Cat bond investors push back on terms as hard market bites
Investors have been pushing back on pricing and structure on cat bond deals that have come to the market post-Ian, with transactions featuring higher costs to sponsors to extend coverage past expiry or to terminate bonds early.
Investors are also asking for up-to-date inflation tables, and in some cases avoiding aggregate structures and excluding secondary perils.
While only a few deals have settled so far, spreads suggest that investors are now expecting higher minimal rates.
Sources told Trading Risk that cat bonds were now unplaceable if they do not include a higher-rate extension feature. Investors have zeroed in on including a buffer loss mechanism that ensures cedants pay a higher spread to hold capital that is not close to attaching.
The market standard up until now was for cedants to pay a spread of 0.5% to extend deals at their election. This let them hold capital past a deal’s maturity to pay out claims crystallising in the period after a cat event.
Investors want to adjust the terms on extensions so that the premium payable will be around 250-300 basis points (bps) on any capital, which, according to the buffer loss calculation, is unimpaired or expected to be unimpaired. The premium on the impaired amount remains at 50 bps as before.
This means cedants are incentivised to release funds and not to block them.
“Historically, distressed positions are very, very unlikely to trade. When a bond is put into extension it becomes a form of trapped capital,” said a source.
Liberty Mutual’s latest Mystic Re, Allstate’s Sanders Re, Inigo’s Montoya Re and Fidelis’s Herbie Re were among the bonds to have revised terms on extension spreads, all offering 300 bps in extension spreads for any capital that is not close to attachment.
The other structural element that’s being looked at afresh is call provisions, or optional redemption prices. Call provisions allow for the deal to be closed early, after the first year.
In the context of hard market rates and typical three- to four-year cat bond durations, call provisions are in demand by cedants who want to minimise their expenditure if they can get a better deal further down the line.
Redemption spreads are going up to “two or three” times higher than pre-Ian, sources said. In the case of Herbie Re, it was 11% for a redemption at December 2024, and 5.5% for December 2025, while Mystic Re offered 7% if called at December 2023, and 3.5% as of December 2024.
Investors with capacity to deploy in cat bonds are also well placed to push on the pricing lever, with rates “punishingly high”, according to one market participant.
US wind is up 50%-100% in some cases. The high degree of change reflects the low baseline rates on remote risk deals placed in the cat bond segment, as the market sets a higher floor on the level it will take US wind risk for.
Allstate’s Sanders Re provided a benchmark for remote wind risk, with a sub-1% expected loss beyond the rough one-in-100-year level.
The insurer’s latest deal priced at 625 bps, a rise of nearly 80% compared to 350 bps on the Sanders Re Class A notes placed in March which had a similar expected loss of under 1%.
Sources said current market conditions would be “prolonged”, continuing until at least mid-year 2023. Others called it a “two- to three-year” opportunity.
“Near-term, some top-up capital will come in Q1 but not enough to change market conditions,” one predicted.
Secondary market trading is freeing up capital to some extent, particularly trades in short-dated, non-Ian-exposed bonds, which are being discounted.
At least two anticipated new cat bonds have now not come to market this quarter as broker-dealers advised clients to delay until Q1 2023, because of prevailing market conditions.
Other cedants are seeking lower limits than in previous years, with a view potentially to coming back for more next year.
Liberty Mutual has come to market seeking $125mn of Mystic Re wind and quake cover, less than half of what it achieved last June.
Fidelis’s latest Herbie Re issuance settled at a size of $80mn, which was 20% lower than target and almost halved from the $150mn achieved in its most recent similar deal placed in May 2021.
Peril coverage is also being stripped back. The Herbie Re deal focussed on earthquake risk in California, Oregon, Washington and Canada.
This compared to the $150mn Herbie Re bond placed in May 2021, which covered thunderstorm, winter storm and wildfire, across North America, as well as wind and quake in Japan, Europe, the Caribbean and Australia, and quake in New Zealand and Turkey.
Inigo also trimmed the scope of perils on its new Montoya Re bond down to US wind and quake, after also bundling Japanese risks into its first ILS issuance earlier this year.
Meanwhile, USAA’s recent $195mn Res Re bond showed coverage can be achieved for a range of perils at the right price, with cyclone, quake, thunderstorm, winter storm, wildfire, volcano, meteorite and other perils included.
Primary insurers particularly were thought most likely to struggle to stomach hard market pricing, being less able than reinsurers to pass on rate increases.
On the other side, investors want to show willingness to provide capacity particularly for “strategically important deals.”
These included long-term sponsor USAA’s Residential Re, which raised $185mn, with the Class 3 and Class 5 notes pricing at the top end of guidance, and Allstate’s $100mn of Class A Sanders Re notes.
“We want to find a way to be supportive and to demonstrate that capacity is not going away just because we had another storm,” one said.