As Cat Bond Market Evolves, Investors Break from Traditional Market Pricing

Interest in the catastrophe-bond market is picking up, the investor base is expanding, and “non-traditional” capacity is pushing down reinsurance-renewal pricing as institutional investors show a willingness to break from price levels set by the traditional market, a new report says.

In a May update from GC Securities, Guy Carpenter says, “During the first quarter there is no question that the capital markets had a dampening influence on rate conditions at the April 1 renewals and are having a dramatic dampening influence on expected conditions for June and July renewals.”

Noting the investors' break from the traditional-market pricing, Guy Carpenter says that institutional money is offering capacity to Florida wind at 40 percent less than last year's pricing. The report says this does not mean that the risks are priced incorrectly, but rather the institutional investors do not have the same capital costs as reinsurers, “and therefore can, on a sound basis, charge less for peak U.S. wind risk than the traditional reinsurance market on a sustained basis.”

The report continues, “This dynamic is the so-called 'decoupling' behavior that has been predicted for some time as a possible consequence of seasoned direct institutional-capital participation in catastrophe-risk markets.”

Guy Carpenter also says the breadth of the investor base is “rapidly expanding.” Previously, a small number of large, dedicated insurance-linked securities managers supported the majority of the cat-bond market, the report says. But it adds that investor interest broadened at the end of 2012 and particularly in 2013.

“Increasing the breadth of an informed sophisticated investor base can only be a good thing for the markets' long term prospects as it increases available capacity without leaving the market susceptible to reckless capital that will support transactions with ill considered terms, which eventually cause problems themselves or set problematic precedents for others to follow,” the report contends.

The higher capacity and competitive pricing, though, does not point to a lack of discipline, according to Guy Carpenter. The report argues that capacity is expanding “because sophistication and attention to transaction mechanics is increasing, not decreasing.”

In the 2013 first quarter, Guy Carpenter says two natural peril-exposed catastrophe bond transactions closed for a total of $520 million of issuance. This was offset by $352.5 million of maturities, driving an increase of risk capital outstanding of USD167.5 million. 

“When looking to the remainder of 2013, GC Securities expects the market to approach, if not exceed, the record for annual issuance of $7 billion set in 2007,” the report says, noting that this view is dependent on cat bond market pricing remaining stable and non-U.S. peak peril sponsors taking advantage of attractive conditions to bring sizable issuances to the market during the balance of 2013.