The growth in convergence capital has resulted in ILS catastrophe risk pricing decoupling from price expectations in the traditional reinsurance market, with some ILS products now offering the most competitive terms for reinsurance buyers. Strong appetite for U.S. hurricane catastrophe bonds, for example, has tightened spreads in the secondary market by an average of approximately 45 percent on a weighted notional basis since issuance in 2012. Despite the significant decrease in ILS pricing over the last 12 months, investor demand continues to be robust. Indeed, projections by GC Securities indicate that the catastrophe bond market alone could reach USD23 billion by the end of 2016.
The decrease in traditional reinsurance pricing has been as equally dramatic as reinsurers have responded to this competitive threat. Pricing for property catastrophe business in the United States in particular has fallen considerably.
While the impact of convergence market participants has been less marked in non-U.S. property catastrophe classes, general downward rate movements have been observed for property business in several other regions. Furthermore, there was some evidence during the 2013 renewal season that competition was spilling over into other business segments as traditional reinsurers’ capital was redeployed, convergence participants started to explore other modeled risk classes and a new wave of hedge fund sponsored reinsurers gained traction. Absent significant catastrophe losses in 2013, market expectations are for these trends to continue throughout the year and into the January 1, 2014, renewal.
The influence of products and pricing available from convergence market participants and hedge fund sponsored reinsurers poses important questions for the traditional reinsurance market. Some reinsurers have already responded to the challenge by developing strategies to exploit the demand for the asset class from investors. Indeed, many reinsurers have hired capital markets executives and established operating divisions of their own to attract and manage capital from these investors. This allows reinsurers the opportunity to securitize the most capital-intensive parts of the business while providing valuable cost-efficient capacity to their clients by leveraging their access to business and depth of underwriting, risk management and claims management expertise. More firms are expected to follow this trend.
Figure F-3 shows that the recent wave of reinsurer sponsored ILS asset management products and platforms differs from previous activity and is in direct response to the threat from the convergence market. Previous moves into this market were demand driven in response to capacity needs and market hardening following major catastrophe events such as WTC (2001), Katrina (2005) and the New Zealand/Tohuku earthquakes (2011).