FY 2015 Catastrophe Bond Lite Issuance by Trigger Type
Source: PCS, Artemis Deal Directory
After a grueling four-month-long march that began in Monte Carlo, the January 1, 2016, reinsurance renewal is pretty much behind us. With fresh perspective, now is the time to truly appreciate how the ILS market evolved in 2015 and what could be in store for the years ahead. Let’s take a look at some of the top ILS sector trends of 2015 and what they could mean for us in the new year.
1. Keep it “lite”: Cat bond lite issuance finished the year at nearly $500 million in original issuance, half of it using the PCS Catastrophe Loss Index. While the fourth quarter was silent, market discussions suggest that further use of this form of risk transfer would come in the first quarter of 2016. 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. Additionally, it’s a natural step in the progression toward exchange-traded catastrophe risk options, which are likely to become the industry’s next innovation for faster, cheaper risk and capital management.
2. 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. Worldwide, the industry is excellent at improving what it already does well, but that only offers diminishing returns. 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. In addition to opening access to catastrophe-prone markets, original risk can come from accessing existing lines of business in new ways (such as energy and marine), launching microinsurance programs, and developing coverage solutions for emerging risks (such as cyber). Among the reinsurance industry’s greatest challenges, bringing original risk into the market is at the top of the list.
3. Balance two types of innovation: The reinsurance and ILS market has two types of innovation generally available. One, as mentioned above, is to find ways to make mature market transactions more efficient. While there are gains to be had, this usually means identifying opportunities to strip fractions of a basis point out of existing deals, which has a limit on ultimate benefit. After all, you can’t cut below zero. The other type of innovation is the one that can benefit the industry most: bringing more original risk to market. New risks can help reinsurers and ILS managers generate the stronger returns necessary to achieve higher ROE. And the efficiency gains in mature markets can be applied to original risks to maximize profitability sooner.
4. Engage publicly managed entities: Perhaps the most active source of original risk in 2015—and several years prior—publicly managed entities accounted for approximately a third of the year’s catastrophe 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. There are enough success stories worldwide to ensure that the catastrophe bond market remains an important strategic alternative for publicly managed entities.