AM Best: Cat bond and collateralised re may see pent-up demand at year-end
The cat bond and collateralised reinsurance markets could benefit from pent-up demand for reinsurance cover among cedents that did not have room in their budgets at mid-year, AM Best has commented in a new report suggesting cat bonds have lifted a “muted ILS market”.
AM Best noted that hard market conditions have helped the ILS market secure advantageous terms and conditions for both new and renewed programs. This has led to a significant increase in yields for both funds and cat bonds.
First-half issuance of $9.7bn surpassed the full year total for 2022, which AM Best said indicated high demand from cedants. This issuance outpaced maturity volume by $4bn and pushed the size of the cat bond market to $38.6bn.
AM Best said it is likely that 2023 will set a new record, despite the second half typically having lower issuance volume.
“The dearth of capital injections into the reinsurance market and the resulting supply shortfall have meant that many insurers were unable to fill their requested covers from reinsurers except at exorbitant prices during the year,” said Wai Tang, senior director, insurance-linked securities, AM Best.
Tang added: “At year end, the cat bond and collateralised reinsurance markets may be met with pent-up demand for reinsurance cover among cedents that didn’t have room in their budgets to purchase as much reinsurance coverage as they would have liked at the January or July 2023 renewal periods.”
AM Best expects the ILS market will remain hard if heightened cedent demand for capacity is met with overall reinsurance capital levels.
Sting of losses remains
According to AM Best and Guy Carpenter estimates, overall ILS capacity has increased $3bn since the start of the year to $99bn at mid-year.
The rating agency commented that “cat bonds, in particular, remain one of the bright spots in the ILS market”, helping lift the overall capacity in the “muted ILS market”.
“Private funds have been performing well so far, with cumulative returns hitting record highs during mid-year that have not been seen in over a decade,” the report said.
There was $38.6bn of cat bond capacity at the mid-year point, up 12 percent from the $34.4bn at the end of 2022.
The remaining $60.4bn is composed of collateralized reinsurance, sidecars and industry loss warranties.
AM Best commented, however, that the net capacity provided by the ILS market is lower than $99bn because there is an unknown amount of trapped capital due to Hurricane Ian and Ida.
ILS managers expect Ian losses to be much lower than the initial estimates of $50bn to $60bn, meaning some trapped capital will be released and recycled back into the reinsurance market.
In the report, the ratings agency said that the “persistently hard market indicates that ILS investors have not gotten over the sting of severe catastrophe losses averaging over $100bn from 2017 through 2022, during which investors’ returns were paltry, especially when considering the volatility in loss experience”.
AM Best said that the capital inflows into cat bonds and the private collateralised reinsurance market “may follow divergent paths”, with additional capital flowing into cat bonds while some ILS managers believe the lack of meaningful capital inflows into the private collateralised reinsurance market may persist into 2024.
The ratings agency said that cat bond capital inflow will possibly result in the relative softening of the market as evidenced by a slight tightening in spreads in Q2 2023.
ILS managers with more than $2bn in assets under management (AUM) have raised capital this year compared to January, with the increase attributable to cat bond strategies rather than private ILS allocations. However, AM Best said AUM is still down compared with July 2022.
The substantial price increases associated with the hardening of the market are boosting ILS investor returns to new heights. The Swiss Re Global Cat Bond Index posted first-half returns of 10.34 percent, its highest ever, while the Eurekahedge ILS Advisors index returned 6.99 percent.
“Whether higher returns posted by the ILS asset class [will] begin to attract additional capital remains an open question,” said Emmanuel Modu, managing director, ILS, at AM Best. “Industry observers have noted that ILS investors are likely focused on other, more familiar asset classes that offer higher expected returns with greater liquidity and perhaps less volatility.”
AM Best’s report was released the same week that Leadenhall Capital Partners CEO Luca Albertini speaking at The Insurer’s Pre-Monte Carlo Forum also highlighted that investor demand for cat bonds has been “very healthy” while caution remains for collateralised reinsurance placements.
While sidecars, industry loss warranties and collateralised XoL reinsurance placements are locked in, the secondary market for cat bonds provides investors with the additional reassurance of liquidity in the event an early exit is required, Albertini explained.