What does this mean for the Cat Bond market?
We expect the issues described above and the resulting imbalance between supply and demand to cause (re)insurance premiums to rise and (re)insurance coverage to become significantly more expensive.
Given the expected decline in traditional reinsurance capacity, the alternative risk-transfer (via Cat Bonds) will become increasingly more important, and we expect a strong pipeline of new transactions. However, these will only be able to be placed on investors' terms. The need to recover the losses associated with Hurricane Ian, but also the strong pursuit for sustainable returns on capital for Cat Bond investors over the long term (considering topics like inflation or climate change) will dominate the pricing discussions.
One big question remains, however: Can (re)insurers, who have already suffered significant capital losses from Hurricane Ian, afford paying such high prices? And how is the Florida (re)insurance industry, which was already severely weakened before Hurricane Ian, dealing with this event?
The Louisiana Citizens Property Insurance Corporation, for example, has received approval from regulators to increase its rates for homeowners insurance by 63%. An increase that was necessary to maintain operations due to the increased cost of reinsurance. It remains to be seen if Florida will take similar action. Florida's reinsurance costs are already significant. However, further increases seem almost inevitable for the insurance industry, while becoming almost unaffordable for homeowners. In general, it can be said that the entire industry is on the verge of an upheaval, which can offer interesting market opportunities for Cat Bond investors.
The increase in the yield spread indicated in the illustration below already includes the increase to date of approximately 60% (as of Q2 2022). Consequently, we expect a further increase of approximately 50-80% in 2023. The extent of the final premium increase will depend primarily on the ultimate losses caused by Hurricane Ian and the level of demand or inflow of new capital into the Cat Bond market.
In addition to rising risk premiums, also the collateral return, which is generally invested in money-market funds, has risen sharply in the face of the increasing interest rates, and is expected to rise even further, bringing the total return of new Cat Bonds likely to new high.