Risk Capital Outstanding
Total risk capital outstanding increased during the first quarter of 2013, reaching an all-time high water mark of USD15.0 billion - up from USD14.83 billion at year-end 2012, representing a net increase of 1.13 percent (USD168 million). This is the eighth consecutive quarter of growth in risk capital outstanding. Risk capital outstanding is up more than 17 percent since the end of the first quarter of 2012.
Given the scheduled maturities for the balance of 2013 and our current expectations about the deal pipeline, risk capital outstanding should continue to increase over the balance of 2013. Our level of expected additional issuance (up to an additional USD5.0 billion to USD7.0 billion) should support further growth to USD17.0 billion to USD19.0 billion of risk capital outstanding. Critical factors remain relating to pricing, capacity and terms available in the traditional reinsurance and retrocession markets.
First Quarter Market Dynamics and Outlook for the Balance of 2013
Spreads in the catastrophe market tightened significantly during the first quarter of 2013, due to strong demand from investors for additional deployment opportunities. But, it is unfair to characterize this demand as a “bubble” or assume that institutional money is chasing risks at returns that are necessarily too low. Rather, there is significant demand because the traditional reinsurance market (which has capital constraints for the peak zones typically addressed by the catastrophe bond market) has different (higher) capital costs for peak risks. The institutional money that is offering capacity to Florida wind at 40 percent less than last year’s pricing isn’t pricing Florida risk incorrectly, it just does not have the same capital costs and therefore can, on a sound basis, charge less for peak U.S. wind risk than the traditional reinsurance market on a sustained basis.
This dynamic is the so-called “decoupling” behavior that has been predicted for some time as a possible consequence of seasoned direct institutional capital participation in catastrophe risk markets. Institutional investors are no longer uncomfortable breaking from price levels set by the traditional market, provided the rationale for doing so is intellectually sound. During the first quarter there is no question that the capital markets had a dampening influence on rate conditions at the April 1 renewals and are having a dramatic dampening influence on expected conditions for June and July renewals.
The breadth of the investor base is rapidly expanding as well. In recent years the catastrophe bond investor base has been characterized as rather “top heavy,” with a small number of large dedicated insurance linked securities (ILS) managers supporting a majority of the market. Sustained capital inflows to the space occurred during 2011 and 2012, but the majority of these inflows were garnered by the largest ILS managers with the longest track records, which exacerbated concentration concerns. During the end of 2012 and particularly in 2013 however, GC Securities has observed a broadening of investor interest, which has manifested in two ways. First, smaller and mid-size dedicated ILS mangers are also starting to “score points,” generating new mandates from institutional asset managers (primarily pensions); these inflows are increasing their available line sizes. Secondly, there are a growing number of non-specialized but very sophisticated institutional investors that are participating in the 144A market on a direct basis. These include life insurers, endowments, asset managers, multi-strategy hedge funds and other institutions that are interested in accessing catastrophe risk on a liquid basis and are seeking stable, modest returns that are expected to be non-correlated to the balance of their portfolios rather than opportunistic plays. Importantly, these are institutions of significant size, meaning their participation on deals is meaningful and in some cases larger than the leading dedicated ILS managers, who, it should be noted, continue to sustain or have quick access to significant additional capital inflows too.
Increasing the breadth of an informed sophisticated investor base can only be a good thing for the markets’ long term prospects as it increases available capacity without leaving the market susceptible to reckless capital that will support transactions with ill considered terms, which eventually cause problems themselves or set problematic precedents for others to follow. It is important to note that while capacity is expanding and the market is willing to consider defensible adjustments to terms and conditions, it is not the case that new capital inflows are not prompting a general reduction in market discipline. Capacity is expanding because sophistication and attention to transaction mechanics is increasing, not decreasing.
In general terms, it is safe to say that capacity from alternative markets has never been more competitive and in some cases it is clearly priced below the traditional market. The traditional market is adjusting though, reacting to the low spreads the catastrophe bond market is posting. Cat bond sponsors are reacting too. Notwithstanding 144A cat bond risk capital outstanding at all time high levels, GC Securities expects 2013 to approach if not exceed the record for annual issuance of USD7.0 billion. Whether this actually comes to fruition will be dependent on cat bond market pricing remaining stable in the context of potentially heavy issuance and also non-U.S. peak peril sponsors (including perhaps reinsurers, who have been less active of late) taking advantage of particularly attractive conditions to bring sizeable issues to market during the balance of the year.
* 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.