A visit by Insurance Insider ILS to Zurich ILS market participants this month showed that managers were positive on the outlook for cat bond funds despite the prospect of regulatory change, with other areas of focus controlling exposure to convective storm risk and investigating AI potential.
Firms were unphased by the European Securities and Markets Associations’ (ESMA) recommendation to disallow cat bonds in UCITS structures.
The European Commission (EC)’s potential adoption of ESMA’s recommendation, which could take years to enact, is not something of concern at this stage.
ILS managers believed there would be a transition period, with any recommendations accepted by the EC not coming into effect for at least two years.
ESMA issued its view last month that cat bond investments would be better handled under the Alternative Investment Fund Managers Directive (AIFMD), than as a permitted investment in UCITS funds, as they are currently.
This was based on its opinion that cat bonds are “structured in a way which is closer to insurance products than a traditional transferable security.”
Managers noted that, while one benefit of a UCITS-structured product is liquidity, liquidity is not the main attraction of cat bonds for most end investors.
Instead, these investors, typically pension funds, family offices and endowments, and sovereign wealth funds, are locked in for multiple years, valuing the diversification, non-correlation and strong returns offered by cat bonds.
Some managers also noted that a move away from UCITS structures does not mean a shift away from liquidity, and that the ability to trade will still exist outside of the UCITS parameters.
Organic market growth is also expected to create greater liquidity, due to the higher volume of deals that can be traded on the secondary market, and a growing number of managers willing to trade.
Currently, around $14.1bn of cat bond investments are held in UCITS funds, according to data from Plenum Investments.
UCITS AuM has grown by 171% in the five years since July 2020, when the figure stood at $5.2bn.
The assets in UCITS funds now account for around 29% of total cat bond notional outstanding of around $49bn. This is up from around 17% of total cat bond notional outstanding of $30.4bn as of mid-year 2020.
Aggregate deals and SCS exposure
Another point of discussion for ILS managers centred around the structure of aggregate cat bond deals.
Multi-peril aggregate deals, such as Arch’s Claveau Re 2021-1 bond and Fidelis’ Herbie Re 2021-1 note, have suffered principal losses in the last 24 months.
According to the secondary pricing sheet of one broker, as of 30 May, there is only $48mn remaining of the $150mn principal outstanding on the Claveau bond.
Herbie Re was reported as a full loss in June this year, after the Missouri SCS event in March pushed losses beyond the bond’s exhaustion, this publication reported.
Other deals, such as USAA’s Residential Re 2021-11 and 2022-11 notes, are suffering an implied loss based on secondary market pricing.
Increasing losses linked to secondary perils, particularly SCS, has played a significant role in the triggering of recent multi-peril, aggregate deals.
Gallagher Re’s H1 catastrophe report said the first six months of the year caused $33bn in insured losses from US SCS, behind only 2024, 2023 and 2011.
It is also only the fourth time that SCS outbreaks are averaging $1bn in insured losses per event, which also occurred in the 2024, 2023 and 2011 seasons.
As a result, some managers will avoid aggregate structures altogether, believing they are “mispriced.”
“We are cautious around investing in aggregate structures,” one source added.
Others will be selective, investing in those aggregate deals that sit at the top of reinsurance towers.
For example, one manager said that they hold a position in USAA’s Residential Re 2025-1 Class 15 bond, which attaches at $5.525bn of losses for 2025, according to the cat bond investor presentation, but will avoid the lower layer bonds, as they are deemed as too risky.
AI efficiencies
Finally, managers were also discussing early uses of artificial intelligence (AI).
At this stage, AI implementation is around efficiency, using tools such as ChatGPT to condense loss reports, for example.
However, ILS managers have hopes that AI can be used to make better investment decisions and to improve how they provide service to clients, thus giving them a competitive edge in the market.
One ILS manager said that incorporating AI into their models enabled them, within hours of Hurricane Milton making landfall, to predict the size of the insured loss from the event within roughly a 10% variance of the current PCS loss estimate.
Securing this level of accuracy almost immediately post-event can allow managers to source value on the secondary market while competitors are still assessing losses.