Cat bonds down to $34.5bn, top avenue for ILS growth restart: AM Best

Cat bonds will be the first and primary beneficiary of any reheated investor interest in insurance linked securities (ILS), even after a dry spell in issuance in late 2022 took the sub-segment down to $34.5 billion, as returns, liquidity and transparency trump that in lingering ILS segments, analysts at  AM Best have declared.

"If new capital does flow into the ILS market, the cat bond segment is likely to receive an outsized proportion of the new inflows,” analysts wrote in their latest research publication. "Despite performing better than the broader financial markets, ILS funds still face difficulty attracting new capital. The ILS market has not seen a flood of new capital despite significant hardening of prices.”

The outstanding cat bond market at year-end 2022 likely measured nearly $34.5 billion, chiefly in the 144a cat bond format which accounted for some $33.4 billion, AM Best said of its calculations. Full-year issuance of approximately $9.4 billion was down from the record $12.5 billion in 2021.

New issuance was stymied late in the year, chiefly in a drought following Hurricane Ian. H2 average deal size fell to $131.6 million from $233.6 million in H1 and priced at the higher end of initial guidance versus a stronger run from Q2 2020 through Q2 2021 marked by upsizing and pricing low in the range.

Loss multiples, the ratio of the premium paid to investors to the expected loss, told a similar story. The dollar-weighted loss multiple rose from 3.21x in H1 2022 to 5.00x in the second half.

Lingering ILS sub-segments have struggled, either with trapped capital in low or zero-liquidity structures, or with uncertainty about how the reinsurance industry is repricing to get ahead of the loss curve.

Capacity for the largest ILS sub-segment, collateralised reinsurance, likely falls in a range from $45 to $50 billion, AM Best said of its estimate following interviews across the industry.

But collateralised deals lack the liquidity of cat bonds, thus suffering “a high degree of capital trapping.” Ongoing capacity becomes highly dependent on how much trapped capital can be recycled, with some loopholes allowing trapped capital to be released if it is guaranteed for redeployment, analysts noted.

Industry loss warranties (ILW) may sport capacity at an estimated $5 to $7 billion, but their illiquidity leaves them prey to potential sizable capital trapping after an event like Hurricane Ian.

Sidecar capacity is now estimated at approximately $6 to 7 billion, with appetite visibly down “as investors wait to see if the underlying primary insurance pricing increases are enough to make the proportional covers provided by sidecars more attractive,” AM Best analysts wrote.

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