Hurricanes, earthquakes test mettle of burgeoning alternative capital marketReprints
The catastrophe bond market set a record for new issuance in 2017 with months still left to go, but the insurance and reinsurance markets are facing their first major test in years in the combined form of hurricanes Harvey and Irma.
Catastrophe bond issuance in the 12 months ending June 30 reached a record $11.3 billion, breaking by $1.9 billion the previous record of $9.4 billion set in 2014, Aon Securities Inc. said in its latest annual review of the cat bond market.
The second quarter of 2017 drove the record, with $6.38 billion of limit placed, a new quarterly record and $1.89 billion more than the prior largest quarter, second quarter 2014’s $4.47 billion, according to “Insurance-Linked Securities: Alternative Capital Breaks New Boundaries.”
The record levels show a market growing steadily and building a greater presence.
“Catastrophe bonds are now part of the competition, along with other forms of alternative capital, to traditional reinsurance,” said Gary Martucci, director of financial services ratings with S&P Global Ratings Inc. “It’s an important step in increasing their share of the market.”
“I think it’s important to keep in mind that this was a market traditionally dominated by reinsurers, and the catastrophe bond and alternative capital investor has come in and made huge inroads,” said Mr. Martucci.
Catastrophe bonds give policyholders choice and flexibility, according to one issuer.
“Traditional reinsurance represents about half of our placements and the bond market the other half,” said John Polak, general manager for the Texas Windstorm Insurance Organization in Austin, Texas.
The association’s Alamo Re Ltd. Series 2017-1 Class A secured $400 million of coverage for Texas hurricane and severe thunderstorm and represents a return to market for the insurer.
“We issued the $400 million largely because the first tranche of bonds that we issued in 2014 had expired, so essentially what we did was we reloaded those by reissuing them,” Mr. Polak said.
The association gets several benefits from the bond market, he said.
“We found that it did give us multiyear capability, which was much more available at that time in the catastrophe bond market than it was in the traditional market,” Mr. Polak said. “It gave us a lot more stability, because at any given time we have a three-year program in place, which doesn’t have to be renegotiated at the end of every year.”
Choice for the buyer leads to healthy market competition, he said.
“I think the fact that there is a vibrant insurance-linked securities market basically serves to heighten competition, and keeps down the prices of traditional reinsurance as well,” Mr. Polak said. “It helps on both sides. Not only do catastrophe bonds have to compete with the traditional reinsurance market, the traditional reinsurance market realizes they have to compete with the capital from the catastrophe bond market.”
The bonds also constitute an important part of the market for investors.
“There’s a demand for the bonds themselves as an investment,” said Bill Dubinsky, head of ILS at Willis Towers Watson P.L.C.’s securities division in New York.
“At year-end 2016, there was $75 billion of nonlife alternative capital, and within that $75 billion there is a certain demand for a liquid product, for the bond form. And in the past last year the demand for that type of product has increased.”
The market is expected to keep its momentum and continue growing.
“Our view is that alternative capital is expected to grow and reach $90 billion by the end of this year,” Philipp Kusche, New York-based global head of ILS and capital solutions at TigerRisk Partners L.L.C., said in an email. “Ongoing catastrophe bond market issuance confirms the depth of the market and continued interest from investors in the insurancelinked securities space.”
As the market grows, it appeals to a wider range of investors.
“I think the space continues to grow each year,” said Brad Adderley, a Hamilton, Bermuda-based corporate partner at offshore law firm Appleby. “There are more and more people out there who never did catastrophe bonds doing them,” such as corporate entities and nonprofits such as the World Bank.
“There’s definitely been a couple of corporates out there, whereas before they didn’t do them at all,” Mr. Adderley said, pointing to the New York Metropolitan Transit Authority’s MetroCat bond as one example.
In addition to new players, the market could potentially expand into new perils, observers say.
“I think there is a desire to move into new perils, that’s where I think the growth will come from,” Mr. Martucci said. “If residential and commercial property owners had to purchase some amount of insurance, U.S. quake could be a huge area,” he said, adding that major catastrophe modelers now have U.S. flood models and have models for other parts of the world, including India, the Philippines and China.
“Flood has the most obvious potential for growth due to the fact that you have a lot of flood modeling and a lot of loss experience to augment the modeling,” Mr. Dubinsky said.
“As modeling firms continue to develop and refine tools for new risks such as cyber or flood, we expect more interest and transparency in such risks,” Mr. Kusche said in his email.
Money is not expected to flee the sector despite the potential for losses in recent catastrophes, including hurricanes Irma and Harvey as well as the recent earthquake in Mexico, although they may seek better terms.
“Based on current reports, it is likely that the 8.1 earthquake off Mexico will result in a 100% loss to investors,” Mr. Martucci said. “This, in conjunction with the potential losses from Irma, could cause investors to reconsider the market based on current pricing. While losses are not unexpected, two major events resulting in significant losses so close to each other could make investors think current yields are too low and cannot offset losses given defaults. While we expect most investors to stay in the market, we would think an increase in yields likely.”
Mexico also suffered a 7.1-magnitude quake on Sept. 19 that left hundreds dead and injured and reduced portions of Mexico City to rubble. Early estimates put the upper band for insured losses at about $2 billion.
The first quake likely affected the FONDEN 2017 catastrophe bond, which provides the Mexican government with $360 million of earthquake and named storm disaster insurance protection, with the $150 million Capital-At-Risk Series 113 tranche of Class A notes issued in the FONDEN 2017 cat bond deal exposed to earthquakes striking Mexico, according to media service Artemis, which serves the alternative capital sector.
The second quake, however, at magnitude 7.1, “is likely not high enough on the Richter scale to trouble the cat bond, which is still going through a calculation process right now, despite the fact this earthquake looks to have been much more severe in terms of damage and impact to lives,” according to Artemis.
If money did leave the space, however, it would likely be replaced by new capital, said Mr. Adderley.
“I think there’s so much capital out there that if some of it left, new people would come into the space, and at the end of the day it would be the same size or bigger,” Mr. Adderley said.
Protection gaps demonstrated by the storms could also lead to the introduction of new products, he added.
Further, if the storms have the effect of raising rates and premiums, “there’s people on the sidelines with fresh capital who have not been hit who will be jumping in for a year or two to take advantage,” Mr. Adderley said.