The catastrophe bond market could help address demand for aggregate covers at the January 1 renewals, although the structure of transactions will be key, according to early discussions at the Monte Carlo Rendez-Vous.
One of the factors that could increase the issuance volume of cat bonds around the renewals is the demand from insurance companies for aggregate covers, Aon Securities CEO Richard Pennay told The Insurer.
“To the extent that the catastrophe bond market is willing to entertain those types of structures, we could see a meaningful amount of increase in the amount in aggregates being purchased,” he continued.
“There has always been appetite for aggregate covers in the cat bond market,” Pennay said.
Referring to industry-loss-index transactions in particular, he said: “I think excess 80% of those covers are actually on an aggregate basis, and they do cover the aggregation particularly of U.S. hurricane and U.S. earthquake.”
Cat bond investors have appetite for aggregate covers for secondary perils too, Pennay said. “However, investors are keenly aware of the ultimate structure and just making sure that they can ultimately get comfortable with the way in which that aggregate has been put together.”
Aggregate transactions are happening for nat cat perils for which modelling is established and where there are retentions and event deductibles investors will accept, said Shiv Kumar, president of GC Securities.
“The issue was there because in aggregates, you are picking up the frequency of severe convective storms and (other) secondary perils,” Kumar said.
Tornado, hail and wildfire losses have been a subject of concern from risk capital in recent years. Some wildfire and severe convective storm models from third-party modelling firms have been updated in recent months, showing higher frequency and severity of these events, Kumar continued.
“I think the fact that the models are being recalibrated, that is helpful,” Kumar said.
“As an investor, that gives you the confidence that the system is recalibrating itself, that the aggregate structures are reflecting the level of risk that is embedded in them, and therefore they can price it accordingly.”
He added that he expected to see greater issuance of aggregate cat bonds in the future.
PRICING PRESSURE
Beyond changes in demand for aggregate covers, the interplay between the pricing of cat bonds and traditional reinsurance will also determine how much cat bond limit is placed at January 1, Pennay said.
“If we continue to see increasing capital positions of reinsurers and we see that pricing continues to tighten in the reinsurance market, there is absolutely the potential for our clients to ultimately have a harder decision to make as to whether they continue to grow that allocation into the cat bond market or whether they’re ultimately happy with what’s being achieved in the reinsurance market.”
However, there continues to be strong interest from investors in supporting cat bond transactions. “Therefore there is the opportunity that spreads will continue to tighten in the cat bond market as well,” Pennay said.
Kumar also said cat bond pricing was expected to tighten at the January 1 renewals, adding that investors remain comfortable with expected returns even as spreads tighten.
With increased capital from reinsurers as well, “it is good that there are options available in both markets,” Kumar said.