Cat bond growth seen as long-term trend

By Henry Gale

June 25 - (The Insurer) - While some cyclical market dynamics have contributed to recent growth in catastrophe bond issuance, senior ILS market participants believe cedants' move towards cat bond coverage is here to stay.

"The issuance in each of the past two years exceeded $15 billion and is on track to exceed $20 billion this year," said Shiv Kumar, president of GC Securities. More than $20 billion of cat bond issuance would be a record for the market.

"I would say that this is part cyclical in that investors have been generating very strong returns," said Aon Securities CEO Richard Pennay. "From a cat bond loss perspective, we've had really quite a benign three-year period since the end of 2022. And that's meant that investors have performed very, very well with double-digit returns."

This strong performance in recent years is one reason why the cat bond market has been attracting capital inflows.

"There’s a constant flux of the relative supply of capital between the reinsurance and ILS industries, and it happens that in the most recent months, there’s been a reasonable flow of capital into the ILS market," said Mark Gibson, senior investment director at Schroders Capital.

This increased supply of capital has resulted in favourable pricing for cedants, encouraging them to transfer more of their risks through cat bonds.

To some extent, these factors are shaped by changeable market conditions. The well-above-average returns for investors of 2023 and 2024 were driven by a high-spread environment and low cat bond losses, which will not be repeated forever. Reinsurance pricing cycles will also affect the relative affordability of cat bond coverage for cedants.

"That being said, when you look at the extent of the growth, it is part structural, the movement here, because we're just seeing clients really taking a long-term view of this market and wanting to better integrate and more holistically integrate bonds into their overall reinsurance and retrocession programs," said Pennay.

Kumar added: "The evidence points towards the growth in the market being a long-term trend." He attributed most of its recent growth to cedants' need for "additional limit to hedge against increased cat activity, impact of inflation on their insured values, and rating agency capital requirements as model estimates of risk are revised upwards".

Gibson also pointed to cedants' longer-term needs for increased coverage as a factor behind the cat bond market's recent growth. "The need for protection globally is never going down, it’s always going up," he said.

Meanwhile, Gibson said he believed recent inflows of capital to the ILS market have been driven more by investors' long-term strategic allocations than short-term factors.

The long-term value proposition of cat bond investments is here to stay, said Twelve Securis' chief investment officer for liquid strategies Etienne Schwartz, as it remains an attractive asset class with low correlation to financial markets.

Schwartz said he did not expect that catastrophe events would change that. "It's actually the opposite. I think a lot of investors are on the sidelines waiting for a larger event to have even more significant premium increases thereafter," he said.

"So like a situation which we had in 2022 with Hurricane Ian. In these kinds of situations, we expect rather inflows than outflows, because if premiums double or triple, then the investor appetite would increase even more significantly."

In an opposite scenario, another benign year for catastrophe events and more capital inflows could put pressure on spreads to narrow further.

"That could be a balancing factor," Schwartz said, suggesting that some investors might exit the market if spreads get too narrow for their appetite.

That would effectively be a self-correction for the market, pushing it back towards a healthy state where cedants find the price of coverage appealing and investors continue to be satisfied with their returns.

"Barring unforeseen developments, we expect the cat bond market to continue to remain healthy," said Kumar.