ESG and new sponsors spell healthy ILS growth

After a resilient year for catastrophe bonds during the pandemic, the sector is on course for growth with increased investor demand and new types of sponsors, writes Fitch’s senior director Jeffrey Mohrenweiser.

The catastrophe bond market has shown great resilience throughout the Covid-19 pandemic. Unlike other sectors, we did not see a departure of investors, so they clearly still like this space.

Investor demand prevails

In 2021, issuances have exceeded their initial amounts. Sometimes they’ve been oversubscribed by 25 percent or even 50 percent. When investors see a deal they like, they have really stepped up, which has spurred on competition within the group, and we’ve seen spreads come down a bit compared to 2020.

Demand is still buoyant because investors still really value the non-correlation of cat bonds to other sectors and asset classes. For example, they are very attractive to large pension funds that invest in real estate, corporate and high-yield bonds.

But it’s a niche market. It takes a special group of investors to take these assets on and the majority of them have been in the market for dozens of years so are very familiar with how they work.

We normally rate these bonds at non-investment grade because of the catastrophe risk, but you could get 200-300 basis points over Libor for them, which makes them attractive alongside the zero correlation to other asset classes.

This keeps existing investors interested.

New types of sponsors

Additionally, the cat bond market is no longer only catering for the risks of the insurance community.

We are seeing new and unique sponsors come to market such as governments, the World Bank or companies. For example, the Danish Red Cross sponsored a $3mn cat bond that covered volcanic eruptions. If the plume reached a certain elevation, the bond would be triggered and that would allow the charity to then expedite its relief efforts. Meanwhile, one of the World Bank’s pioneering pandemic bonds, launched in 2017, triggered when the coronavirus ravaged the world.

Some large corporations, including Google, have also issued a California earthquake bond because they feel they are not getting enough insurance coverage for their property and risks. Another example is asset manager Blackstone’s real estate arm, which this year issued a California earthquake bond for its properties. We may see more corporate sponsors working through their captives to do just that.

The new interest from non-insurers is a sign that the cat bond market, as an alternative capital route, has now reached a level of maturity.

In 2020, the cat bond market paid out around $810mn for losses, which probably sent a signal to various sponsors and maybe even new investors that these cat bonds do pay out. That $810mn represented about 90 percent of the scheduled maturities, which meant 10 percent went back to the sponsor and 90 percent to the investors.

ESG is opportunity

ESG, especially climate change ahead of COP26 this October, is a very hot topic for investors – and it offers a great opportunity for further growth of the cat bond market. While these products can help satisfy investors’ thirst for ESG, the key challenge for ILS fund managers, which tend to buy most of the cat bonds, is to analyse and document why they should be tagged with the ESG label.

There are a lot of different reporting standards across the globe as ESG is still in its nascent phase. When we start getting robust reporting working its way through the supply chain, ESG has the potential to really expand the market.

But until there’s a unifying regulation reporting standard, it will take another couple of years before ESG really starts taking off in the ILS market.

From new types of sponsors, continued investor demand for non-correlating assets as well as hunger for ESG, the cat bond market is set for yet more growth over the coming year.