Cat bonds to overtake collateralized reinsurance, if trends continue: Fitch

Given the strong growth of the catastrophe bond market over the last year and the fact market conditions and investor preferences favour the structure, if these trends continue, Fitch Ratings Senior Director Brian Schneider said he expects cat bonds will become the largest segment of the alternative reinsurance capital market.

Speaking in Monte Carlo at the annual Rendez-Vous event, Schneider explained that the insurance-linked securities (ILS) market has experienced a resurgence of interest, particularly cat bonds.

“ILS funds continue to raise capital in 2023, with particularly strong growth in the cat bond issuance and we do expect these favourable conditions to continue to have growth in alternative markets for the rest of 2023,” Schneider said.

Adding, “In conjunction with significantly higher reinsurance pricing on the traditional side, we’ve seen the ILS market have had a very favourable pricing environment as well that has helped investors to be more attracted to this risk class, which is really the difference from what we saw late in last year.”

With the return potential higher, thanks to improved spreads as compared to expected losses in ILS transactions, Schneider said that, “We see the investors are having a very strong interest in both reinsurance and retro deals.”

He said that cat bonds are a very important capital source in the current hardening reinsurance market.

While on the investor appetite side, he said, “Given that it does offer that diversification, it will continue to be a very attractive asset class even though other alternatives out there with the higher rates in the market.”

He said that recent spread compression is also benefiting the sponsors of catastrophe bonds, while attracting them to it as a source of reinsurance and retro capacity.

Then stated, “But overall, the returns that we’ve been seeing from the capital markets are near-record returns for the year so far.”

With cat bonds pricing down and growing in size during their marketing to investors, Schneider explained that this is, “Really highlighting that investor demand for reinsurance investments.”

“We expect this to continue, in particular for cat bonds, we expect to see a record for full year issuance in 2023,” he added.

While the collateralized reinsurance, or private ILS, component of the alternative capital market has dipped in size, it remains the largest segment.

“The biggest beneficiary of that drop has been the cat bond market, which increased to about 41% of the market, from 31%,” Schneider told the assembled audience in Monte Carlo.

Saying, “So if this trend continues, we would expect to see cat bonds overtake collateralized re.”

Collateralized reinsurance is currently not seeing as much investor appetite he explained, with issues from model accuracy, to secondary peril losses, loss creep and trapping of collateral.

“ILS investors have been reevaluating the asset class, which I think has been a positive for the overall market. They’ve been demanding, better pricing, given a lot of the uncertainty that we’ve seen,” he said.

But added that, on ILS investors, “I think they’re aligned with the traditional market and that they’re both looking to improve their overall economics and their overall risk-adjusted returns, which is not necessarily something that we’ve seen in previous markets, where maybe alternative capital was willing to accept lower returns, which ultimately could hurt the traditional market environment.”