Attractive conditions for investors and the growing demand for the transfer of peak risks such as large natural catastrophes, led to a surge in the issuance of catastrophe bonds in 2023.

A new report from Thomas Holzheu, chief economist Americas, Swiss Re Institute and Roman Lechner, P&C economic research lead said the uptick in issuance stabilises the transfer of mounting peak risks.

The report said: “The $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.”

Swiss Re forecast cat bonds expanding further in 2024, with declining collateralised reinsurance.

Capacity limitations in the retrocession market are likely to continue as the increase in cat bonds reinforces the role in transferring peak risks, such as large natural catastrophes.

The increase in cat bonds reinforces the role in transferring peak risks, such as large natural catastrophes.

The report said: “A bumper year for cat bond issuance in 2023 highlights the ongoing transition in the alternative capital market, in which investors can directly invest in [insurance and] reinsurance risks rather than via traded [insurance and] reinsurance companies.

“[Alternative Capital] securities include risk securitisations to transfer insurance risks directly to the capital markets.

“Most risks relate to property catastrophe risks and the reinsurance retrocession market has increasingly come to depend on [alternative capital].

“Cat bond issuance has reached a new record of $15 billion this year, up by 8 per cent from 2022. This takes total capital deployed into cat bonds globally to $41 billion.

“Global cat bond capacity has grown at about 4 per cent 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.”

The report said exposures have been boosted by inflation, longer-term trends of migration, value accumulation and climate change.

“The replacement cost of US residential structures increased 42 per cent from the end of 2019 to end-2022.

“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 natural cat losses have grown by 5-7 per cent annually on an inflation-adjusted basis.

“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. 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.”

But alternative capital capacity is not growing, with Swiss Re estimating the $100 billion deployed in 2023 not higher than 2017.

The report said: “Adjusted for inflation, capacity was 17 per cent lower in 2023 than in 2017. The main driver is declining capacity from collateralised reinsurance, 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.

“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 reinsurance 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.”