Paul Schultz of Aon Benfield Securities outlines the state of play of the ILS market and finds that 2013 looks on track to be a record year.
The year ending June 30, 2013, was a dynamic period for the insurance-linked securities (ILS) market. Large investor infl ows, from both new and existing participants, drove declining spreads, which in turn sparked increasing sponsor interest.
As of June 30, annual issuance volume reached $6.7 billion (see Figure 1) and total bonds on risk were at an all-time high of $17.5 billion, an increase of $2.6 billion from the previous year and surpassing the previous record of $16.2 billion at June 30, 2008.
The new record level of catastrophe bonds highlights the recent expansion of the ILS market. An increasing number of bonds will mature over the next two years due to the increase in issuance following the global fi nancial crisis. Aon Benfi eld Securities forecasts that the market expansion will continue, as new issuance volumes are expected to outweigh maturities in the coming years.
Twenty-seven transactions (including three deals covering life and health risks) closed during the 12-month period ending June 30, 2013. The average transaction size increased to $247 million for this period, compared to $211 million for the 12-month period ending June 30, 2012.
US hurricane risk continued to be the main peril ceded to the ILS market, and comprised around two-thirds of notional limit issued over the 12 months. The contribution to expected modelled loss from US hurricane risk for new property catastrophe issuances increased from 51 percent for the year ending June 30, 2012 to 56 percent for the same period in 2013. By comparison, the contribution from Europe windstorms decreased from 17 percent to 6 percent in the same timeframe. The contribution to expected modelled loss from US earthquakes increased slightly from 20 percent to 23 percent. Meanwhile, life and health issuance activity contributed $545 million of issuance across three transactions.
The first half of 2013 produced a total of $4 billion in new issuance, an increase of $400 million over the first half of 2012, and the highest first half issuance level since 2007.
Key market drivers
Supply and demand
In the 18 months ending June 30, 2013, there were large capital inflows across the ILS sector from both existing and new investors. Since January 2012, an estimated $5 to $6 billion in new capital has entered the market, with around $3 billion flowing into the market in the last six months. This additional capital has created strong demand from investors for new issuance. In 2013, sponsors began to benefit from this demand, with transactions often closing at spreads below the rates expected in the traditional reinsurance markets.
Spreads were down between 30 and 45 percent in the first half of 2013, compared to the fourth quarter of 2012. This spurred a very active period of issuance for the first half of 2013, which continued well into the third quarter. Investors kept pace with primary activity, even during periods where many transactions were on offer simultaneously.
Indemnity issuances continued to be an important component of the catastrophe bond market, comprising 13 of the 27 issuances that closed in the year ending June 30, 2013. A number of sponsors securing US hurricane coverage also locked in capacity for longer than the typical three years. These included Nationwide Mutual Insurance Company, Allstate Insurance Company, Louisiana Citizens Property Insurance Company and Amlin AG, which all secured coverage for four years.
American International Group (AIG) successfully moved to an indemnity trigger, following several industry index transactions. The ground-breaking indemnity transaction, which includes commercial property and energy risks, provides AIG with coverage for five years.
Benign loss activity
There was no loss activity that resulted in catastrophe bond payouts for the year ending June 30, 2013. Superstorm Sandy, which made landfall in the US on October 29, 2012, gained significant attention due to the amount of Northeast exposure in the ILS market. As losses were reported over the following months, and as Property Claim Services’ (PCS) estimate of the total industry insured property losses stabilised, it became clear that Sandy was unlikely to have an impact on the catastrophe bond market.
The Aon Benfield ILS Indices
The Aon Benfield ILS Indices are calculated by Thomson Reuters using month-end price data provided by Aon Benfield Securities.
On an annual basis, through June 30, 2013, all Aon Benfield ILS Indices posted gains. The Aon Benfield All Bond and BB-rated Bond Indices posted returns of 12.14 percent and 8.16 percent, respectively. The US Hurricane and US Earthquake Bond Indices returned 13.19 percent and 6.89 percent, respectively. Each bond index benefi ted from strong mark-to-market gains, especially throughout the first half of 2013 as investor demand drove spreads to historically low levels. On an annual basis, each Aon Benfield ILS Index outperformed comparable fixed income benchmarks; they did not, however, outperform the S&P 500 index.
"Investors kept pace with primary activity, even during periods where many transactions were on offer simultaneously."
The 10-year average annual return of the Aon Benfield All Bond Index was again superior to other benchmark returns. This demonstrates the value of a diversifi ed book of pure insurance risks for long-term investors, who continue to value the asset class as a true alternative. For the annual period to June 30, 2013 the market continued to expand as institutional investors allocated additional capital to ILS products.
As of August 23, new catastrophe bond issuance for the third quarter of 2013 had already reached $1.1 billion. This represents—and may ultimately exceed—the highest level of issuance during a third quarter since 2007, whic h included State Farm Fire and Casualty Company’s $1.2 billion Merna Reinsurance Ltd, the largest ever single catastrophe bond issuance.
Despite declines in ILS spreads, we continue to see new capital flowing into the market on a direct and indirect basis. Aon Benfield Securities believes that these investors are long term in nature and will tend to stay invested even if interest rates improve in traditional investments. Spread levels achieved in the fi rst half of 2013 are expected to continue for the remainder of the year and into 2014.
The willingness of ILS investors to broaden the risks available for securitisation has already brought new interest from sponsors in ILS market initiatives. We expect the market will continue to broaden the scope of coverage beyond vanilla natural catastrophe risks, and fi nd innovative ways to utilise fresh capital sources.
Repeat and, increasingly, new sponsors are accessing the ILS market to leverage favourable market conditions. There is strong demand for catastrophe bonds for the remainder of the 2013 calendar year, with investors seeking to deploy capital. Conditions remain positive for the catastrophe bond market, with 2013 issuance on track to reach $7 to $8 billion in total.
Paul Schultz is CEO of Aon Benfield Securities. He can be contacted at: email@example.com
Paul Schultz of Aon Benfi eld Securities outlines the state of play of the ILS market and finds that 2013 looks on track to be a record year.