Aon’s Schultz: no stopping cat bonds, missing out ‘negligent’

Property insurers pinched by a still-dislocated reinsurance market are all but destined to generate record cat bond issuance, an asset class that has long commanded the terms that reinsurers are still pressing to achieve in the current hard market,  Aon’s chief of ILS operations told Intelligent Insurer.

“For the large buyers of property cat, it seems almost negligent to not consider transferring some of that risk to the capital market,” Paul Schultz, CEO of Aon Securities, told Intelligent Insurer of market conditions.

Investors are sufficiently enticed to make it happen. “We should easily set a record for new issuance in the market this year,” Schultz said.

Records are already coming quarter by quarter, leaving the market within seeming striking distance of the annual record after just the first six months. First half gross issuance neighbourhood $9 billion had nominal outstanding up $2.8 billion, Aon said. That pushed the total ILS market past the long-sought $100 billion mark even as collateralized reinsurance continues to stagnate.

Investors seem to know what they want and cat bonds are more than the flavour of the month, and certainly not just a bottom-feeder’s target after Hurricane Ian knocked wind out of the market in late 2022. Interest even accelerated as cat bond pricing regained pre-Ian levels through Q1 2023, then continued to distance them thereafter.

“We speak to investors, how they prefer to invest and, once they've decided on insurance risk, what is the best product for them,” Schultz said of his year to date drumming up business and how cat bonds distanced collateralised products. “In the current market, cat bonds are getting that marginal dollar.”

The marginal dollar is no marginal add-on. Third party capital may be only neighbourhood one sixth of reinsurance capital overall, but with cat bonds tilted heavily towards property cat and traditional reinsurance capital spread out over the full swathe of reinsurance lines, ILS weighs in heavily in the property cat mix.

Cat bonds beat other elements of the ILS spectrum for investor attention in part for having already included the very characteristics and structures that reinsurers have been seeking most ardently in the current hardening cycle.

The higher attachment points and higher placement in reinsurance towers enjoyed by cat bonds look like a redux of 2022 reinsurer demands. Those elements had already put cat bond performance close to the marketing promises, Schultz noted. Compare collateralised reinsurance, sitting lower in towers and getting hit by the wider range of events that had been knocking the broader reinsurance industry.

And the cat bond market had likewise already turned towards single-peril and event-triggered structures, also in line with demands heard throughout recent treaty reinsurance renewals. A one-time interest in aggregate-triggered cat bonds had long since turned passé.

“Redeploying capital into the marketplace following Ian, it was pretty clear that from a relative risk to return analysis, and given where rates have moved for all property exposed business, the greater value lay in cat bonds,” Schultz said of the investment manager calculus triggering the current rally in issuance.

That comparative risk-return profile may have shifted some money out of collateralised reinsurance and retro into cat bonds, but Schultz sees a broader money flow. He puts the run up in investor moneys to a mix of higher ILS allocations from existing investors and some new players coming into orbit.

“More of it is just fresh capital coming into the marketplace,” Schultz said. He offers hints that increased risk margins on cat bonds “now look attractive enough to bring some hedge funds back” for the first time in ages.

Schultz’s early view to the possible H2 deal pipeline suggest a strong run September to year-end, in part as groundwork for 1/1 renewals, but preceded by the rather traditional Q3 hiatus as hurricane-exposed cedents already have their cards on the table.

“All things aligned, you still have a good supply of capital from investors, still good demand from issuers and all things being equal from where we sit today. Unless something changes, we should see a pretty active end of the year.”

While Schultz can’t seem to oversell his superior return argument for cat bonds, he is far from writing collateralised reinsurance out of the picture for the long-term. “Where we are doesn’t say where we will always be,” he told Intelligent Insurer. “There will be other times when there will be greater value seen in collateralized than in cat bonds.”

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