Catastrophe bond prices have been falling in 2014, but they may not sink any lower, Fitch Ratings suggested in a statement Tuesday, pointing to Munich Reinsurance Group’s decision to pull its Queen Street X bond last week.
Munich Re announced last week that it had withdrawn its latest catastrophe bond issuance due to weak demand, Fitch said, characterizing the demand weakness as “a signal of investor restraint due to less favorable price-to-risk terms.”
Pushback on the deal’s pricing could be a sign that investors are approaching a limit on acceptable catastrophe risks, Fitch said. Before this, cat bond investors in 2014 were willingly accepting higher levels of risk at lower risk premiums. Fitch believes that this is because the investors still viewed the cat bonds as attractive compared to other asset classes. Diversification benefits relative to traditional investment market risks were another attraction, Fitch said.
Ratios of risk premiums to expected loss have fallen dramatically in the cat bond market over the past several years, with investor demand greatly exceeding available supply. Fitch noted that the decline is clear just from a review of the Queen Street transactions: the ratio for Queen Street VI, issued in 2012, was 4.72-times; Queen Street IX, issued this year, was 2.02-times.
Although the perils were different, the underlying expected loss remained relatively constant at 2.7 percent, while the risk premium declined to 5.50 percent from 10.35 percent.
If Queen Street X had been placed at the lower end a price range between 4.75 percent and 5.50 percent, it would have been one of the first bonds for which the risk premium/expected loss ratio would have fallen below 2.0-times.
- Through first-half 2014, nearly two dozen catastrophe bonds with varying risk levels were issued globally with an average risk premium of approximately 4.3 percent.
- This compares to the same period of 2013, which experienced an average of 5.7 percent.
- Of the bonds issued in 2014, four individual tranches were issued at a risk premium to expected-loss multiple of less than 3.0-times: Residential Reinsurance 2014, Ltd. (Class 10 Tranche: 15 percent risk premium), Queen Street IX Re, Ltd. (5.5 percent), Lion I Re, Ltd. (2.25 percent), and Kilimanjaro Re, Ltd. (Class A: 4.75 percent).
During the June-to-November, Fitch believes that the catastrophe bond market will see less U.S. named-storm peril issuance coming to market, while other perils are expected to continue to be issued at relatively low risk premium/expected loss multiples throughout the remainder of the year.
As the market approaches a floor for cat bond pricing, the risk premiums paid to investors will be an important factor in determining the demand for cat bond transactions, Fitch said.
Source: Fitch Ratings