In an effort to effectively manage risk, re/insurers are continuing the use of capital markets to access catastrophe bonds amid a firm market, driving up the issuance of insurance-linked securities (ILS), a trend that is expected to persist, Fitch has highlighted.
This, according to analysts, also presents a unique opportunity for ILS investors to secure exceptional total returns, diversify their portfolios, and maintain a reduced risk profile.
“Traditional (re)insurers have increasingly utilised the ILS market to backfill unmet property risk needs and diversify counterparty exposure,” Fitch stated.
Adding: “We expect YTD 2024 cat bond issuance of $13 billion (75 issues) to surpass 2023’s record issuance of $16 billion (95 deals). However, with nearly $48 billion outstanding, cat bonds represent less than 10% of the total reinsurance market.”
Similar to the traditional reinsurance market, the costs for (re)insurers to issue bonds have experienced a significant increase.
Notably, underlying risk spreads have hovered within the 6%-8% range in 2024, primarily aimed at eliminating cat-related risks.
Sponsors also face higher administrative, legal and bookrunning expenses not associated with dealing with reinsurers directly. Investor demand, while improving, is not yet meaningful enough to spur price competition and reduce risk spreads, analysts also noted.
Besides the diversification benefits offered by cat bonds, their recent total returns have been highly attractive due to their high coupons, significantly outperforming other fixed-income assets.
Fitch stated: “Investor demand has been rewarded with favourable risk-adjusted returns since 2022 amid the hardening (re)insurance market, typified by increasing premiums, stricter underwriting criteria and reduced capacity for coverage. ILS bonds have also benefited from the rise in yields for money market funds in 2023 and 2024 to the 4.5%-5.0% range after being 0%-0.25% during the pandemic.
“Returns in 2022 were negatively affected by an overreaction to Hurricane Ian where forecasted loss estimates were very conservative. Actual loss payouts beginning in 2023 were lower than the initial estimates, which helped propel returns for the year.”
The outlook for investment losses has improved, Fitch’s report also noted, contributing to increased investor demand. Over the last two years, the average expected loss has dropped to 2.0%-2.25%, down from 2.5% in the three years prior.
Insured losses for 2024 have already exceeded $100 billion, additionally, analysts believe that Helene -which Fitch estimates insured losses of $5 billion-$10 billion – and Milton – with estimated losses $20 billion-$40 billion- will not cause significant principal losses to cat bond investors.
Fitch also warned that these events will incrementally increase losses to those aggregate cat bonds, that are currently principal-at-risk due to hurricane Ian and prior loss events and still in the risk period (not in the extended maturity period).
Fitch concluded: “(Re)insurers and cat bonds have generally increased attachment points; a slight rotation to per occurrence versus aggregate triggers and terms and conditions. Specifically, insured claims are highly dependent on landfall location as evidenced by Milton, which narrowly missed the highly populated Tampa area. Similar to insurance policies, flood losses are typically not covered by the cat bond market.
“However, additional weather-related loss events could occur in 2024, as the hurricane season typically lasts through November. Issuance will pick up in the fourth quarter as sponsors start planning for the Jan. 1, 2025 renewal season.
“Risk spreads will remain attractive as supply and demand continue to favour reinsurers. The 144A cat bond may face some competition from re-energized collateralized reinsurance structures, and the sector is still over-exposed to Florida’s peak perils and secondary losses.”
Readers can access our sister’s publication, Artemis, cat bond market issuance charts here.
