What 2023’s cat bond spread guidance taught us about reinsurance pricing

With more than 100 cat bonds issued at a record volume of roughly $16bn, the 2023 issuance season demonstrated the role the cat bond market’s resilience plays in stabilising the global reinsurance landscape.

But when we look at how the cat bond market is discussed in relation to the wider reinsurance market, it is often at a distance, if not in isolation from the market conditions affecting the reinsurance industry.

So, what else can we learn from 2023 about cat bonds and their role in the global reinsurance industry and specifically what else can the wider reinsurance market learn from the cat bond market during 2023?

One of the significant inferences we were able to draw from our analysis of cat bond issuance throughout 2023 was how cat bond spread guidance helped inform reinsurance pricing. A dynamic reflected in underlying market expectations and one that points towards the potential role of cat bond offerings within traditional reinsurance intermediaries and insurers.

A look at the data

“The data reflects a pleasing and very intuitive result. Afterall, cat bonds are another form of reinsurance and retrocession, which, per se is connected to the reinsurance market. No surprises.” - Sandro Kriesch, Co-Managing Director Acrisure Re Cat Bond Solutions.

Chart 1: Average final spread vs Average initial spread for cat bonds issued in the respective month in 2023. NB. In August and September no bonds with critical cat exposure were issued. Data: Artemis.bm, ARCAS analysis

In January, final spreads were higher than initial indications. This was driven by the fact that the initial guidance was too low and/or investors were asking for higher spreads.

What piqued our interest was why this initial guidance was too low and why were investors asking for a higher spread.

What we found, was that as the market came off a rather challenging 1/1 reinsurance renewal with expectations of a strongly hardening market, the cat bond supply side, the protection buyers, were offering significantly below the asking price, causing initial spreads to be set low. On the demand side, however, the protection sellers, and mostly ILS investors, did not settle for the attempt and asked for higher spreads, driving an increase in spread guidance.

Come February and the following months, however, the high spreads started to be perceived as out of sync, being too close to the price for capital. Spreads needed to decrease, and voila, a correction to acceptable levels set in and spread guidance was decreased.

The cat bonds issued in Q4, then reflected the hardening reinsurance market as investors asked for higher spreads compared to the initial offers.

Chart 2: Average Spread, Expected Loss and Risk Premium for bonds issued in respective quarters 2023. Data: Artemis.bm, ARCAS analysis

At this time, it is worth looking at Chart 2 which depicts the average spread, expected loss and risk premium as well as the spread multiple, spread divided by expected loss, of issued bonds during the respective quarter.

These metrics illustrate the riskiness of the issued bonds. When focusing on EL, Q1 had the most risk compared to Q3 with the least risk. This partially explains the change in spread multiple between 1Q and 3Q, as low risk implies high multiples².

However, why has the multiple not increased from 1Q to 2Q? We believe that here, what we can see is an overreacting market, one that compressed spreads too much after a phase of high multiples.

The connection between cat bond guidance and reinsurance pricing

“Over 2023 we have observed a very active reinsurance market for sellers of reinsurance across traditional and ILS investors. Insurance companies and MGAs are actively considering all reinsurance and risk transfer options for their reinsurance structures. Clients are looking to secure efficiencies across their program structure, with a heightened interest in collateralized reinsurance and especially Cat Bonds.” - Craig Darling, EVP & Head of Critical Cat

While it is difficult to provide robust causation between cat bond spread guidance and reinsurance pricing, the two are, ultimately, two forms of reinsurance subject to the same market shifts as each other.

What is especially noteworthy is that if you concur that the analysis highlighted above does suggest that cat bond spread guidance is indicative of general market pricing, then it is going to be interesting to see the role cat bond services begin to play in informing reinsurance pricing.

Cat bond offerings are already crucial in the way that they provide access to alternative capital, reduce counterparty credit risk, and increase the stability of reinsurance purchases. Likewise, we have already seen the use of catastrophe bond structures being used to hedge life insurance-related risks, such as mortality, longevity, and health insurance claims.

Cat bond offerings are also likely to become increasingly useful when it comes to determining the pricing of incumbent traditional capacity, furthering the angles of market information available to enable the best reinsurance purchase is found, be it through traditional reinsurance or third-party capital making use of a cat bond.

1 August and September: We know of only one bond issued in either month, a mortgage bond (which we do not cover in this article) and a cyber bond for which we did not have the relevant data.

2 Because with less risk modelling uncertainty increases and this more spread is required from the investor.