Property Claim Services Claims and Crime Analytics PCS Full-Year 2013 Catastrophe Bond Report: Underlying Change
OVERVIEW Last year was the busiest in the history of the catastrophe bond market. Sponsors raised $7.2 billion in capital through 32 transactions. In addition to approximately matching the 2007 year-end result, the transactions completed last year show an increase in market maturity. Developments discussed for years from cat bond lite to midmarket participation occurred in enough volume that the market could not dismiss them as merely opportunistic. The market has demonstrated that it can support growth through more than just large deals exposed to peak U.S. perils. The diversity and innovation underlying this year s headline number are poised to support broad growth going forward. As in the broader market, a strong PCS performance benefited from new market dynamics. Catastrophe bonds in the $75 million to $500 million range used data from PCS in both index- and indemnity-triggered deals. Also, three catastrophe bonds used data from the PCS Canada service. Five sponsors used PCS data for the first time four in index-triggered catastrophe bonds reflecting more than $1 billion in new limits. Expanded use of PCS demonstrates there is room for new thinking even for index-triggered deals that cover peak perils in the United States. FULL-YEAR 2013 CATASTROPHE BOND ISSUANCE According to data from the Artemis.bm Deal Directory, insurers and reinsurers issued approximately $7.2 billion in catastrophe bonds in 2013, up 23 percent from $5.9 billion in 2012. Transactions with U.S. risk continued to dominate the market, representing $5.4 billion 1 in capital, up 11 percent year over year. Average deal size fell from $236 million in 2012 to $226 million in 2013, largely because of the many smaller transactions ($200 million or less) completed. The averages do not include cat bond lite and private transactions, both of which came to market last year. Those developments speak to the increase in flexibility now available in the global catastrophe bond market, particularly for smaller sponsors. 1 This includes catastrophe bonds that included the United States and other regions. PCS 4Q2013 Catastrophe Bond Report 1
Full-Year 2013 Issuance Activity FY 2013 FY 2012 PCS trigger use ($ billions) 2.8 3.1 PCS trigger use (# of transactions) 14 15 North American issuance ($ billions) 5.4 4.9 North American issuance (# of transactions) 27 21 Total issuance ($ billions) 7.2 5.9 Total issuance (# of transactions) 32 25 Sources: PCS, Artemis Deal Directory Sponsors used data from PCS as the trigger in 14 catastrophe bonds, representing approximately $2.8 billion in fresh capital, essentially consistent with the full-year 2012 result. Beneath the overall issuance volume, however, there was much more diversity than in past years. Sixty percent of transactions covering Canadian risk used data from the PCS Canada service and the total number of catastrophe bonds including Canada jumped from two in 2012 to five in 2013. Four indemnity-triggered catastrophe bonds used PCS for catastrophe designation, including one from a first-time sponsor. And deal size varied widely. Tar Heel Re, the largest issuance of the year at $500 million, used PCS (for catastrophe designation). At the other end of the spectrum, ten catastrophe bonds of $200 million or less used PCS data. Fourth-quarter issuance reached $1.8 billion, in line with the fourth quarter of 2012. Of the six bonds that included the United States, four used data from PCS, three in index triggers. Two came from first-time users of PCS data. Galileo Re, sponsored by Catlin, uses the PCS Catastrophe Loss Index for both the United States and Canada. Catlin last turned to the catastrophe bond market in early 2008 with Newton Re, an indemnity-triggered transaction. American Modern Insurance Group, a first-time catastrophe bond sponsor, used PCS for catastrophe designation in Queen City Re. PCS 4Q2013 Catastrophe Bond Report 2
Historical Q3 Issuance Activity 2400 2000 1600 1200 800 400 0 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Sources: PCS, Guy Carpenter & Company, LLC Fourth-quarter issuance was in line with the average since 2009 ($1.8 billion) when the market regained its momentum after the global financial crisis and followed the most active third quarter in the history of the catastrophe bond market, in which sponsors raised $1.5 billion. While the number of fourth-quarter issuances remains unchanged year over year (at seven), the average deal size fell slightly from $270 million in 2012 to $261 million in 2013. PCS CANADA Interest in Canadian risks surged in 2013. (In the past, catastrophe bonds only occasionally included such risks.) Five catastrophe bonds with exposure to Canadian risks came to market, up from two in 2012. Of the transactions completed last year, 60 percent used data from the PCS Canada service, and the two that did not came from the same sponsor. Two of the catastrophe bonds using PCS Canada are from sponsors that have used this data in the past, with Catlin s Galileo Re using it for the first time. In addition to catastrophe bond issuance activity, PCS has noticed an increase in inquiries about the PCS Canada service for internal use, and we are aware of industry loss warranties (ILWs) with exposure only to Canadian risk. While future activity will be determined by the risk and capital management needs of cedents and investors, we believe that this trend could continue through 2014. PCS launched its core service in Canada in late 2009, marking our first operation estimating catastrophe losses outside the United States, Puerto Rico, and the U.S. Virgin Islands. Since then, PCS has designated 32 events as catastrophes in Canada five in 2013. To get started with PCS Canada, please contact Don Hahn at +1 201 469 3115 or dhahn@verisk.com PCS 4Q2013 Catastrophe Bond Report 3
CATASTROPHE DESIGNATION IN ILS Indemnity-triggered catastrophe bonds have become more common in part because of prevailing market conditions. Within the category, use of PCS for catastrophe designation has grown. In 2013, three sponsors completed four indemnity-triggered catastrophe bonds with PCS catastrophe designation, representing just over $1 billion in capital. With PCS catastrophe designation, only claims assigned a PCS catastrophe number count toward attachment and exhaustion points. That approach provides an independent thirdparty perspective and offers protection against moral hazard. Some investors may find those benefits attractive. PCS catastrophe designation can be particularly useful for perils such as thunderstorm, tornado, and wildfire, where another third-party standard (such as NOAA) is not available. For PCS to designate an event a catastrophe, it must generate an industrywide insured loss of at least $25 million and affect a significant number of insurers and insureds. The PCS team reviews 40 to 50 events a year in the United States that have the potential to become catastrophes and designated 29 of them catastrophes in 2013. CONTINGENT CAPITAL In the fourth quarter of 2013, Swiss Re used the PCS Catastrophe Loss Index as a trigger in a contingent capital transaction. This is the first time anyone has used PCS data for that purpose. PCS first raised the prospect of using our index in such transactions in PCS Third-Quarter 2012 Catastrophe Bond Report: The Calm before the Fourth-Quarter Storm. An industry catastrophe loss index trigger in contingent capital transactions can help insurers raise capital following a large catastrophe event. At the same time, such transactions can mitigate the risk of increased costs that can accompany periods of peak demand, especially if broader economic conditions are unfavorable when the need occurs. Past contingent capital programs in the insurance and reinsurance industry have had triggers for both catastrophe losses and macroeconomic events. As the contingent capital market evolves and achieves wider adoption among insurers and reinsurers, it will have to demonstrate flexibility to meet a broad range of issuer needs. The catastrophe bond market has succeeded because it has demonstrated such flexibility, along with the ability to cover a number of perils with several triggers for varying amounts of time. The contingent capital market shows the same potential. For more information about using the PCS Catastrophe Loss Index in contingent capital transactions, please contact Tom Johansmeyer at +1 201 469 3140 or tjohansmeyer@verisk.com. PCS 4Q2013 Catastrophe Bond Report 4
CATASTROPHE BOND TREND TRACKING The growth and maturation of the catastrophe bond market in 2013 provide a sense of its direction in 2014. Rather than continued issuance increases for common risks (such as U.S. wind), it appears that the market has developed a much larger platform for growth, thanks to the underlying diversity in issuance activity last year. Midmarket sponsors showed signs of potential (in Florida, for example). And new structures that meet the specific needs of unique cedents (such as MetroCat Re) reveal the potential for continued innovation. 1. Continued issuance growth Increases in traditional issuance activity and participation from new sponsors and regions appear to have made high levels of issuance the new norm, regardless of whether 2014 turns in record-breaking results. Innovation will also contribute to future market growth as stakeholders continue to seek new ways to improve risk and capital management through techniques that resonate with investors. 2. International diversification In 2013, catastrophe bonds covering risks in Turkey, Japan, and Australia came to market, representing an increase in diversification. U.S. risks continued to dominate, but Canada and Europe featured more prominently than in years past. Appetite for diversifying transactions appears to be on the rise. In fact, the market has responded favorably to PCS s plan to expand into South Korea working closely with the Korean Fire Protection Association (KFPA). Establishing the potential for index-triggered catastrophe bonds in the new regions should contribute to future market growth. PCS and the KFPA expect the service in South Korea to launch in 2014. PCS is committed to helping local insurance industries around the world access industrywide catastrophe loss data. In addition to helping them with catastrophe response, claims payment benchmarking, and loss reserving, such efforts should help open new opportunities for risk transfer to the capital markets. 3. Deeper midmarket penetration The prevalence of smaller deals in 2013 represents an important step forward in efforts to engage midmarket cedents. Ahead of the June 1, 2013, reinsurance renewal, catastrophe bonds were a hot topic among Florida cedents, two of which entered the market. And the emergence of new cat bond lite platforms could help further engage smaller potential sponsors. Depending on risk profile, index transactions may be easier for this sector to execute given the lack of underwriting, ease of understanding, and the elimination of concerns about a sponsor s data. Those factors could facilitate further midmarket penetration. 4. Continued innovation Cat bond lite platforms were just the beginning in 2013. Some sponsors looked at existing resources in new ways. For example, Allstate used only personal property and auto estimates from PCS in Sanders Re. And market participants continue to explore new ways to use data from PCS and other sources to improve risk and capital management. Further, new projects are in the works. PCS and the Cayman Islands Stock Exchange, for example, are working on an exchange-traded risk program that would bring cedents and markets together in a listed ILW environment. PCS 4Q2013 Catastrophe Bond Report 5
5. Indemnity discipline The increased use of indemnity triggers has led to greater adoption of PCS catastrophe designation for those deals. The trend should continue, especially as sponsors become more ambitious in transaction structuring. Also, catastrophe designation would make it easier for experienced sponsors to include perils other than U.S. wind and earthquake in indemnity-triggered catastrophe bonds. ILW LICENSING UPDATE For ILWs with exposure to U.S. and Canadian risks, PCS data is the index of choice. Despite the use of PCS in the overwhelming majority of transactions, many still use it improperly. PCS is committed to helping the ILW market remedy the situation. Authorized use of the PCS Catastrophe Loss Index requires an ILW issuance license not an internal use license. Only one party to the transaction (cedent, capital provider, or intermediary) needs to have a license. Historically, the capital provider has usually had the license. However, PCS is willing to be flexible in serving the market, and we remain neutral on which party should hold the license. Pricing may vary with portfolio size, and PCS is open to annual licenses that allow the licensee to write as many ILWs as it wants. If you receive a PCS catastrophe bulletin from an intermediary or other market participant and use it in a transaction, you are engaging in unauthorized use of our intellectual property. The PCS team has discussed the unauthorized use of our data, and we feel it is fundamentally unfair to the companies that pay license fees and use the data properly. PCS has already begun to address unfair use in the market, and we plan to increase those efforts significantly in 2014. We see this as following through on an important commitment to our clients. In addition to compliance, there are many benefits to proper licensing and use of the PCS Catastrophe Loss Index. You ll receive: access to the PCS team for any questions you have about the data or underlying methodology catastrophe bulletins supplied directly by PCS in the event of a dispute the only way to receive a known legitimate copy historical data you can use to explore new risk-transfer opportunities (such as statespecific ILWs for perils such as wildland fire) PCS presentations and other sessions for your company to discuss catastrophe trends, strategic initiatives, and other relevant issues PCS 4Q2013 Catastrophe Bond Report 6
If you re not sure if you re in compliance and would like to address the matter proactively, please contact Tom Johansmeyer at tjohansmeyer@verisk.com or at +1 201 469 3140. PCS has developed a number of licensing models designed to meet the needs of a wide range of issuers and keep frictional costs to a minimum. Or simply visit http://my.iso.com/ilwtrigger to get started. CONTACT PCS For more information about PCS, please use the contacts below: PCS methodology Joe Louwagie Assistant Vice President, PCS +1 201 469 3107 jlouwagie@verisk.com PCS data for ILS transactions Tom Johansmeyer Director of Marketing +1 201 469 3140 tjohansmeyer@verisk.com PCS data for internal use Don Hahn Account Executive Sales +1 201 469 3115 dhahn@verisk.com PCS 3Q2013 Catastrophe Bond Report 7
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