Cat bond market shifting, issuance down 28% in first half of 2015 compared to first half of 2014: PCS

The catastrophe bond market is continuing its trend toward larger transactions by fewer sponsors, witnessing US$4.1 billion in issuance activity for the first half of 2015 compared to US$5.7 billion for the same period in 2014, notes a new report issued Wednesday by Property Claims Services (PCS).

PCS notes in its Q2 2015 catastrophe bond report – which cites data from the Artemis.bm Deal Directory – that despite a recent run of record-setting quarters and years, transactions completed by insurers and reinsurers fell 11%, from 18 to 16. A chart in the report shows there were 16 transactions in the first six months of 2015, down from 18 in the first six months of 2014; total issuance was US$4.1 billion compared with US$5.7 billion; the number of transactions for North American issuance was 12 compared with 14; and total North American issuance was US$3.8 billion compared with US$4.8 billion.

In addition during the first half of 2015, “average transaction size fell 19.5% to US$255 million, in large part because of several very large transactions completed in the second quarter of 2014,” states the report. [click image below to enlarge]

All that said, PCS points out that the US$4.1 billion in issuance during the first half of 2015 “is the second most active first half in the history of the market, ahead of 2013’s US$3.9 billion in first-half original issuance.”

PCS reports that while some of the decline in new limit can be attributed to several large second-quarter deals last year, “few new sponsors have entered the market, and many familiar faces didn’t return.”

The report explains that abundant capacity and low catastrophe activity — particularly in North America — have contributed to total Cat bond limits remaining below their 2014 peak. “An apparent shift to more flexible structures with lower frictional costs (such as Cat bond lite and collateralized reinsurance) has been a factor as well,” the report adds.

“The continued growth of cat bond lite adoption indicates that the market has seen the value of securitization for private transactions in conjunction with a streamlined issuance process. And the structure, rigor and discipline involved in issuing through a cat bond lite platform may give this form of issuance an edge over private catastrophe bonds,” the report suggests.

“Additionally, the cat bond lite structure enables more participants to enter the ILS (insurance-linked securities) sector. Funds with a mandate to participate only in securitized transactions, for example, can use cat bond lite instead of collateralized reinsurance or industry loss warranties to issue and consume risk.”

“It also appears that a narrowing of strategic intent has come to bear. The concentration of issuance activity from publicly managed entities – all veteran sponsors – is but one indicator of this trend.”

Beyond the larger transactions and fewer sponsors, “the two most striking developments in this year’s second quarter came from publicly managed entities and private catastrophe bonds,” states the report. “The former accounted for more than half of catastrophe bond issuance activity by capital raised, and the latter has already topped full-year 2014 issuance activity.”

Cat bonds sponsored by publicly managed entities account for 53% of the capital raised in 2015 Q2 and almost half of the deals completed, PCS points out. “Net of those transactions, sponsors completed five catastrophe bonds in the quarter, raising approximately US$1.3 billion. In fact, capital raised by publicly managed entities represents 34% of the first-half total.”

While the “year-over-year drop of nearly 50% for second-quarter issuance activity does signal a change,” PCS reports, it adds that a little break from record-setting quarters may be a good thing. “The second-quarter respite from new heights may be a natural stage in the maturity cycle as potential and existing sponsors evaluate the alternatives available to them in optimizing capital management,” the report notes.

“The catastrophe bond market – this year, at least – seems to be focused on specific market niches. This may be a function of the multi-year coverage that catastrophe bonds provide, because some sponsors don’t need to come back to the market every year. It’s worth watching these dynamics, however, to see if they’ll become a constraint on the sector’s growth,” the report recommends.

PCS notes that the five key trends in the Cat bond market right now that indicate increased flexibility and a strong foundation for future market growth include the following:

• a break from records – Rapid growth in collateralized reinsurance and Cat bond lite appears to have stolen some of the Cat bond market’s momentum, but that’s indicative of a market sill maturing and finding the most effective tools to use in managing risk and capital. Stakeholders probably have to wait for the fourth quarter to get a better sense of where the Cat bond market is headed.

• keeping it private – Publicly revealed cat bond lite activity reached US$400 million in the first half of 2015, putting it at close to twice the full-year 2014 total. Significant potential for increased adoption remains.

• representing the public – Publicly managed entities are no strangers to the catastrophe bond market, but the high concentration of them in second-quarter issuance is profound. Capital raised through catastrophe bonds for this sector accounted for a third of the first-half 2015 market total and more than half of the second quarter’s activity. Further, publicly managed entities have a history of big issuances.

• a place for old pros – Veteran sponsors continued to dominate issuance activity this year. Yet there is chatter in the market about the need to include new risks areas and lines of business. It seems as though soft market conditions are refocusing the industry’s use of catastrophe bonds until more alternatives become available.

• competition from alternatives – Cat bond lite isn’t the only alternative available to insurers and reinsurers. Collateralized reinsurance has growth rapidly over the past six years. And traditional reinsurers have also become more competitive as they seek to protect and grow their share of the market.