Need for high-layer capacity drives cat bond surge

The increased demand for the bonds, which were one of the first insurance-linked securities when they debuted about 25 years ago, was one of the drivers that helped push the 2020 cat bond market to its record $11.3 billion in new issuance, market sources say.

“Catastrophe bonds helped to fill some of the retrocession capacity,” said Philipp Kusche, New York-based global head of ILS and Capital Solutions for TigerRisk Partners Inc. Limited capacity in the retrocession sector was “one of the trends seen in fourth-quarter 2020,” he said.

Retrocessional reinsurance provides protection for reinsurers. Historically, the coverage was provided by traditional reinsurers and specialty retro writers, but over the past decade ILS structures, including collateralized reinsurance, sidecars, industry loss warranties and cat bonds, have played a bigger role in the retro market. “We have seen a number of reinsurers, including Swiss Re, continue to be users of the catastrophe bond market,” Mr. Kusche said.

Swiss Re Ltd. used catastrophe bonds in 2020, issuing notes through Matterhorn Re, after returning to the ILS market in 2019 with the Matterhorn Re SR 2019-1 A catastrophe bond, according to the reinsurer’s March ILS report. The 2020 bonds provide a total of $685 million of protection in two tranches on a PCS index, per occurrence basis against U.S. named storms affecting coastal states from Texas to Maine and Northeastern states.

Other reinsurers issuing catastrophe bonds in 2020 included Hamilton Re, a unit of Hamilton Insurance Group Ltd., and Convex Group Ltd., the specialty insurer and reinsurer founded by former Lloyd’s of London underwriter Stephen Catlin.

The Convex bond Hypatia Ltd. provides $150 million of retrocessional coverage for losses from U.S. named storms, including the District of Columbia, Puerto Rico and the U.S. Virgin Islands, and U.S. and Canadian earthquake risks, on an annual aggregate basis, using a weighted PCS industry loss index trigger, through June 7, 2023, according to listing information on the Bermuda Stock Exchange website. Many ILS transactions are listed on the BSX.

Hamilton Re’s Easton Re Pte. Ltd. provides $150 million of coverage for U.S. named storm and U.S. earthquake through Jan. 8, 2024, according to the BSX.

Cat bonds helped fill in a retraction in retrocessional capacity due to existing market participants exiting the marketplace, said Brad Adderley, a Bermuda-based corporate partner at law firm Appleby. Improved pricing and investor demand also helped bolster cat bond performance, he said.

Improved catastrophe bond pricing is partially due to increased demand as the vehicles were used to replace reduced capacity, Mr. Adderley said.

Increased supply from both catastrophe bond investors and the market for ultimate net loss coverage led to 7% year-over-year growth in nonproportional retrocession capacity, said Des Potter, managing director in London for GC Securities, part of Guy Carpenter & Co. LLC.

The retrocession market showed shifting demand for capacity as index cat bond issuance grew to provide approximately 28% of nonproportional retrocession capacity, he said. Meanwhile, traditional retrocession catastrophe placements decreased by 9% and standalone catastrophe in direct and facultative placements grew by 32%.

The cat bond market is expected to maintain its momentum.

Issuance in 2021 is already at “a fairly high level and we expect that to carry forward throughout the year,” said Mr. Kusche of TigerRisk. “We expect continued use of the catastrophe bond market throughout 2021.”

Guy Carpenter expects a continued flow of new allocations to the insurance-linked securities asset class after the recent disruption in the financial markets from the pandemic reaffirmed the low correlating features of the ILS asset class, Mr. Potter said.