Upwards pressure on cat bond spread multiples to persist into 2023: Schroders Capital
It is a compelling time for investors to build on their insurance-linked securities (ILS) allocations Schroders Capital believes, with the asset manager forecasting persistent cat bond spread widening into 2023.
Schroders Capital explains the supply-demand imbalance being seen across reinsurance markets, as well as the macro-financial volatility experienced and how these factors had already started to drive wider catastrophe bond spreads earlier this year.
The cat bond market was seen as “in equilibrium coming into 2022,” but everything changed in February, the manager notes.
“Due to a drought of underwriting capacity, it was already expected that the next issuance cycle would bring substantially higher yields,” the investment manager said.
Inflation took hold, assets sold off and balance-sheets in the insurance and reinsurance industry suffered.
Insured values are elevated on the back of inflation, driving demand for protection, just at the time capital levels are subdued in the industry.
On top of this, capital market investor cost-of-capital is higher, which is affecting deal terms across many asset classes.
Then along came hurricane Ian, which Schroders Capital calls a “tipping point”, saying that the loss this storm caused has now amplified this cat bond spread widening trend.
On whether now is the time to deploy more capital into catastrophe bonds and ILS, Schroders Capital said, “We believe that the current spread that investors can secure is compelling – in the mid-teen range – when adjusted for the expected impact of Hurricane Ian.
“However, it is possible rates will harden further as elevated demand hits limited supply in the new cycle.”
They highlight the high multiples now being seen among the first catastrophe bonds to come to market in the fourth-quarter of the year, with some pricing much higher than guidance, but also failing to secure their initially targeted levels of reinsurance capital.
Activity levels are increasing too, which Schroders Capital feels is a positive sign.
“The number of new bonds in the market at the same time is higher than normal,” the manager explained, adding “This is another sign of the pressure on sponsors to seek protection, in addition to that which is available in the traditional reinsurance market.”
Leading them to forecast, “We expect this will cause the upwards pressure on spread multiples to persist into 2023.”
As a result, Schroders Capital feels it is a compelling time for investors to build on their ILS allocations, ending by pointing out that, on the back of higher spreads and risk-free rates, a repeat of a catastrophe even on the scale and cost of hurricane Ian would result in a smaller impact on ILS fund performance going forwards, as yields provide an added buffer.
