2015 was an interesting year for cat bonds, from record high issuance in Q1 to a six-year low in Q4. Cory Anger, global head of ILS Structuring; Jordan Brown, analyst; Ryan Clarke, senior vice president and Sung Yim, senior vice president, all of GC Securities, report.
144A property and casualty (P&C) catastrophe bond primary issuance levels were uncharacteristically low in the fourth quarter, with an aggregate notional of $1.425 billion of 144A P&C catastrophe bonds issued, benefiting five sponsors. The 2015 full year primary issuance of 144A P&C catastrophe bonds totalled $5.917 billion from 25 transactions, benefiting 24 sponsors. 144A P&C risk capital outstanding as of December 31, 2015 totalled $22.640 billion, 0.56 percent lower than 2014’s all-time high in the 144A P&C catastrophe bond market (see Chart 1).
Fourth quarter primary issuance
After 2015’s beginning with record historical issuance levels in the first quarter, the fourth quarter of 2015 was dramatically different—only $1.425 billion of 144A P&C catastrophe bonds benefiting five sponsors were completed. This represented the second lowest level since 2005 and the lowest since 2009.
One explanation for this development may be that sponsors who would ordinarily have been willing to issue in the fourth quarter of the calendar year may have had the flexibility to delay their issuance to the following first quarter in order to obtain best execution and/or avoid transaction crowding.
We view sponsors’ willingness to focus on best execution rather than specific renewal dates (while still important for overall capital planning purposes) as a further sign of the maturity of the insurance-linked securities (ILS) space. The ILS space is perceived as performing in a manner similar to the broader capital markets with their availability of capital throughout the calendar year (see Charts 2 and 3).
Despite a limited amount of capital placed in the quarter, one new sponsor (and the second corporate of the year), Amtrak’s captive Passenger Railroad Insurance, and four repeat sponsors (Everest Re, Munich Re, USAA and Zenkyoren) accessed the 144A catastrophe bond market.
The most significant transaction of the fourth quarter was the successful placement of $275 million of Principal At-Risk Variable Rate Notes issued from the newly formed PennUnion Re special purpose reinsurer in order to provide reinsurance protection to corporate sponsor Amtrak’s captive, Passenger Railroad Insurance.
The Series 2015-1 Notes provide per occurrence, parametric-triggered protection from storm surge and wind resulting from named storms as well as earthquakes affecting the Northeast region of the US for a period of approximately 3.17 years. The transaction is triggered based on key intensity measurements of the physical parameters for each respective peril captured at specified measurement locations. Depending upon the peril, the measurements are taken from inland and offshore locations ranging from the Washington, DC to Providence, Rhode Island regions.
Storm surge water height measurements are captured at seven tidal gauge stations in the Long Island Sound, East River, Lower New York Bay and Delaware River. Wind measurements are captured and interpolated for 60 zip codes along Amtrak’s Northeast Corridor railways from Washington, DC to near Providence. Earthquake intensity is interpolated to 21 zip codes within the states of Delaware, New Jersey, New York, Pennsylvania and Rhode Island. The underlying exposure was modelled by RMS and the Series 2015-1 Notes carry a one-year expected loss of 1.97 percent, corresponding to an interest spread of 4.50 percent per annum (which was the low end of an initial price guidance quoted as 4.50 percent to 5 percent).
Private catastrophe bond placements in 2015
In the private market 20 private cat bond transactions were made in 2015, representing $903.94 million of risk capital transferred to capital market investors (see Chart 4).
Pricing dynamics in the fourth quarter of 2015 were mixed, with bonds trading in different directions based on the risk level, peril exposure and relative market size rather than the market shifting categorically in one direction across all names. The typical fourth quarter ‘Dead Cat’ market (in which bonds prior to their scheduled redemption date that have little to no remaining modelled risk exposure remaining are still paying their full scheduled coupon) was active. Notably however, the required return for Dead Cat liquidity providers in the fourth quarter of 2015 averaged 255 basis points per annum, whereas in the fourth quarter of 2014 the required return averaged closer to 220 basis points.
Looking towards 2016, absent a major market disruption, our expectation is that risk spreads in the 144A P&C catastrophe bond and private cat bond marketplace will remain flat to slightly down depending on investors’ perception of available forward supply of investment opportunities relative to the market’s redemption schedule.
We expect the 144A P&C catastrophe bond market issuance to be similar to that of the last several years with further growth in the private cat bond market (relative to 2015) as new sponsors incorporate alternative capital. In addition, particularly in a compressed rate environment where the margin for error is low, investors will likely look to overweight their books toward ‘quality’ risks, all else being equal.
This preference set is relevant for indemnity trigger transactions for which we would expect a widening of the pricing gap between offerings for portfolios deemed to have a high degree of data capture, transparent modelling and established performance track records relative to those with a less verifiable exposure set. The composition of risk metrics rather than the risk metrics themselves will become all the more relevant to investor decision-making.
Overall, we view these patterns as a long-term net positive for the stability and reliability of the 144A and private cat bond marketplaces.
Securities or investments, as applicable, are offered in the US 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 EU by GC Securities, a division of MMC Securities (Europe) Ltd (MMCSEL), which is authorised 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.
This article was originally published on Intelligent Insurer.
GC Securities, Insurance, Reinsurance, Cory Anger, Jordan Brown, Sung Yim, ILS, Bermuda, North America