Surge in catastrophe bond issuance stabilises transfer of mounting peak risks

Record-high catastrophe bond issuance in 2023 is a sign of attractive conditions for investors as well as the growing demand for transfer of peak risks such as large natural catastrophes. The USD 15 billion new cat bond issuance will not tilt the supply-demand balance in the global reinsurance market significantly in our view, since alternative capital for reinsurance has been flat overall since 2017 and the retrocession market remains tight.

• Catastrophe bond issuance has reached a record high of USD 15 billion this year. 
• We expect the AC market dichotomy to continue into 2024 with cat bonds expanding further and collateralised reinsurance declining. 
• Capacity limitations in the retrocession market are likely to continue into 2024. 
• The increase in cat bonds reinforces the role in transferring peak risks, such as large natural catastrophes.  

A bumper year for cat bond issuance in 2023 highlights the ongoing transition in the alternative capital (AC) market, in which investors can directly invest in (re)insurance risks rather than via traded (re)insurance companies. AC securities include risk securitisations to transfer insurance risks directly to the capital markets. Most risks relate to property catastrophe (cat) risks and the reinsurance retrocession market has increasingly come to depend on AC.

Cat bond issuance has reached a new record of USD 15 billion this year, up by 8% from 2022. This takes total capital deployed into cat bonds globally to USD 41 billion (see Figure 1).¹ Global cat bond capacity has grown at about 4% annually for the past six years, adjusted for inflation, roughly in line with the growth of global natural catastrophe exposures, as illustrated by Verisk's estimated global aggregate average annual losses (see Table 1).² 

Figure 1: Alternative capital deployment, 2002-2023E, USD billions

The recent inflation surge has boosted exposures in addition to the longer-term trends of migration, value accumulation and climate change. For example, the replacement cost of US residential structures increased 42% from the end of 2019 to end-2022.³ Solid growth in cat bonds is needed to maintain their role of providing capacity for peak risks and therefore freeing up traditional reinsurance capacity for lower layers. Since 1992, global insured nat cat losses have grown by 5-7% annually on an inflation-adjusted basis.⁴

Table 1. Nat cat aggregate average annual loss, AC deployment, annual growth, 2017 – 2023E

We expect investor capital to continue to favour cat bonds as they offer exposure to peak risk layers, where the risk-return profile currently is attractive and liquidity can be provided in the secondary market. Cat bonds have a solid track record despite above-average global natural catastrophe losses annually in recent years.⁵ Based on floating rate collateral, they were also not exposed to valuation losses from rising interest rates. We also see a similar "flight to quality" by investors in the expansion of investment in cat-related reinsurance sidecars in recent years.⁶  

However, overall AC capacity is stalling, with total capital deployed of around USD 100 billion in 2023, we estimate, broadly unchanged from 2017. Adjusted for inflation, capacity was 17% lower in 2023 than in 2017. The main driver is declining capacity from collateralised reinsurance (CR), where investors participate in lower-layer indemnity-based reinsurance structures. CR has suffered poor returns from unanticipated (and unmodeled) loss exposures since 2017. CR structures can also face competitive disadvantages relative to traditional reinsurance in terms of cost of capital (less scale, diversification and need for collateralisation) and underwriting knowledge. Meanwhile, the competitive position of the traditional reinsurance business model has improved strongly with the normalisation in interest rates and the benefits of more asset leverage.⁶

We expect the market dichotomy in AC to persist in 2024, with the cat bond market expanding further and collateralised reinsurance declining. Strong cat bond issuance is complementing and stabilising the traditional (re)insurance markets. The limited and selective deployment of cat capacity will likely continue in the retrocession and reinsurance markets into the next year. We think current hard pricing is not primarily driven by a capital crunch but rather a significant step-up in the cost of capital and elevated economic and model uncertainties; all factors that will continue next year.