Stroking the cat

IFR IMF/World Bank 2020
11 min read
Jonathan Rogers

Interest in insurance-linked securities has risen since the advent of Covid-19, and while the product has been slow to gather momentum in APAC, that seems set to change even though its position on the ESG spectrum is controversial

Stroking the cat

The market for insurance-linked securities (ILS) has grown at a heady pace globally in 2020, issuers and investors alike showing interest from a prevention, yield opportunity and correlation perspective.

Catastrophe bond issuance has dominated supply, chalking up US$10.4bn of issuance in the nine months to September, according to independent research firm Artemis - some US$2.6bn higher than the same period last year and cementing the growth dynamic of a market in which just under US$42bn of securities are outstanding. Just over US$10bn has printed annually in the product over the past four years.

Despite this impressive growth and issuance having emerged in the product from the private sector in Japan, Singapore and Taiwan in recent years, the growth of the product in APAC has been sluggish in relation to that seen in the US market.

But a headline-grabbing trade, and perhaps the shape of things to come for the growth of cat bonds in Asia, emerged last November, when the World Bank raised US$225m in a two-tranche deal for the the Republic of the Philippines, with US$75m raised at three years to cover against earthquake risk and a like-tenor US$150m tranche providing tropical cyclone cover.

That deal - listed on the Singapore Exchange with GC Securities and Swiss Re acting as structuring agents, bookrunners and managers and Munich Re on the deal as structuring agent, placement agent and manager - represented the first cat bonds to be sponsored by the government of an Asian country and was a model of multilateral-government cooperation, with the Philippines enjoying the World Bank’s Triple A credit ratings as well as its expert technical assistance.

The template for the deal has been used by the World Bank before for cat bond issuance on behalf of governments in Central and South America, and involves principal reduction in the event of a disaster which meets certain parameters, in this case modelled by independent research firm AIR Worldwide and involving earthquake and tropical cyclone force and contingent on staggered losses to the Philippines economy as a result of the perils occurring.

Total principal wipeout will occur if an earthquake causes losses to the Philippines economy of Ps115.8bn (US$2.4bn) or higher, and the same if a cyclone causes Ps152.7bn of economic fallout.

Following the Philippines deal, there is growing interest in the product in Asia, with Covid-19 having sharpened the minds of governments to the need for disaster insurance in a region vulnerable to earthquakes, typhoons and hurricanes.

And there is a ready audience looking to book paper which has a low correlation to broad market volatility and which offers a generous yield pick-up to the scant returns available in the US dollar fixed income space. The Philippines deal offered low correlation in its floating-rate format and attractive risk margins of 550bp and 565bp on the respective tranches.

“Asia has historically been an underinsured region versus the US, with economic losses due to catastrophes having totalled US$776bn in the region over the past 100 years, of which only around 9% was insured, versus some 38% in the US," said John Corbin, managing director in the financial institutions group at Citibank in New York, citing data compiled by AIR Worldwide.

“Undoubtedly, there has been an increase in interest in ILS in the midst of market volatility as the result of fallout from Covid-19 due to the product’s low correlation coefficient rate, credit and market risk, and this is an attractive proposition for institutional investors such as pension funds and life insurance companies.”

The listing of the Philippines cat bond in Singapore continued the momentum established in February last year, when the first issuance of the asset class to list in the city state printed via a A$75m (US$53m) Orchard ILS which provides catastrophe protection to Australia and New Zealand underwritten by Insurance Australia Group, and which was the first issuance using a Singapore-domiciled Special Purpose Reinsurance Vehicle (SPRV).

That deal was subsidised by the Monetary Authority of Singapore - which covered 100% of the upfront issuance costs up to S$2m (US$1.5m) under an ILS grant scheme - and underscored the authorities’ ambition to make the city state a domicile hub for ILS within the region.

The scheme has certainly borne fruit, with nine deals pricing since it was introduced last year, and market players have reported notable interest interest in the product from Japanese investors as they look to beat the negligible yields available in the domestic debt markets.

The scheme will run until the end of 2022 and Singapore has broad ambitions within the ILS asset class, with the MAS’s assistant managing director, Benny Chey, stating at a virtual conference in July that the aim is to broaden the market into areas such as pandemic, cyber and climate risk.

“The Singapore exchange is assessing the feasibility of introducing a platform for the listing of catastrophe bonds. We are also keen to grow a vibrant ILS ecosystem based in Asia, to service Asian risks and clients, including structurers and arrangers, modelling firms, lawyers, advisers, loss reserve specialists and ILS fund managers,” said Chey.

"The development of the ILS market within APAC exhibits a dynamism led by Singapore, where the financial authorities have helped encourage the emergence of the cat bond product and the ecosystem of ILS for the region,” said Cory Anger, managing director ILS Origination and Structuring (New York) at GC Securities.

Hong Kong is looking to emulate Singapore in developing an ILS market, having in August approved issuance of the product within the territory, with Hong Kong’s ambitions first unveiled in the 2018 and 2019 budget and with the regulatory regime likely to become effective before the end of the year. The Insurance (Amendment) Bill 2020 sets out a special purpose insurer (SPI) structure under which cat bonds and other collateralised reinsurance products can be brought to market.

“Hong Kong's recent legislative approval of insurance-linked securities has been greeted with excitement in the ILS community, with both financial hubs seen as complementing rather than competing with each other - with Hong Kong's initial focus as a conduit for Chinese insurers and reinsurers to access the global ILS market,” said Anger.

“There is a need for more insurance penetration in Asia, and that creates a positive underlying dynamic for the development of the ILS market within the region. Asia also represents an attractive diversification play for investors and an opportunity to balance portfolios which may for example have concentration risk in relation to US perils,” said Citibank’s Corbin.


Still, there has been noise within the ESG community - particularly in the aftermath of Covid-19 - regarding the appropriateness of the cat bond as an instrument. This is partially the result of a pandemic bond issued in 2017 by the World Bank to cover losses incurred as the result of the Ebola outbreak in Africa that provoked controversy due to the long period of payout disbursement to the countries covered. It took 136 days for the funds to arrive due to the thrashing out of legal parameters in the bond’s documentation.

“If there are any criticisms to be made of the asset class, it is whether it is an appropriate instrument for multilateral banks, governments and other international organisations,” said, Kamran Khan, head of ESG for Asia Pacific at Deutsche Bank in Singapore.

“The interest of these type of institutions should be to ensure that capital is ready to be deployed when disaster strikes, capital is secured at pre-disaster market terms/pricing and, very importantly, the disaster recovery agencies are incentivised to remain prepared for disasters. Transfer of financial risk is typically not part of their mandate.”

With cat bonds having originated out of the reinsurance sector and where issuers are still active, the product is seen as an ideal model for public-private partnership within Asia.

"The product can serve as a good example for successful risk-transfer public-private partnerships, involving insurers, capital markets investors, governments and multilateral organisations,” said Michael Schwarz, managing director, head of public sector, Asia Pacific at Guy Carpenter in Singapore.

"When it comes to pandemic, the risk is systemic, and hence challenging for reinsurance markets to achieve effective diversification across geographies and business lines.”

In the face of rising global concerns regarding credit quality and default risk, cat bonds represent an appealing asset class thanks to a history of predictability in terms of risk profile - even if the higher-yielding tranches of cat bonds present the possibility of principal being wiped out.

"The fact that the almost 20-year performance of the 144A cat bond market, in terms of triggered payouts, has matched up to modelled losses has provided great confidence to investors,” said GC Securities’ Anger.

Meanwhile, Citibank’s Corbin proposed tweaks to the instrument to ease the burden on governments in the event of natural disaster occurrence:

“There is potential to consider the issuance of cat bonds whereby the tenor could be extendable in the event of a trigger event, to ease the burden on say a sovereign issuer.

"Rather than having to face redeeming a hard bullet maturity in the event of an earthquake or typhoon which could lead to a sovereign ratings downgrade, a country could have the option of extending maturity, perhaps with a coupon step-up included.”

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