19 January 2015

Winds of change blow through cat risk markets

Growing investor demand for catastrophe exposure is helping the insurance sector change how it manages natural disaster risk, Barney Schauble of Nephila Advisors tells Environmental Finance

Barney SchaubleEF: 2014 has been a pretty quiet year for natural catastrophes – does that mean it's also been a good year for investors in the cat risk asset class?

Yes, it's been quiet; and, if you're just taking catastrophe risk, that's been good news – 2014 had almost no meaningful natural catastrophe loss experience, so returns were positive for investors in the asset class.

That's good and bad. It's good in that the market has once more generated positive performance that isn't correlated with other markets. It's bad in that it makes it harder for investors to determine how much risk managers are taking to generate those returns. Returns are not necessarily related to risk in a linear fashion. There are now many more cat risk alternatives available to investors making it challenging for the market to come up with consistent methodologies to allow investors and managers to make apples-to-apples comparisons between various investment vehicles. We offer our investors tools to evaluate returns relative to a risk benchmark, for that reason.

EF: It's also been a record year for catastrophe bond issuance. What opportunities does it present for an investor like Nephila?

It's good to see growth in cat bond issuance. Cat bonds to the cat risk market are a bit like corporate bonds to credit markets – they are both the easiest parts of the market to access, with the most transparency, and the thinnest spreads.  

It should be remembered, though, that public cat bond issuance is still less than $10 billion/year, while the overall size of the cat risk market – including privately negotiated deals, traditional reinsurance, etc – is somewhere north of $300 billion/year. We're also seeing growth in that broader cat risk market.

EF: Meanwhile, I understand that risk-taking capacity is also growing. Is there a danger that this will see capacity providers underpricing risk to win deals?

For a long time, the cat risk market was only for specialists – just being in the market meant it was relatively straightforward to find attractive transactions across the spectrum.

Now it's a little more complicated, with various forces causing spread levels to compress. For example, there are vehicles seeking to participate in spreads that are uncorrelated with other markets at a wholesale level without any risk selection, and there are also reinsurance companies fighting hard to defend their market share. It's becoming a market like any other – there are good deals and bad deals. Today it is a bit more of a 'risk selector's' market. But that also means that there's more potential value to be created for investors.

EF: What about investor demand for cat risk exposure via funds like yours?

Institutional investor demand continues to increase and they are hungry for assets uncorrelated with broader financial markets. Investors' decision-making takes time, but now that the asset class is broadly accepted – it's almost 20 years since the first catastrophe bond was executed – there are a lot more people interested in it than there were even five years ago.

In terms of our inflows, we have been very judicious about capital – we've deliberately stayed around the same size for the last couple of years, at about $10 billion in total assets. We're not growing for the sake of growing. We have grown in terms of people and capability, but not in assets under management.  Our view is that it's best to time the inflows to match the opportunity.  

EF: How about the weather market – how's that been in 2014?

We've been active in the weather market for over 10 years, and we think that market is seeing more recent growth – partly from renewable energy risk hedging, partly because you've seen more concern in the agriculture and utility sectors about fluctuations in demand and supply caused by weather. And more corporations are being asked about their exposure to weather and climate risk, given both SEC and NAIC risk disclosure rules and the recent volatile weather. We're starting to see increasing interest in weather risk capacity – one area where we've been accepting more capital and growing assets.

EF: What are your expectations for 2015?

There's been a lot of change in this marketplace, particularly in the last few years, in terms of how catastrophe and weather risks are transferred into the capital markets. We started in this space in the mid-1990s. We believed then, and are even more certain now, that is a change in the basic capital structure of the sector, and is a positive for both hedgers and investors. We think we're in the early days of those changes, and we're excited to see where it goes from here.  

For more information about Nephila Advisors please contact Mandi Kristufek, Investor Relations, Nephila Advisors LLC at mkristufek@nephilaadvisors.com or tel +1-615 509 9007.

Nephila Advisors
Barney Schauble
Sponsored by

Phone: +1 415 799 4099
Email: info@nephila.com

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