Can ILS Move Beyond the Boutique?

Despite high hopes of opening the pipeline for insurance linked securities, market participants expect that deal flow will remain a fraction of the traditional reinsurance market for the near future.

“At the moment it’s a niche, boutique market,” said Paul Schultz, president of investment banking for AON Benfield during the recent IQPC Insurance Linked Securities Summit in New York. “They questions should it continue to be boutique or can it become more mainstream.”

Statistics reveal that catastrophe bonds in particular remains a small fraction of the overall market for property/casualty capacity.

According to Schultz, Aon research reveals approximately $30 billion in cat bonds have been issued on a cumulative basis through 2009.

About $13 billion in catastrophe bonds remain outstanding at the end of 2009 which represents approximately 10 percent of all property cat transfers for the year, Schultz said.

Even that percentage of the market that catastrophe bonds have carved-out in the property-casualty market is threatened by rebounding reinsurance market.

Shultz said that Aon expects sat rates in the U.S. will be down anywhere from five to 20 percent year over year at the July renewals and that capacity in the traditional market will be up by similar percentages.

“Traditional markets will have more capacity and are pricing their products cheaper,” Schultz said. “I think it’s a relevant questions as to whether we continue to competitive.”

Solidium Partners managing partner Karsten Bromann said that from an investor perspective growth in the catastrophe bond market has been hindered by too many “surprises” on bonds that defaulted or lost value for non-insurable reasons.

“Too many negative surprises can scare away new investors,” Bromann said. “Transparency can improve, but we only see to learn the hard way.”

Bromann pointed to several cat bond failures, including Georgetown Re, Kamp Re, Crystal Credit and various bond backed by Lehman Brothers collateral as examples of unexpected losses.

“Except for the Lehman structure, most were indemnity bonds that suffered in an unexpected way,” he said. “While there should be portfolio transparency, but loss development transparency is also important.”

From the sponsor perspective, understanding the business case of the counterparty will be a key to new issuance, said Insa Adena, head of advanced risk intermediation at Allianz.

“It’s very much an issue of cost transparency,” she said. “There is quite diverse amount of investors and we don’t know how their funds are set set up and what the return hurdles are. We need to understand the fundamental things that are really driving them.”

Adena added that it would also be important to sponsors to receive more information on secondary trading of cat bonds beyond the market quotations currently being distributed by reinsurance brokers.

“Many of the quotations are insufficient for a transparence and vibrant market,” Adena explained. “We need number such as tradable volumes so we can’t put these prices on the sheets into perspective.”

Counterparties will also need to develop standardized documentation on paper laden catastrophe bond deal in order for the market to grow but few are willing to take the first step, said Christian Bruns, fund manager with Clariden Leu.

“Sponsors tell us they want standardization and an need standardization, but they often add ‘not for our deal,’” he said. “Part of the cat bond market is standardize, but its not standardize in such a way that its an easy document to handle.”

However, even if the market was able to address all of the concerns of sponsors and investors it is unlikely that the ILS market will ever take the lion’s share of capacity from the traditional reinsurance market.

“From out perspective as a ceding entity, we entered this market as a method of diversifying away from the traditional industry” Adena said.

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