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Insurance-linked securities rebound from pandemic disruption


Issuance of insurance-linked securities slowed when the COVID-19 pandemic roiled markets earlier this year, but interest in the nontraditional reinsurance mechanisms has since picked up as investors continue to be attracted to investment vehicles that allow them to diversify their portfolios.

While established ILS products offer investors investment opportunities that are not closely correlated to mainstream financial markets, some more recent ILS structures are not so far removed, expert say.

In addition, they say, volatility in equity and fixed-income markets has in some cases distracted investors from ILS products, which include catastrophe bonds and other securitized products.

The ILS market, from a new issuance point of view, “shut down for a few weeks in March and April,” according to Paul Schultz, Chicago-based CEO of Aon Securities, a unit of Aon PLC. The market, however, saw “good levels in the second quarter despite the COVID-19 interruption.”

“The valuation and trading levels were down a bit but held greater value than other asset classes,” Mr. Schultz said.

The catastrophe bond market took a “slight pause” when COVID-19 spread globally, causing widespread economic disruption in March and April, but has since been “going like gangbusters,” said Jeff Mohrenweiser, senior director at Fitch Ratings Inc. in Chicago.

The $6.6 billion in first-half catastrophe bond new issuance exceeded the $4.7 billion issued for all of 2019, Mr. Mohrenweiser said. For the whole ILS sector, the total outstanding stands at $29.7 billion.

Both fourth quarter 2019 ($2.244 billion) and first quarter 2020 ($3.755 billion) saw record issuance, according to Aon PLC’s mid-year ILS report issued Tuesday.

Second-quarter issuance of $2.748 billion was “dampened by the effects of COVID-19,” the report said.

For the 12 months ended June 30, there was $9 billion of catastrophe bond issuance, an increase of $3.5 billion year over year, according to the report.

“ILS markets have shown resilience, and record issuances in Q4, 2019, and Q1, 2020, in the period ending June 30, 2020,” the report said.

ILS products, which first began to emerge about 25 years ago, are used by insurers and reinsurers as a means to access capital markets for reinsurance and retrocessional reinsurance capacity outside of the traditional reinsurance markets.

One area of recent growth in catastrophe bond issuance has been among mortgage insurers, Mr. Mohrenweiser said, which while technically insurance-linked securities are more correlated with financial markets than other ILS products.

“It breaks with the ILS mandate of being a diversifier from other fixed-income assets because as the U.S economy falters, the risk to mortgage insurance escalates. It is much more correlated to the economy,” he said. 

Investors may have been caught off guard by the closer link.

“As we’ve seen with (mortgage insurance bonds), correlations tend to converge when there are these extreme-type events,” said Brian Schneider, senior director for Fitch Ratings in Chicago. “Investors did not expect strong correlation between the pandemic situation, which is typically thought of as a life insurance type issue.”   

Catastrophe risks such as hurricanes “you would still tend to see as strongly independent of the economic situation,” Mr. Schneider said.

“The noncorrelation you get from hurricanes and earthquakes is not necessarily true in the pandemic scenarios,” said Philipp Kusche, New York-based global head of ILS and Capital Solutions for TigerRisk Partners Inc.

The pandemic has also rattled investors as markets whipsawed, taking attention from the insurance capital markets, Mr. Kusche said.

“Investors are distracted and worried about other markets like fixed-income and equities,” Mr. Kusche said. “They are seeing interesting opportunities in other markets and are less focused on the insurance-linked securities market.”

The stability of the ILS market has in some cases led traders to look for profits elsewhere, according to a recent report by Swiss Re Ltd. 

“A secondary market selloff, largely caused by entities like multi-strategy asset managers seeing opportunities in other markets, sold cat bonds holding stable valuations compared to other assets classes at discounts to par value,” the August report said.

One cat bond that was hit directly by the pandemic was the World Bank’s Pandemic Catastrophe Bond, part of the institution’s Pandemic Emergency Financing Facility. The total amount of risk transferred to the market through the bonds and derivatives is $425 million.  

COVID-19 is one of the viruses covered by the Pandemic Emergency Financing Facility, according to a fact sheet from the World bank.

On April 17, AIR Worldwide, which tracks COVID-19 for the bond, “reported that the virus had met all the necessary activation criteria including outbreak size, spread and growth,” the World Bank said.

On April 27, the steering body of the Pandemic Emergency Financing Facility announced the allocation of $195.84 million to 64 of the world’s poorest countries with reported cases of COVID-19. As of July 27, $146.5 million of the $195.84 million had been transferred to support COVID-19 responses in 48 countries.

The magnitude of the losses to investors in the World Bank Pandemic Bond could affect the pricing of any similar future bonds.

“I would expect appetite from investors will be somewhat limited for pandemic risk,” Mr. Kusche said, adding a pandemic bond would be more correlated with market risk than investing in a hurricane bond.

Despite the market hiccup and others before it, Mr. Schultz sees the market persevering.

“The ILS market has shown a lot of resilience,” he said, including tests like Hurricane Katrina, the financial crises and the losses of 2017. “It shows investors this is a sustainable and resilient market.”