Press Review – Flooding the market (Interview with David Strasser on SCI – Structured Credit Investor)
New challenges driving cat bonds forward
Dear Ladies and Gentlemen
Disappointing financial markets and the search for yield mean that catastrophe bonds are an increasingly appealing source of investment. As new perils and jurisdictions continue to be tapped, the ILS market is expected to remain on the upswing as it rolls into 2015.
Catastrophe bonds are expected to keep hitting the market up until year-end. Issuance volumes continue to rise, in line with general trends over the last eleven months.
„As of 1 December, there was about US$23.5bn outstanding cat bonds, with possibly another US$500m by the end of the year,“ says David Strasser, senior ILS portfolio manager at Plenum Investments. „The estimated US$24bn of outstanding cat bonds by year-end would be a new record.“ The volume of cat bonds outstanding at end-2013 was just over US$20bn. The busy end to the year has, in turn, paved the way for investors to rebalance their portfolios. „Capital market investors have constraints on how much they can write in every peril region. For example, with hurricane in the US, typical cat bond funds tend to write between 40% to 50% of their total assets. Therefore, during busy primary market issuances – as is the case now – investors tend to rebalance their portfolios, trying to sell short-dated cat bonds in order to accommodate the new issuances,“ Strasser explains.
According to Strasser, one of the drivers behind the record-breaking surge in the market is the fact that capital market investors have become more sophisticated. „Therefore, it allows insurance companies to cede more complex risks to the capital market – hence making the capital market more appealing to insurance companies and other entities seeking to transfer risks. This, in turn, allows the capital market to see an increasing diversity of risks, which is very much needed as the market is heavily weighted towards US hurricane risk, with about 65% of outstanding cat bonds covering this peril region.“
Among the new risks that have recently been brought to the capital market are volcanic and meteoric perils. The cat bonds covering these perils – Residential Re Series 2014-1 and 2014-2 – provide coverage against the risk of tropical cyclones, earthquakes, severe thunderstorms, winter storms, wildfire, volcanic eruption and meteorite impact.
An earlier example of the sector branching into new perils arrived with the New York Metropolitan Transport Agency’s decision last year to purchase US$200m of coverage on storm surge losses (SCI passim). Strasser explains that the decision was influenced by the large costs inflicted from the damage of Hurricane Sandy.
In spite of the unconventional nature of these perils, they retain a commonality in that they were issued in established jurisdictions. Yet, there is a growing expectation that new jurisdictions could also enter the cat bond market soon. As of now, attitudes remain generally cautious while no substantial details have been laid out. However, Strasser says that certain markets are being mooted. „It is only a rumour, but typhoon risk in certain Asian countries is a potential untouched jurisdiction now being mentioned,“ he suggests. This is in light of talk earlier in the year that the Philippines was seriously considering issuing cat bonds. While such jurisdictions edge towards tapping the market, the established jurisdictions continue to thrive. „We have seen a lot of money come into both the cat bond and ILS markets recently,“ says Strasser. „They are both very strong and definitely increasing further. With yield hard to come by and financial markets not performing as well as expected, the contrastingly attractive yields and de-correlation to traditional capital markets that cat bonds are offering means that you can see why these markets are becoming a more attractive alternative to traditional asset classes.“
Whether this will continue into 2015 is contingent on the performance of the financial markets, as well as the possible occurrence of severe natural catastrophes going forward, explains Strasser. „If the financial markets get better, there are chances that some of the money will be pulled out of the ILS and cat bond markets. However, if they continue to disappoint, then we can reasonably expect money to keep flowing into ILS and cat bonds.“
The secondary cat bond market has also seen healthy activity recently, with a notable surge in trading in October. Strasser says that further activity here in the near future will rest on the performance of the primary market.
„Trading depends on how firm a market is. When nothing is brought forward in the primary markets, the secondary markets will tend to stay quiet and vice versa. This will be the driving factor,“ he concludes.
With best regards
Plenum Investments Ltd.