Reinsurers and cat modellers make their forecasts as ILS market returns

ILS activity looks set to increase in 2010. A record volume of catastrophe bonds is due to mature in 2010. Much of it was issued in 2007 ? the most active year ever for ILS to date.

Munich Re believes the volume of new issues in 2010 could be in the region of $5bn. During the year, $4.5bn of cat bonds are due to expire.

All the indicators are positive for the insurance-linked securities sector. The market has also learnt a few lessons from the financial crisis, according to Thomas Blunck, a Munich Re board member.

“Today’s structures are such that investors can now be sure they are really investing only in insurance risks,” he says. “As investor confidence grows and return expectations fall to appropriate levels, catastrophe bonds can again assume their intended role. The capital market is a supplementary risk carrier especially for peak risks for which capacity is in short supply in the traditional insurance market.”

The last three months of 2009 were the most active quarter yet seen for catastrophe bonds, reaching almost $1.1bn in total volume, eclipsing the previous best fourth quarter by more than 75%.

This accounted for a third of the $3.5bn issued throughout 2009. The major cat bonds of the last part of the year were issued by Swiss Re, Flagstone Re, Zurich, Travelers and Scor (see story links at the right of this page).

The sum total issuances in 2009 thus exceeded the volume of expiring bonds so that overall the outstanding bonds rose marginally to just under $12bn.

The high level of activity at the end of the year was remarkable given that it is usually the second quarter of the year that sees the most issuances as companies seek coverage before the start of the hurricane season.

However, favourable pricing in the second half of 2009 led more companies to choose cat bonds as an alternative to reinsurance before the January 1 renewals. The spread required by investors also returned to previous levels.

“We have seen growing appetite for catastrophe bonds as spreads have returned to pre-credit crunch levels and the cost of issuing has dropped by 30 to 40% over the last six months,” says Robert Stone, director with the RMS dedicated ILS team, RiskMarkets. “More companies have put their toes back in the water after a slow start in 2009 and we have been engaged to provide expert risk analysis for a broad variety of deals including new and innovative transactions.”

Overall, the prices for catastrophe bonds from the second quarter have reverted to mid-2008 levels. “Prices indicate that the market has recovered,” says Rupert Flatscher, Head of Munich Re’s Risk Trading Unit. “This year will see the expiry of bonds totalling $4.5bn and the proceeds will need to be reinvested. The good performance of the catastrophe bond market also during the financial crisis should ensure an influx of capital of around $1bn into funds specialising in such bonds. In addition, the basic interest shown here by new investors such as pension funds should translate into further growth in the medium term.”

In 2010, the required spread is expected to fall by some 50 basis points up to the middle of the year. However, Munich Re believes it will still be possible to place European risks at lower risk premiums than those for US risks.

The development of the PERILS joint venture, which tracks sums insured and insured losses in the industry, thus making it possible to determine market-loss-based triggers for European risks, will favour the placing of European insurance risks on the capital markets.

“The way the market is developing is highly opportune for Munich Re. In the crisis, we invested heavily in catastrophe bonds on the secondary market. And now, as the market recovers, we can support our clients with new issues, just as we did recently with the Zurich Financial Services Group in structuring and placing Californian earthquake risks,” says Board member Thomas Blunck, who oversees the Risk Trading Unit. “Our strategy of providing an all-round service for risk assumption and risk transfer has clearly paid off.”

New modelling analysis and trigger systems have been developed that make the cat bonds more accessible and more attractive to investors.

David Lalonde of AIR Worldwide which has modelled for more than 50% of outstanding capital in the cat bond market, says: “Not only have we expanded the scope of perils and trigger types used to model a wide range of insurance-linked securities, but we have continued to be innovative in helping non-insurance organisations, such as governments, transfer risk,” he adds.