Losses sufficient to maintain discipline, insufficient for material cat bond impact: Man Group

Insurance and reinsurance market loss activity in 2023 is seen as having been sufficient to help maintain discipline in the sector, global independent alternative and active investment management firm Man Group has said.

Man Group invests in catastrophe bonds across some of its alternative investment funds under its Man AHL arm, that has a focus on systematic strategies to deliver diversification as well as returns to investors.

Commenting on the past year of catastrophe losses and the fact the catastrophe bond market came through 2023 relatively unscathed, the investment management firm explained that a busy catastrophe loss year for insurers and reinsurers does not necessarily translate into major cat bond market losses.

It’s a natural conclusion that an active season of losses, particularly hurricanes, would drive greater catastrophe bond impacts.

But, in the wake of consecutive years of reinsurance market firming and tightening of terms and conditions, this is no longer always true. Or, at least, the types of loss activity that will cause significant impacts to the catastrophe bond market can now be defined differently.

2023 was a good example, as a year with above average levels of tropical cyclone activity in the Atlantic, but that caused little in the way of losses to insurance-linked securities (ILS).

Conversely, 2023 also saw the most significant severe convective storm (SCS) losses ever for the insurance industry in the United States and significant SCS activity elsewhere, such as Europe. But this activity also had little loss impact in ILS markets.

“It may seem somewhat counterintuitive that despite the record number of billion-dollar events, the cat bond industry did not incur material losses. Looking under the hood at the nature of these events reveals that the 2023 season was primarily comprised of lower-level tornadoes and linear wind scenarios, which cat bonds were broadly insulated from,” Man Group explains.

Aggregate catastrophe bonds did face some pressure, due to the significant SCS, tornado and hail loss event frequency in the United States, some aggregate cat bonds continue to face that.

But, the amount of aggregate exposure in the outstanding catastrophe bond market has continued to shrink through the last year, meaning exposure is lower to this type of event frequency, while the updated terms and attachments mean any new aggregate cat bonds are typically more remote anyway.

While very active secondary peril years used to have relatively significant implications for portfolios of catastrophe bonds and other ILS securities, this has lessened over the last few years.

When it comes to hurricanes though, as we all know it is landfall locations that matter most, which means that the cat bond and ILS market can face significant losses from a hurricane season with multiple storms, or with just one, if that single hurricane happened to strike a particular location with high insured value exposure concentrations.

“The correlation, or causation rather, between the level of activity and portfolio losses is not necessarily a clear cut one, with the idiosyncrasy stemming from the peril exposure and coverage type,” Man Group said.

Deductibles and attachment points are seen as the most critical change in reinsurance, cat bonds and ILS, one which, as we explained recently, end-investors are most keen to hold onto.

As we said though, there remains an appetite in some quarters to take on riskier layers and aggregates, although the terms and price still have to be right.

Man Group recognised this, saying, “High profile losses in recent years have led to improved investor discipline and demand for higher return per unit of risk. Insurance losses in 2023 were sufficient to maintain discipline but insufficient to materially impact portfolios, meaning that returns were positive. And while looking at 2023 in isolation would lead us to the conclusion that higher activity does not necessarily precipitate wider losses in the cat bond market, this relationship is dependent on the nature of bonds held.

“Per occurrence deals within cat bonds were largely safe in 2023, but the number of billion-dollar events meant that the risks for annual aggregate bonds particularly those with low deductibles, were skewed to the upside.

“Looking at this coverage type in isolation, one could even conclude that higher activity in fact meant higher losses.”