Cat bonds bounce back
Reinsurers and primary carriers are showing increased interest in catastrophe bonds, according to Paul Schultz, chief executive of Aon Securities.
Non-life ILS issuance in the first half of the year was 20% more than for all 2019; what’s the outlook for H2 2020 and beyond?
This year has seen a good rebound year after 2019 despite a number of headwinds, notably COVID-19 and the disruption of the financial markets. Issuance levels were depressed last year due to a number of special circumstances, but this year the momentum has returned, with ILS assets proving to be more resilient than other asset classes. I expect that momentum will carry over into 2021 and thereafter. Essentially, ILS returns have been healthy against other benchmark indices, while the class’s important non-correlation benefits have also checked the box.
Are cat bonds still attractive from an issuer perspective?
One of the founding principles for issuers is that ILS offers a valuable way to diversify within their risk transfer programmes, and the ability to put in longer-dated risk transfer contracts in a period of uncertainty is also proving attractive.
Reinsurers have been more active in using cat bonds to replace UNL retro strategy, and that will continue, while primary companies will continue to structure their programmes in a diversifying risk transfer strategy that has multiyear features, as opposed to annual renewable reinsurance contracts.
What might change in the context of a hardening market and spread levels?
We have seen a widening of spreads that’s reflective of market conditions. There have been questions over the past couple of years over whether investors are getting adequate returns for the risk they’re taking. That was partly to do with heightened loss activity, and it’s less of a consideration now that the market is hardening.
The questions we’re being asked now are more likely to be about the potential impact of climate change and whether returns are appropriate given the risk of climate change. But assuming we don’t have any very large cat events before year-end, we would expect a strong performance in 2020 that will drive more capital into the market in 2021. It will be intelligent capital and won’t be a flood of opportunistic capital, allowing market conditions to continue to improve.
Is trapped capital still an issue for some?
Trapped capital will continue to affect some products in the ILS spectrum more than others. Cat bonds won’t be affected at all, compared with UNL retro products, for example, as losses develop. It means that reinsurers and insurers are more likely to increase cat bond purchasing. In 2020, we’re seeing investors refocus on the more liquid cat bond market and less on the illiquid products such as sidecars and UNL retro business.
But there will also be innovations around trapped capital risk, to give cedants the protection they require and the return profiles investors need. It will entail creating liquidity around an illiquid position to reduce the trapped capital risk, while maintaining the necessary coverage.
What impact is the continuing COVID-19 pandemic having on sentiment in the ILS market?
Questions have been asked by investors because of the business interruption issues around primary coverage and any possible judicial moves, but it isn’t having a significant impact. Some of the contract wording around coverage will be tightened up to ensure that all the risk included was intended to be included. People are watching to see how the coverage situation will pan out, but there hasn’t been any panic.
How will the life ILS market be affected by events?
Everyone expects there to be some loss on the life side from the pandemic. The World Bank programme has recorded a loss, as expected, and some losses will also flow through the life ILS mortality segment. But the pandemic market will continue to attract capital from investors, and the lessons from COVID-19 will be factored-in to the way that triggers and coverage are structured in the future.
Economies will move through the current crisis and then people will start to think about how to prepare for the next event, which will lead to a pick-up in demand for coverage that addresses the different types of disruption we have seen this year. Having a more robust way of responding to the fall-out from pandemic is going to be high on the list of priorities for policymakers, and that will create more demand for ILS to play a role.
