Cat bond market in a healthy position with higher-for-longer collateral returns: Plenum

With catastrophe bond issuance so far in 2024 outpacing prior years and supply and demand dynamics contributing to an increase in spreads in recent weeks, Dirk Schmelzer, Managing Partner and Senior Portfolio Manager at Plenum Investments, the Zurich-headquartered manager of insurance-linked securities (ILS) and related assets, feels the market is in a very healthy and effective position.

During a recent webinar hosted by Plenum, Schmelzer discussed the risk spread of cat bonds, revealing that the current spread level is roughly 200 basis points above the 10-year average, and has actually been on an upward trend since 2016.

After an all-time high of 11.37% in January of last year, due to Hurricane Ian recovery, Schmelzer explained that the market average risk spread has come down, but has again been on the rise since April 2024, driven by supply of new transactions exceeding demand.

In fact, according to Plenum, at almost 8%, the cat bond market average risk spread is well above the average.

“In total, this means that the cat bond market yield gross is around 30%, which is a very attractive statement. This is one of the reasons why cat bonds have attracted so much investments and investor interest over the last few months and weeks.

“The spread compression that was observed is by far not sufficient enough to bring spreads of cat bonds down to their old levels,” said Schmelzer.

“So, you still have an elevated risk premium situation. And despite the fact that we had very strong demand, that strong demand, of course, created some pressure on spreads. 65% of all cat bonds issued in 2024 had either downward revision in prices or an upsizing, so the demand was strong,” he added.

Schmelzer went on to say that this shows that the cat bond market environment is still very attractive, and that one of the reasons for elevated spreads in recent weeks is the supply and demand dynamics.

“What we can see here is that yes, issuance sensitivity is on an absolute record path. So, we are outpacing the issuance of prior years in this year, and especially after the first quarter. So yes, we had significant issuance activity in the first quarter, but at the same time, we had a lot of maturities coming to the market. So, demand was still outpacing supply. That has changed over the last few weeks, and we see the record issuance activity leads to increases in spreads,” he said.

While supply and demand is one driver of spread tightening and widening, Schmelzer explained that what Plenum has also observed is that some cat bonds appear to drive spread development more than others.

“We looked at the top 10 positions with the largest price change, price decreases, of course, and spread increases. So, these are the positions that had the strongest change in prices. We looked at the change in risk modelling results for these bonds and what trigger type they comprise. Two things stick out. So, most of the transactions, nine out of 10, are part of the PCS index trigger family, and these bonds seem to have seen the most significant changes from version updates here, RMS.

“So, we see that we have two factors obviously driving that spread increase. One is the supply demand dynamics, but it also shows that index triggered bonds had significant risk changes, or how the market might look at the risk. And of course, the sponsor had the biggest price change and therefore driving that spread increase,” said Schmelzer.

In summary, Schmelzer said that it’s fair to say that the “cat bond market stays in a very healthy and effective position and is an interesting place for investors to look at.”

“We’ve looked at collateral returns. They seem to be higher for longer, which contributes positively to the overall and the absolute performance of this asset class. But more importantly, is that we also are in a harder for longer risk spread environment. So, the compression that we have seen, the spread tightening trend has stopped, and risk compensation remains very attractive and above average historical levels, which means that cat bond yields remain well above historical average levels, and that is something that investors of course benefit from investing in cat bonds.

“We believe that cat bonds remain very attractive and should be part of a broader asset allocation because they help improve performance and diversification within investors’ portfolios,” said Schmelzer.

Analyse catastrophe bond market yields and risk spreads using our interactive chart.