Surge in catastrophe bonds showcases growing demand for transfer of peak risks

Surge in catastrophe bonds showcases growing demand for transfer of peak risks – Swiss Re | Insurance Business America

Reinsurance

Surge in catastrophe bonds showcases growing demand for transfer of peak risks – Swiss Re

Issuance of cat bonds saw an 8% surge from 2022 figures

Reinsurance

By
Kenneth Araullo

In 2023, the issuance of catastrophe bonds (cat bonds) reached a record high of US$15 billion, signaling robust investor interest and growing demand for risk transfer of significant natural catastrophes, new insights from Swiss Re Institute revealed.

Despite this surge, the impact on the global reinsurance market’s supply-demand balance is expected to be minimal. Since 2017, alternative capital for reinsurance has remained stagnant, and the retrocession market continues to face capacity constraints.

This year’s record cat bond issuance represents an 8% increase from 2022, elevating the total global capital in cat bonds to US$41 billion. The growth of cat bond capacity, averaging about 4% annually when adjusted for inflation over the past six years, aligns with the global increase in natural catastrophe exposures. This trend is highlighted by Verisk’s estimates of global aggregate annual losses.

The recent spike in inflation has amplified exposures, alongside long-term factors like migration, value accumulation, and climate change. For instance, the replacement cost of US residential structures rose by 42% from the end of 2019 to the end of 2022. The steady growth in cat bonds is essential to maintain their capacity for peak risks, thereby alleviating pressure on traditional reinsurance for lower-layer risks. Since 1992, global insured natural catastrophe losses have seen an inflation-adjusted annual growth of 5% to 7%.

The benefits of catastrophe bonds

Investors are likely to continue favoring cat bonds, attracted by their exposure to peak risk layers and the appealing risk-return profile. Additionally, cat bonds offer liquidity in secondary markets and have a solid performance record despite recent high global natural catastrophe losses. They have also been shielded from valuation losses due to rising interest rates, thanks to floating-rate collateral. A similar investor preference is observed in the growing investment in cat-related reinsurance sidecars.

However, overall capacity in the alternative capital (AC) market is plateauing, with an estimated total capital of around US$100 billion in 2023, a figure consistent with levels since 2017. Inflation-adjusted, the capacity in 2023 was 17% lower than in 2017. The decline is mainly attributed to reduced capacity in collateralized reinsurance (CR), which has faced lower returns due to unexpected loss exposures since 2017. CR structures often face competitive challenges compared to traditional reinsurance, including higher capital costs and less underwriting expertise.

Looking ahead to 2024, the divergence in the AC market is expected to persist, with cat bond issuance continuing to grow and collateralized reinsurance likely declining. Strong cat bond issuance complements and stabilizes traditional re/insurance markets. Limited deployment of cat capacity in the retrocession and reinsurance markets is anticipated to continue. The current high pricing in the market is attributed not solely to capital scarcity but also to increased capital costs and heightened economic and modeling uncertainties, trends expected to continue into the next year.

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