Catastrophe Bond Update: Second Quarter 2010 – Activity Surges…Reflecting Favorable Issuance Conditions and Strong Investor Demand: Part I
In the second quarter of 2010, eight catastrophe bond transactions were completed, and USD2.05 billion of risk capital was issued (1), making it the second most active second quarter on record. USD1.70 billion of this total (and all but one transaction) included exposure to U.S. wind as sponsors and investors focused on this peril, leading into what is expected to be an active North Atlantic hurricane season.
Notwithstanding the significant amount of new issuance during the second quarter, total risk capital outstanding in the catastrophe bond market at the mid-point of 2010 is down 0.80 percent (USD105 million) relative to the end of the first quarter of 2010 and 5.5 percent (USD693 million) relative to year-end 2009. In addition, the USD1.06 billion Merna Re Ltd. transaction is scheduled to mature in early July. Though not all of this maturing risk capital has flowed back into the hands of active catastrophe bond investors, demand for new issuance remains robust. While current appetite for additional U.S. wind risk is limited, there is significant investor appetite for other peak, non-peak and diversifying perils including U.S. earthquake, European wind and Japanese wind and earthquake perils (as well as other global diversifiers). With respect to U.S. wind peril, it would not be surprising to see sentiment shift back towards a protection buyer’s market, at least for bonds with exposure to more isolated sub-regions within the U.S. Gulf and Atlantic coastline, provided there is a less active than expected first half of the North Atlantic hurricane season.
Catastrophe bond investors continue to increase in number and size of assets under management. During the quarter most investors sustained net inflows or remained flat with respect to assets under management. At least three funds secured new investment mandates or capital allocations to be deployed into the insurance linked securities (ILS) sector. In several instances personnel from existing ILS investors elected to move to new firms, where they expect catastrophe bonds to remain within their investment guidelines (which, in turn should translate into an increase in total ILS capacity). Other existing dedicated ILS investors recently elected to hire additional marketing / fundraising personnel to focus exclusively on raising additional capital.
The outlook for the (typically quiet) third quarter and remainder of 2010 is entirely subject to catastrophe activity and in particular the number and severity of land falling U.S. hurricanes. However, assuming no market moving events, and based on existing pipeline and consideration of scheduled maturities, a full year issuance total of USD4 billion to USD6 billion (implying additional issuance in the second half of 2010 of USD1.7 billion to USD3.7 billion) is a reasonable estimate for the balance of the year.
Second quarter issuance activity technically began on the first day of the quarter with the closing of State Farm’s USD350 million Merna Re II Ltd., a transaction for which marketing was substantially completed in March. True second quarter marketing activity however commenced on April 14th with the announcement of Assurant’s IBIS Re Ltd. 2010-1. Thereafter, the last three weeks of April and the full month of May 2010 was one of the most active periods for new issuance on record in which seven transactions securing USD1.70 billion of risk capital closed. All of these transactions had exposure to U.S. wind.
During each week of this seven week period there were at least two transactions in the market contemporaneously. For three of these weeks there were four transactions in the market and, during the business week beginning Monday, May 10th, there were five transactions in some stage of the marketing or allocation process. This level of deal activity contributed to an inflection point with respect to U.S. wind appetite. Investor demand for U.S. wind risk, which was robust during the fourth quarter of 2009 and the first quarter of 2010, became more circumspect over the course of the second quarter as the mostly homogeneous issuance surge caused some investors to run up against U.S. wind exposure limitations. In addition, some investors, perhaps with an eye on 2010 wind season forecasts, sought to trim U.S. wind exposures by selling (or attempting to sell) U.S. wind exposed positions in the secondary market. Prospective buyers on these trades, sensing an opportunity to put on risk at a discount, (and managing U.S. wind exposures themselves) were only inclined to pick up modest amounts of additional U.S. wind paper, at prices significantly below par. In several cases, investors choosing to pick up discounted secondary paper were thereby unable or uninterested in also providing capacity for new issuances. Additional commentary on this dynamic is provided later in this report.
Issuance Composition: By Peril
Of the USD2.05 billion issued in the second quarter of 2010, USD350 million had exposure solely to New Madrid earthquake and USD1.70 billion had exposure to U.S. hurricane. Of this USD1.70 billion, USD 1.17 billion was exposed to both U.S. hurricane and U.S. earthquake perils, USD505 million was exposed exclusively to U.S. hurricane peril, and USD30 million was exposed to U.S. hurricane and European windstorm perils.
Issuance Composition: By Sponsor
Second quarter issuance activity included Lodestone Re Ltd., a USD425 million transaction benefitting first time sponsor Chartis. The remaining seven transactions (USD1.63 billion) benefitted repeat catastrophe bond sponsors.
Seven of the eight transactions and USD1.97 billion of risk capital ultimately benefits primary insurer sponsors. During the first half of 2010 over 92 percent of all risk capital issued was associated with insurer sponsored transactions, extending a generally increasing proportion observable since the impact of the last reinsurance “capacity crisis” which, prompted by Hurricanes Katrina, Wilma and Rita, occurred prior to (and during the beginning of) the 2006 North Atlantic Hurricane season.
 The risk period of the Massachusetts Property Underwriting Insurance Association’s USD96 million Shore Re Ltd. catastrophe bond, which was marketed during the second quarter of 2010, incepts on July 8, 2010 and therefore is considered a third quarter transaction.
• Cory Anger, Managing Director**
• Chi Hum, Managing Director**
• Hong Guo, Managing Director**
• Ryan Clarke, Vice President**
• Brad Livingston, Analyst**
ILW market commentary provided by
• Barry Law, Managing Director (Guy Carpenter London)
• Larry Rothstein, Vice President (Guy Carpenter London)
*Securities or investments, as applicable, are offered in the United States through GC Securities, a division of MMC Securities Corp., a US registered broker-dealer and member FINRA/SIPC. Main Office: 1166 Avenue of the Americas, New York, NY 10036. Phone: (212) 345-5000. Securities or investments, as applicable, are offered in the European Union by GC Securities, a division of MMC Securities (Europe) Ltd., which is authorized and regulated by the Financial Services Authority. Reinsurance products are placed through qualified affiliates of Guy Carpenter & Company, LLC. MMC Securities Corp., MMC Securities (Europe) Ltd. and Guy Carpenter & Company, LLC are affiliates owned by Marsh & McLennan Companies, Inc. This communication is not intended as an offer to sell or a solicitation of any offer to buy any security, financial instrument, reinsurance or insurance product.
**Registered Representatives of MMC Securities Corp.