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III. Insurance-Linked Securities
III. Insurance-Linked Securities
A. Overview
Insurance-Linked Securities (“ILS”), is the name given to a group of capital markets-based risk transfer products that are an alternative to traditional reinsurance. This group includes catastrophe bonds (“Cat Bonds”), sidecars, industry loss warranties, collateralized reinsurance facilities, extreme mortality derivatives and bonds, XXX/AXXX excess reserve financing facilities, embedded value securitizations and insurance-based asset management vehicles. With over $65 billion now committed to the ILS market by capital markets participants, the benefits of favorable pricing and collateralization for sponsoring ceding companies, together with relatively non-correlated yield for investors, has resulted in robust and consistent transaction activity in 2015 in most segments of this increasingly important market.
The overarching trend of convergence between traditional reinsurance and ILS continued in 2015. Several commentators have noted a prolonged “soft” market in traditional reinsurance due to excess supply of risk-taking capital, particularly in short- tail catastrophe-exposed markets most accessible by ILS participants. Historically, one of the most profitable segments of the reinsurance market has been the reinsurance of natural catastrophe risks for peak perils, such as U.S. hurricanes. As noted above, the competition among P&C reinsurers that is one of the main drivers of the wide-spread consolidation of P&C reinsurers in recent years is in major part a consequence of these sustained soft pricing conditions resulting from the further commoditization of risk-taking capital from ILS. We discuss these trends in more detail below.
B. ILS Market Update
2015 was a year of consistency and continued entrenchment for the Cat Bond market, with approximately $7.5 billion in new issuances and total outstanding volume reaching approximately $26 billion at year-end, an all-time high for the market. In addition, over 30 different insurance, reinsurance and corporate sponsors offered Cat Bonds in 2015, including new entrants Amtrak, China Re and UnipolSai Assicurazioni,
Developments and Trends in Insurance Transactions and Regulation 2015 Year in Review
as well as long-time participants USAA, SCOR, Swiss Re, AIG and Munich Re. While overall deal volume has decreased from 2014, which saw a record issuance of almost $9 billion, much of the difference is due to two large multi-year issuances completed in 2014: Florida Citizens $1.5 billion Everglades III transaction and Allstate’s $750 million Sanders Re transaction. Overall, the pace of transactions was brisk in 2015, with continued favorable pricing and a deepening of the risk transfer pipeline. Other highlights in 2015 include the following.
U.S. “peak” risk remains the focus of the Cat Bond market, with over 70% of outstanding Cat Bonds exposed to U.S. tropical cyclones and earthquakes, according to industry sources. Although these perils in particular continue to drive the ILS market, it is possible that Cat Bonds issued in 2016 and future periods will cover new perils and utilize different transaction structures.
As spreads have remained near historic lows, sponsors
have continued to push on coverage terms to further replicate traditional indemnity reinsurance protection. 15 Almost 60% of 144A cat bonds in 2015 utilized an indemnity trigger compared with fewer than 40% in 2009-2012. In addition, several sponsors have sought coverage in 2015 for unmodeled perils, such as volcanic eruption or U.S. wildfire outside of California. We believe
it is only a matter of time before the first “all perils” Cat Bond emerges, which will further narrow the difference in coverage terms between ILS and traditional reinsurance.
Several catastrophe bonds were structured with four- year or longer-dated maturities, which traditionally only went out for three years. A longer duration bond permits cedents to lock in pricing and amortize transaction costs over a longer period. In April 2015, Allstate sought seven years of Cat Bond protection, although the transaction was ultimately not completed. In 2016, we expect four- and five-year bonds to become increasingly common.
Opportunities remain in the market for life and health catastrophe risks. Among other transactions completed in 2015, AXA Global Life placed €285 million in U.S. and European extreme mortality coverage through Benu Capital; Swiss Re placed $100 million in Australian,