Cat bond market finds equilibrium as spreads stabilise higher: Plenum

Spreads in the catastrophe bond market, in terms of both new primary cat bond issuance and secondary marks, appear to have stabilised, signalling the market finding a new equilibrium at higher premiums, Plenum Investments has said.

Zurich-headquartered catastrophe bond investment manager Plenum believes that spreads have now stabilised at their new higher levels.

Recently issued catastrophe bonds have seen their premiums increase “significantly”, Plenum notes, with them now reaching levels not seen since hurricane Katrina in 2005.

The increase in premiums witnessed through December 2022 and January 2023’s new cat bond issuance has ranged from 60% to a little above 100%, Plenum said, depending on the demand for new issues.

However, predominantly the premium increase has been seen to average between 70% and 80%, and Plenum notes that “premium levels seem to have stabilized around that level.”

When the premium increase began in the cat bond market, secondary positions saw their prices decreasing, allowing their spreads to adjust to the new premium environment of higher reinsurance pricing.

Plenum explained that, “With the stabilization of the premiums at the current new high, the price decrease on existing cat bond positions will stop and therefore it appears that the market has reached a new equilibrium at this higher premium level.”

Interestingly, Plenum breaks down how spreads have moved across different buckets of cat bond perils.

Spreads have increased across the catastrophe bond market, not just in US perils, the investment manager explained.

In US hurricane risks spreads have, on average, increased from 7.7% to 14%, Plenum’s analysis found.

In US earthquake risks the increase was from 4.7% to 7.7%. In California wildfire cat bonds it moved from 9.8% to 12%. In European windstorm cat bonds spreads increased from 4.4% to 6% on average. In Japanese typhoon from 3.2% to 5.5%. Finally in Japanese quake cat bonds, spreads rose on average from 2.2% to 3.5%.

In percentage terms, the increases are significant, with US wind cat bond spreads rising 82%, US quake cat bond spreads rising 64%, California wildfire rising 23%, European wind rising 36%, Japanese typhoon cat bond spreads rising 72% and Japanese quake cat bond spreads increasing by 59%, according to Plenum’s data.

The average across those spread increase percentages, so across most of the cat bond market comes out at 56%.

It’s interesting to see how Japanese peril cat bond spreads have moved quite significantly higher, likely due to the fact they were very depressed before the spread increases began.

“The increase across all markets and not just for US hurricane risk is caused by a shortage of reinsurance capacity across the whole industry,” Plenum Investments said.

Concluding that, “It is difficult to forecast how long this premium level will be maintained, however we expect this current hard market to persist throughout 2023.”