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6 // THE DISASTER GAP: HOW INSURERS AND THE CAPITAL MARKETS CAN HARNESS BIG DATA TO CLOSE THE GAP


1. SPOT THE GAP


Third party capital is slowly but surely transforming the property catastrophe reinsurance market. Since the height of the financial crisis in 2008 investors have steadily increased their inflows into the industry. “Investor demand continues, especially for new risk types,” says Emma Wilkes, Managing Director of Corporate Trust Insurance Services at BNY Mellon. “Look at Turkey’s 2013 Bosphorus Re issuance, which was being marketed with a coupon of 3.25% over Libor on an issue size of $125m. When it was issued the size had grown to $400m and the coupon came in to a price of just 2.50% over Libor. The issue size is growing and the coupon is shrinking.”


An estimated $50bn of catastrophe bonds, collateralised reinsurance, industry loss warranties (ILWs) and sidecars will be in force by the end of the year, predicts Willis Re. Cat bonds currently account for $19bn of the total year-to-date and collateralised reinsurance for $20bn. Year-to-date cat bond issuance has reached $5bn and this market is on track to surpass the previous record issuance in 2007 of $7.2bn.


“In the last few years the growth has been substantial, but most of the investors and the sponsors driving the issuance are familiar with each other and so it doesn’t have the feel of a bubble to me, it’s just more that the deal sizes are a little larger and the pension commitments are continuing to increase,” says Bill Dubinsky, head of Willis Capital Markets & Advisory (WCMA).


Repeat and increasingly new sponsors are accessing the ILS market to leverage the favourable market conditions. The initial investor base was dominated by opportunistic investors such as hedge funds and private equity. This has given way to investors with longer-term horizons, including pension funds and other institutional investors.


“In the last few years the growth has been substantial, but most of the investors and the sponsors driving the issuance are familiar with each other and so it doesn’t have the feel of a bubble to me, it’s just more that the deal sizes are a little larger and the pension commitments are continuing to increase,”


Bill Dubinsky, head of Willis Capital Markets & Advisory (WCMA).


Fungible capital has now overtaken bricks-and-mortar start-up insurance companies as a preferred route to market, particularly in the aftermath of catastrophe driven industry dislocations. Capital can flow quickly and easily into sidecars, cat bonds and other insurance instruments to take advantage of heightened demand post-catastrophe. But what began as an opportunistic play has evolved into a new market with expanding opportunities.


“Historically insurers, reinsurers and hedge funds were the main investors, but pension funds are much newer to the party and probably have a longer-term view than some of the other investors in that space,” says Chris Waterman, managing director and Head of EMEA Insurance at Fitch Ratings. “The key play for pension funds here is diversification and the lack of correlation between the risks they’re assuming and those in the broader financial markets. A further attraction for pension funds is the additional yield they can generate.”


In insurance, investors have found an alternative investment that provides an attractive risk and return. There is the additional advantage that insurance risk is largely uncorrelated to the traditional capital markets. A Florida hurricane is unlikely to occur at the same time as a stock market adjustment for instance and therefore insurance investments offer all-important diversification.


“The low interest rate environment encouraged investors to look more closely at ILS, and cat bonds in particular” says BNY Mellon’s Wilkes. “A return to the normal interest rate environment is probably some time away,” she continues. “Even when this occurs, we believe allocations of institutional investors such as pension funds to ILS will continue to increase as they seek sources of diversification.”


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