The continued influx of third party capital from new and existing market participants also favorably impacted insurance-linked securities (ILS) pricing for protection buyers. The continued low interest rate environment encouraged institutional investors (such as pension funds and hedge funds) to seek the higher yields offered by natural cat risk notes. As a result, sponsors took advantage of the opportunity to lock in attractive rate on line and essentially, hedge rate volatility.
Throughout the first quarter of 2014 final pricing of cat bonds was, on average, 10 percent lower from the midpoint of initial indicative spread pricing guidance, the likely result of sponsors’ conservative pricing in the first half of the year. As declining rates persisted, the differential of cat bond spreads from initial price guidance to final pricing narrowed, reflecting sponsors’ increasing aggressiveness toward pricing expectations. In the fourth quarter, the differential of cat bond spreads from initial price guidance to final pricing normalized as many issuances settled at the midpoint of initial expectations.
The soft rate environment, combined with the presence of “accommodating” investors, allowed cedents to place more innovative, flexible and bespoke transactions. By the end of the fourth quarter several key structural features emerged and became more prevalent as the terms and conditions of cat bonds and traditional reinsurance continued to converge.
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