A maturing market

Channels: Markets, Policy

Companies: Endurance Global Weather, Willis, Nephila, AIR Worldwide, Reed Smith

People: Claude Brown, Quentin Perrot, Stephen Young, Brent Poliquin,

The catastrophe bond market saw growth slow in 2015, but demand for other risk transfer mechanisms remains strong, says Peter Cripps

After a record-breaking year in 2014, the catastrophe (cat) bond market has seen a slowdown in growth in the past 12 months.

"It was a steady and unspectacular year, a year of consolidation and conservative growth," summarises Claude Brown, a London-based partner at Reed Smith, which retained the title of Best Law Firm.

The value of new issues was $6.5 billion in the year to 7 December, and was expected to hit $7 billion by the end of the year, according to Willis, which was again voted Best Broker. This compares with a record $8.5 billion in 2014.

However, the figures are distorted by Citizens' $1.5 billion multi-year Everglades Re deal in May 2014, Willis adds. Much of the capacity from that deal remains in place, depressing supply in 2015.

"Without Everglades, catastrophe bond issuance would have been more or less flat," says Quentin Perrot, vice president at Willis Capital Markets & Advisory.

There were some $25 billion of cat bonds outstanding at the time of publication (early December), which was roughly flat on the previous year, as the value of new issues was matched by that of bonds maturing.

Following a long period of relatively small losses, spreads have been 'compressed' in recent years.

"The influx of alternative capital into the reinsurance cat risk space continues to put pressure on pricing," says Stephen Young, chief underwriting officer and global head of catastrophe reinsurance at Endurance Re, which was voted Best Structurer/Arranger, displacing last year's winner GC Securities.

"This trend is an outgrowth of persistent low interest rates, several years of relatively benign cat events and the growing realisation that insurance and reinsurance risk are a legitimate, non-correlated asset class."

"Absent a large event, capital market investor capacity remains healthy," adds Brent Poliquin, senior manager, consulting and client services at AIR Worldwide, which retained the title of Best Advisory/Data Service. "As a result, terms and conditions are loosening, spreads are tightening, and investors accept unmodelled perils or no initial risk modelling at all."

Perrot at Willis argues that spreads bottomed out in mid-2014 and have been stable over the past year.

"Investors have displayed a strong sense of pricing discipline. For instance, they have refused to participate or have significantly reduced their participation in certain cat bonds which have been perceived to be priced too aggressively or to contain structural features overly favourable to the sponsor," he says. "This is a positive sign that the market has reached a greater level of maturity and it demonstrates that investors have a long-term commitment to the sector."

The market continued to break new ground in 2015. For example, the Azzurro Re I cat bond for UnipolSai was the industry's first catastrophe bond to cover Italian earthquake and ensuing perils as primary risk.

China Re became the first Chinese reinsurer to sponsor a cat bond when it tapped the market for $50 million for earthquake protection.

However, Brown at Reed Smith notes there has not been as much innovation as in previous years, perhaps because the industry's "bandwidth" has been taken up with digesting Solvency II requirements.

The slowdown in growth of cat bonds is not necessarily a reflection of a slowdown in the overall cat risk space, say market participants – an increasing number of cat risk transactions have been taking place outside of the cat bond market.

One example was the launch in April of the independent firm ABR Reinsurance, which deals with some of the reinsurance risks of insurance firm ACE and is managed by BlackRock, says Willis's  Perrot. It raised $800 million through a private placement.

He adds that sidecars, collateralised reinsurance and private placements are also being used.

Barney Schauble, a managing partner at Nephila, which was again voted Best Trading Company/ Investor, agrees.

"Bond issuance is not a great proxy for the health of the sector – it's not a bellwether," he argues.

He points out that the total outstanding market for cat bonds is less than half of the annual amount of capital transferred outside the traditional reinsurance market, which is closer to $60 billion or $70 billion a year for the non-life sectors. "People now look at a broader range of alternatives than they did in the past. We think that's a good sign of a healthy marketplace."

For all the results from Environmental Finance's Annual Market Rankings, see Ready for take-off