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Investors undeterred by lower catastrophe bond yields


Yields on catastrophe bonds are falling in line with tumbling traditional reinsurance rates, but investors keep coming back for more.

Institutional investors are still looking to diversify their portfolios with insurance-linked securities despite the lower returns, and the lack of opportunity to make large returns from other investments means that cat bonds often are oversubscribed when they come to market.

“As more money comes in, interest rates — or the rates on the risk — naturally begin to go lower,” said Bill Dubinsky, head of ILS at Willis Capital Markets & Advisory in New York.

Increased interest in the relatively new asset class is driving down yields, said Romulo Braga, New York-based CEO of BMS Capital Advisory, a unit of BMS Intermediaries Inc.

“Institutional investors, such as pension funds, continue to seek higher yielding assets including insurance-linked securities,'' he said in an email. “This migration toward higher yielding assets combined with the continued influx of new capital to the reinsurance sector has driven multiples on catastrophe bonds to historic lows.''

The market mirrors declining rates in the overall reinsurance sector, experts say.

“The decline is not only limited to catastrophe bonds,” said Todor Todorov, a New York-based investment consultant at Towers Watson & Co. Reinsurance premiums, “particularly property catastrophe risk, have come down quite a bit over the last year.”

“It's not just catastrophe bonds, but reinsurance in general. Rates have come down significantly in most cases,” said Gary Martucci, a director at Standard & Poor's Corp. in New York.

Insurance-linked securities also are following trends in the corporate bond market.

The decline “is not unique to the insurance-linked securities market,” said Ed Hardy, Basking Ridge, New Jersey-based partner at Deloitte Consulting and managing partner of the firm's financial accounting, valuation and securitization practice. “Corporate bond yields have also come down.”

Some, however, attribute the decline in the traditional reinsurance market at least in part to the influence of third-party capital entering the sector.

“It was capital markets pricing that led the market down in 2013 and 2014,” said Cory Anger, New York-based global head of ILS structuring at GC Securities. “It should be recognized that the marketplace has faced a fairly historic shift in pricing over the last two to three years.”

One example, Mr. Martucci said, is the Everglades Re bond from Citizens Property Insurance Corp. to cover its hurricane risks in Florida, which priced at 17.75% in 2012 but at 7.5% when it renewed in 2014, when it sold a record $1.5 billion after being upsized from an initial offering of $400 million.

Another example is Chubb Corp.'s $250 million East Lane bond for Northeast hurricane, earthquake, thunderstorm and winter storm risks that was priced at 6.65% in 2011. When it renewed in 2015, also including wildfire, volcanic eruption and meteorite impact, it was priced at 3.75%.

With returns falling so far, some say the market may have reached the floor, at least temporarily.

“In the last three to six months, yields have flattened and haven't really fallen much further, and we think that's where things will be in the near to intermediate term,” Mr. Dubinsky said. “We've now moved from an environment where returns are declining to where they're more flat.”

Mr. Martucci said that two deals, Kizuna Re and Merna Re, were priced at 2%, with Kizuna Re rated BBB- as the first bond assigned an investment grade rating since 2008 and Merna Re was not rated.

Still, 2% is higher than the current 1.9% interest on a 10-year Treasury note, and the risk is uncorrelated with financial market risks, sources said.

“It seems to me that (2% interest on a cat bond) might be the floor that people are willing to take. I'd be surprised to see them below 2%. There is risk associated with catastrophe bonds” Mr. Martucci said.

Ms. Anger, however, sees more potential to reduce rates.

“There will always be a minimum amount of compensation that risk takers need to earn for risk, and for the time being pricing is stable relative to the second half of 2014,” Ms. Anger said. “But, again, as capital continues to expand and sources lower (the) cost (of) funding, certainly we think there's further room for rate reduction while risk takers are still getting adequately compensated for the risk.”

Sources do agree, however, that even with yields contracted to the point they are, investors will not shy away from the space that generated record 2014 issuance in excess of $8 billion.

“Insurance-linked securities are growing as an acceptable component of an investable universe for many investors,” Mr. Hardy said.

“We would argue that this new asset class still has a strategic role to play in our clients' portfolios,” Mr. Todorov said, adding, however, that “we would definitely recognize that its relative attractiveness is nowhere near where it was back in 2009 when we started talking to our clients about it.”

“These deals are oversubscribed, usually two to three times, so investors are clearly interested in it,” Mr. Martucci said. “You can get 4% return for a four- to five-year investment, which is more in line with an investment grade spread, but these bonds do provide diversification from other fixed-income assets.”

“Despite the influx of capital to the sector and falling yields and multiples, the yields remain higher than many other fixed-income instruments and offer exposure to a different set of risks (i.e. natural catastrophe risk) with low correlation to general market risks, so many investors still find it attractive,” Mr. Braga said.

“I think investors are still valuing the diversification benefits” of the ILS market, Mr. Dubinsky said.