Posted on 01 Aug 2013 by Neilson
The drop in catastrophe bond pricing has put pressure on traditional property catastrophe reinsurers, which are responding by increasing their participation with third-party capital and insurance-linked securities.
"Providers of catastrophe reinsurance are finding themselves challenged by a renewed availability and interest in cat bonds as well as other alternatives to traditional reinsurance protection," said Timothy Faries, Bermuda-based head of the international law firm Appleby.
He said his office, which advises companies on insurance-linked securities and alternative capital, such as collateralized reinsurance and industry loss warranties, has seen an uptick in inquiries from Bermuda property catastrophe reinsurers. "Everyone is thinking about ILS and that trend shows no sign of abating," he said. "The traditional insurers are looking to get into this space. If you can't beat them, join them."
Catastrophe bond pricing, which has historically been significantly more expensive than traditional reinsurance, has fallen by about 35% since last year, putting cat bonds on par with - or in some cases even cheaper than - traditional reinsurance, Swiss Re, a market leader in the ILS market said earlier this month.
Lower cat bond pricing, in addition to a surge in other types of collateralized reinsurance (such as industry loss warranties, side cars and entities that specialize in collateralized reinsurance), is putting pressure on the pricing in the traditional market, Faries said.
For instance, in posting its second-quarter earnings last week, Ace Ltd. said its global reinsurance business was down by about 5%.
"As you know, the reinsurance market is quite competitive, with an abundance of capacity, particularly in cat. And cat pricing is down about 5% internationally and 10% to 15% in the U.S. We expect these trends to continue for the foreseeable future," Evan G. Greenberg, chairman and chief executive officer, said. In addition to the traditional players, alternate capital is coming in from capital markets while exposures are not growing much. "So you got that pond with more drinking out of it," he said.
The majority of cat bond risks are U.S. wind, and a good portion of that is Florida risk.
Florida's Citizens Property Insurance Corp. tapped the capital market for a $750 million cat bond in 2012, and followed in 2013 with an additional $250 million cat bond, giving Florida's homeowners insurer of last resort $1 billion in collateralized coverage. In addition to obtaining 73% of its reinsurance program through collateralized cover this year, the company found it was able to secure lower pricing in the market for the remaining traditional reinsurance it purchased.
Smaller cat bonds are also surging. Towers Watson Capital Markets said it just closed on a $60 million cat bond for New Jersey Manufacturers Insurance Group, the company's first foray into the cat bond market.
"The ILS market continues to transform traditional reinsurance while becoming more accessible to smaller players," said Michael Popkin, Towers Watson Capital Markets' co-head of ILS. "This is creating a market trend we expect to continue, where new cedants are eager to develop instruments that investors want to participate in."
William Dubinsky, managing director and head of ILS for Willis Capital Markets & Advisory, said, "you can't really compare the pricing of cat bonds with traditional reinsurance due to the different features."
For instance, traditional reinsurance contracts are usually for a single year, while cat bonds can extend multiple years, which allows cedants to lock in prices and terms. Cat bonds can have either an index or indemnity trigger, and offer collaterialized protection. In a worst-case scenario, like a repeat of the 1906 San Francisco earthquake, it's likely some reinsurers would become partially or wholly insolvent, Dubinsky said. A cat bond, or other form of collateralized reinsurance, would offer guaranteed payment.
Despite their differences, traditional reinsurers are looking at different ways they can participate in third party capital and ILS alternative solutions, Dubinsky said. "There's a lot of different ways they can get involved. They can manage money for investors, buy protection themselves with cat bonds, set up side cars, and they can think of strategic relationships such as investing in or entering joint ventures with ILS funds," he said.
A number of companies have set up dedicated capital markets desks. In April, Aspen Re established a new division, Aspen Capital Markets, to expand its participation in the alternative reinsurance market.
In May, Sirius International Group Ltd., the Bermuda-based reinsurance unit of White Mountains Insurance Group Ltd., formed a dedicated team to lead its strategic initiative in the insurance-linked securities/reinsurance capital markets convergence arena.
In June, Axis Capital Holdings Ltd. hired Ben Rubin, the former head of Bank of America Merrill Lynch's investment banking unit, to fill a newly created capital markets position.
Some of these new initiatives are revivals of defunct desks, Faries said. "About 10 years ago, companies were building up capital market desks, but then with the financial crisis, everyone went back to core ideas and products. A lot of those desks were allowed to die, and the business was transferred out. Now we are seeing a proliferation of capital markets desks," he said.
Traditional reinsurers are evolving, Faries said. "It's not that you'll see the shine diminish on what they bring to the market, but it's forcing them to retool and evolve their own product offerings and structures."
The second quarter of 2013 saw $2.2 billion of non-life catastrophe bonds issued through 14 tranches (representing 10 deals), compared with $2.1 billion issued in the second quarter of 2012 through 12 tranches (representing seven deals), according to Willis. This follows a strong first quarter in which the market saw $1.6 billion of issuance, and brings total non-life capacity issued for the year so far to $3.8 billion, said Willis in its latest "Insurance Linked Securities" report.
"We could easily go over $7 billion this year," Dubinsky said. "We're at nearly historic levels. We see a lot of activity around developing new perils that are outside of natural catastrophe risk."
2012 was marked as a banner year for cat bonds, as more catastrophe bonds were issued in 2012 than any other year except for 2007, a sign the 16-year-old marketplace is maturing (Best's News Service, Feb. 13, 2013). Cat bonds for property/casualty-related risks issued in 2012 totalled $5.9 billion, up from $4.3 billion the year before, and the second-highest ever behind the $7.4 billion issued in 2007, A.M. Best said.