investment assets, but Tanja Wrosch of Credit Suisse Insurance Linked Strategies cautions that issuance must be “on investors’ terms.”
As a result, with return potential at or near historical highs, the cat bond market could deliver positive returns even in a repeat of a hurricane as severe as last year’s Ian, Wrosch believes.
After years of catastrophe losses, then rising inflation, the reinsurance industry lacks capital and participants have increasingly looked to the cat bond as a source of protection.
On the investor-side, cat bond fund strategies have continued to deliver expected levels of return in the main, despite elevated catastrophes since 2017 and last year’s hurricane Ian.
“We are currently observing a strong imbalance between supply and demand for reinsurance capacity,” Wrosch points out.
Going on to say that, “This has been evident over the past year but Hurricane Ian has added significant tension to the market.
“Cat bonds represent an alternative way of bringing catastrophe risks to the capital markets. In our view, they are the winners of the current market dynamics.”
With premiums at or near an all-time high in cat bonds, Wrosch said “a sharp increase in market volume is expected.”
While reinsurance capital is down, perceived volatility is higher and re/insurers are looking to better manage their catastrophe exposures, also opting to lay off more risk or pull-back from property catastrophe zones.
As a result, risk transfer via catastrophe bonds is increasing in importance, Wrosch believes.
“With traditional reinsurance capacity expected to decline and natural catastrophe cover premiums rising, we believe alternative risk transfer via cat bonds will become increasingly important and expect a strong pipeline of new issuance,” she explained.
But added that, importantly, “These can only be placed on the investors’ terms.”
Discussions on pricing are likely to continue and the focus will be on the sustainability of returns, Wrosch said.
Pointing out that, “The need to cover losses associated with Hurricane Ian and the pursuit of sustainable returns on capital for cat bond investors over the long term (taking into account issues such as inflation or climate change) will dominate the pricing discussion.
“In general, it can be said that the entire industry is facing a change, which we believe could offer interesting market opportunities for cat bond investors.”
With cat bond prices already much higher than even a year ago, Wrosch said that going forwards what will matter are how hurricane Ian’s losses develop, the amount of capital inflows into the cat bond space, plus the overall discipline in the market when it comes to deploying capital.
Total returns on cat bonds are expected to reach new highs, buoyed by the rising risk-free rate.
“In our view, this means that even in the event of a repeat hurricane of Ian’s magnitude, positive returns can still be achieved,” Wrosch explained.
While full-year 2022 cat bond market performance was negative by most indices and measures, looking over a trailing twelve months shows that by the time the market gets to a year out from Ian, it is likely to be showing a positive return over that annual period.
Given the now much higher issuance spreads seen in the cat bond market, the forward return-potential looks extremely attractive.
