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2015 cat bond issuance activity by new limit fell 25% to US$6 billion year over year: PCS


January 6, 2016   by Canadian Underwriter


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Catastrophe bond issuance activity by new limit fell approximately 25% year over year in 2015 to US$6 billion, while issuance of catastrophe bonds including coverage for Canada witnessed a shift, notes a new report issued Wednesday by Property Claims Services (PCS).

Cat bond issuance activity by new limit down

Overall, the Artemis Deal Directory reports that catastrophe bond issuance – measured by new limit – fell to US$6 billion in 2015, states the PCS FY 2015 Catastrophe Bond Report.

Use of data from PCS occurred in nine transactions, down slightly from 10, while capital raised fell to US$2.1 billion in 2015 from US$2.8 billion in 2014.

“However, with index-triggered cat bond lites included, the year- over-year decline was only US$500 million,” the new report states.

A key driver in the year-over-year 25% decline in new limit was the shortage of extremely large transactions, PCS reports, noting there were single transactions in 2014 with almost US$1 billion in limit, US$750 million in limit and US$1.5 billion in protection. “Part of the reason for the drop was last year’s many large transactions that didn’t need to be repeated this year, such as the Kilimanjaro Re and Sanders Re catastrophe bonds. Together, they accounted for 61% of last year’s PCS-triggered issuance activity,” the report points out.

“Such issuance activity generally doesn’t occur annually, given the multi-year tenor of the transactions, which can lead to swings in overall issuance from year to year,” PCS explains. Also affected is the average transaction size, which dropped almost 25% to US$250 million last year, the company adds. [Click  image below to enlarge]

Full-year issuance activity for 2015

While issuance of cat bonds including coverage for Canada remained unchanged year over year – three were completed in both 2014 and 2015 – sponsors raised almost $1.1 billion in capital through transactions last year, just $20 million shy of the 2014 full-year total.

Although year-over-year issuance did not change, the nature of issuance activity did. “In 2014, sponsors completed two catastrophe bonds with indemnity triggers, one of which used PCS data for independent catastrophe designation. The remaining transaction used the PCS Catastrophe Loss Index and provided $500 million in capacity,” states the report. “Last year, all three catastrophe bonds that included Canada used the PCS Catastrophe Loss Index, with transaction size ranging from $150 million to $625 million,” PCS adds. [Click image below to enlarge]

Canadian full-year issuance activity

PCS Canada has designated 41 events, with total estimated insured losses of $9 billion through year-end 2015, the report states.

Overall, 2015 Q4 was relatively quiet. “As with 2015 as a whole, the quarter showed a year-over-year drop in issuance activity – from US$2.1 million in 2014 to US$1.4 million last year. The 31% decline comes despite only a slight drop in transaction volume,” states the report, pointing out that sponsors completed six transactions in the fourth quarter of 2014 and five in the fourth quarter of 2015.”

Again, PCS points out, size made the difference. “In the fourth quarter of 2014, three catastrophe bonds had limits of US$400 million or more, with another at US$375 million. Last year, the only fourth-quarter transaction to top US$400 million was Kilimanjaro Re at US$625 million. The remaining deals were all US$300 million or below,” the company reports. [Click image below to enlarge]

Historical Q4 issuance activity

With regard to cat bond lite issuance activity, there was no such publicly disclosed activity in 2015 Q4, “but plenty of chatter filled the void as the market began to prepare for the January 1, 2016 reinsurance renewal,” the report states. “The year ended with US$490 million in new limits from 16 transactions, more than doubling the 2014 full-year total of US$242 million in publicly revealed cat bond lites.”

PCS points out that for 2015, the largest cat bond lite raised US$71 million, while the smallest was just under US$10 million. Four transactions exceeded US$50 million, with one closely behind at US$47.6 million.

“At the high end of the range, one can see cat bond lite approaching the traditional lower end of the catastrophe bond market (historically around US$75 million). The other end of the spectrum, with seven cat bond lites under US$20 million, stands as a clear challenge to the notion that smaller deals of this type can become too expensive to complete effectively,” the report explains.

“The cat bond lite structure aims to provide a route to securitization that doesn’t involve the onerous issuance requirements of traditional catastrophe bonds – while still providing the structural discipline and transparency that have characterized catastrophe bonds since the market’s inception,” PCS comments. “As a result, sponsors have increased flexibility to complete smaller and more targeted transactions quickly while managing their cost of capital.”

While the overall 25% decrease represents a noteworthy decline, PCS notes, 2015 was, nonetheless, among the most active issuance years in catastrophe bond market history. “The underlying diversity of issuance activity is a clear sign of current and ongoing market health and vitality,” the report states.

There are many signs the cat bond market continues to mature, “particularly in relation to geographical diversity and adoption by the publicly managed entity space,” PCS suggests. That said, “we need to see further foundational growth – a bigger base for future issuance activity. In 2015, we saw catastrophe bonds come to market covering nine countries,” notes the report, adding that, additionally, six U.S. publicly managed entities raised US$1.9 billion.

Five of the catastrophe bonds completed in 2015 had no exposure to North American risk. Two covered risks in Japan, one provided protection against European risks, and another covered China, notes the report.

Overall, the drop in cat bond issuance activity last year suggests “continued insurance-linked securities (ILS) market maturity as cedents and markets explore the full range of risk transfer alternatives available to them in this sector,” the report states.

“Perhaps counterintuitively, the decline in original issuance indicates that the market continues to gain a deeper understanding of how ILS can support improved risk and capital management worldwide,” PCS notes.

The market has priorities for 2016 and beyond, suggests the report.

“Ultimately, the future of the catastrophe bond market – and the ILS market as a whole – will come down to the attraction of more original risk. New opportunities for sustainable profitable growth will emerge when risks currently not covered in the global insurance and reinsurance supply chain (or risks not covered effectively or sufficiently) become accessible to capital providers worldwide.”

“Recently, several clients have mentioned an interest in the market for global terror ILWs, which has become particularly important because of soft market conditions – not to mention the recent attack in Paris,” PCS reports. As of December 10, Verisk Maplecroft identified 7,657 acts of terrorism or political violence across 81 countries in 2015 (not including kidnap and ransom events).

The report notes that increased interest in flexibility in the ILS market suggests continued growth for cat bond lite and other private catastrophe bond transactions in 2016.

“Continued rapid growth, however, will rely on the introduction of more original risk into this sector. With index triggers available from PCS for Canada and now Turkey, the opportunity exists for smaller stand-alone ILS transactions for risks in these markets, likely on a retrocessional basis.

The introduction of new indices could help grow cat bond lite beyond its traditional property catastrophe focus,” the report advises.

PCS cites the following top ILS sector trends from 2015 and what they could mean in 2016.

  • Keep it “lite” – Market discussions suggest further use of cat bond lite issuance as risk transfer would come in the 2016 Q1. As sponsors seek more efficient and cost-effective ways to transfer small amounts of risk to the capital markets, cat bond lite is likely to gain further adoption.
  • Source original risk – Sustainable profitable growth will only become more difficult as mature markets continue to tighten and competition among risk bearers becomes increasingly intense. To achieve ongoing double-digit return on equity (ROE), every link in the global risk and capital supply chain will need to source original risks from around the world.
  • Balance two types of innovation – The reinsurance and ILS market has two types of innovation generally available: find ways to make mature market transactions more efficient, and bring more original risk to market. New risks can help reinsurers and ILS managers generate the stronger returns necessary to achieve higher ROE.
  • Engage publicly managed entities – Perhaps, the most active source of original risk in 2015, and several years prior, publicly managed entities accounted for about a third of the year’s cat bond capital raised. Further, catastrophe and terror risk pools around the world are either eyeing the ILS market or are active in it, and plenty more could still come into the market.