Cory Anger, Global Head of ILS Origination and Structuring, GC Securities*
A tale of two insurance-linked securities (ILS) quarters is the theme of the first half of 2016 and highlights the divergence of the ILS market this year.
In the first quarter GC Securities, a division of MMC Securities LLC, witnessed the most active Q1 144A property/casualty (P&C) catastrophe bond market in history with USD 1.87 billion of new issuance through seven transactions.
However, the second quarter saw 144A P&C new issuance slow dramatically to the lowest issuance for the period within the past five years, and the second-lowest issuance for Q2 within the past 11 years.
It is also notable that second quarter 144A P&C new issuance (based on aggregate notional) comprised the lowest percentage (29.96 percent) of first-half calendar year 144A new issuance activity since the inception of the ILS marketplace.
The decline in second quarter issuance, coupled with USD 2.76 billion of 144A P&C catastrophe bond maturities and redemptions, has resulted in a decline in aggregate outstanding 144A P&C catastrophe bond issuance to USD 21.07 billion (as of June 30, 2016).
Reviewing additional activity in the ILS space, the private catastrophe bond market continues to grow, although recent growth includes private cat bond issuances that were previously completed in collateralized reinsurance format and/or were from issuers that previously used only the 144A format.
Strong investor interest in new transactions was demonstrated over the first two quarters of 2016 but became more pronounced in the second quarter, with investor demand continuing to increase. Investor capacity was plentiful as nearly all transactions either upsized relative to their initial announced targets or easily could have upsized given market demand.
Pricing was perhaps a more interesting story, as the investor base was reluctant at the beginning of 2016 to continue to push risk spreads downward in line with the general pricing trend dynamic since December 2014.
However, in the second quarter the investor base showed new willingness for further reductions in risk spreads, as demonstrated by Q2 new issuance pricing and secondary pricing of outstanding 144A catastrophe bonds.
Both sponsors and investors are embracing structural and process improvements to enhance the value of catastrophe bond-based protection. Nearly every transaction that has come to market during 2016 thus far has included a structural “first” relative to existing precedents.
Sponsors and investors continue to explore new conduits to the market, including private catastrophe bonds. Risk tranching is more popular than ever before, illustrating sponsor and investor appreciation for structures that can more efficiently fit into different, often more nuanced investment strategies.
Importantly, the discipline of the ILS investor base remains intact as investors continue to evaluate each new structural feature or new perils, triggers or lines of business with a careful eye. Investors are not categorically easing terms and other conditions in exchange for additional issuance.
The ILS marketplace continues to be driven by sophisticated sponsors, investors and intermediaries who are able to strike a balance between the need for efficiency improvements and coverage value, with the goal of providing a stable, long-term source of risk transfer capacity.
Subject to the eventual level of catastrophe losses in 2016, we expect all aspects of alternative capital (pricing, capacity and other terms and conditions) to remain cedent-friendly for the remainder of 2016 and into 2017.
Given the oversupply of available capacity in all forms, the alternative capital market is already signaling a new round of premium rate reductions (at least 5 to 10 percent) based on secondary pricing of outstanding ILS since May 2016.
We expect one or two new primary issuance transactions in the third quarter of 2016 and moderate new primary issuance in the fourth quarter of 2016.
With current maturity trends of ILS expected to remain quite high through the first half of 2017, it is unclear if new ILS issuance will match the pace of upcoming maturities. Approximately 36 percent of outstanding 144A catastrophe bonds (as of 30 June 2016) will mature by the end of the second quarter of 2017. This is in addition to ordinary freed-up capacity from the collateralized reinsurance, sidecar and private catastrophe bond sectors, where private catastrophe bonds tend to be mostly one-year structures.
While we expect some sponsors to take advantage of the improved terms, we are aware that some are not necessarily intending to renew their existing ILS capacity. Therefore, we anticipate that alternative capital end-investors and their ILS managers will be most concerned with the redeployment of existing capital.
Sponsors who are flexible and able to recognize favorable ILS market opportunities may achieve better-than-market-average pricing and other terms and conditions, which can translate into overall savings.
Responding to improving coverage terms in both the reinsurance and retrocession marketplaces is critical for sponsors to increase usage of alternative capital. Fortunately, investors are willing to embrace the needs of sponsors. One of the ways this is achieved is with improved indemnity and multi-line coverages (beyond property lines), where we expect to see innovation over the next six months.
*Securities or investments, as applicable, are offered in the United States through GC Securities, a division of MMC Securities LLC, a US registered broker-dealer and member FINRA/NFA/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. (MMCSEL), which is authorized and regulated by the Financial Conduct Authority, main office 25 The North Colonnade, Canary Wharf, London E14 5HS. Reinsurance products are placed through qualified affiliates of Guy Carpenter & Company, LLC. MMC Securities LLC, MMC Securities (Europe) Ltd. and Guy Carpenter & Company, LLC are affiliates owned by Marsh & McLennan Companies. 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. **GC Analytics is a registered mark with the U.S. Patent and Trademark Office.