Aon’s Schultz on a record year for cat bonds, cyber ILS outlook, and ‘Bermuda-esque’ London Bridge 2

The re/insurance broker has previously put an estimate on at least $15bn of cat bond issuance for this year – which would represent a new record for the market.

“The really fascinating thing about this year is just how quickly the cat bond market changed,” Schultz said.

The final quarter of 2022 saw Hurricane Ian, inflation and foreign exchange movements that augured differently for the ILS markets.

“The combination of that meant that Q4 was one of the most difficult quarters in my career to get through. It was difficult to find capacity and there was a lot of uncertainty about how the market would reprice risks,” Schultz said.

Inflation and FX issues pre-dated Hurricane Ian, which struck in late September.

“Ian was the straw that broke the camel’s back. We still got deals done, we still traded forward, but it was really hard. Smaller deals, wider spreads, and a lot of general uncertainty for transactions,” he said.

“As we got towards the end of Q1 we started to see the benefits of capital coming in and the market started to stabilize. Then as we got into Q2 we saw, much more significant inflows and the heavy calendar of issuance,” he continued.

“At the same time, we saw a tightening of a tightening at risk spreads, because at that point, we had more supply of investment dollars, than demand of issuance. We were in a favorable supply demand imbalance that favored the issuers, so we saw the spread tightening,” he said.

All of which has left the cat bond market sitting pretty, with “elevated growth” expected to continue into next year.

“Now we’re sitting in a relatively attractively priced market compared to traditional markets and compared to other collateralized markets. As a result, we have a significant pipeline going into the remainder of the year and we’re already building a pipeline into 2024. We’re in what I would call a happy market at the moment,” Schultz added.

London Bridge 2

The Lloyd’s market’s London Bridge 2 insurance linked securities (ILS) vehicle is “Bermuda-esque” in the way it has been created and should successfully attract activity the London market, according to Schultz.

London Bridge 2 is the programme created by Lloyd’s, utilising recent changes to the UK regulatory regime, designed to attract more international third party capital into the London re/insurance market.

The original programme was created in 2021 to help Lloyd’s compete with international hubs, such as Bermuda, which specialise in the fast-growing market for insurance-linked securities.

It was expanded last year, London Bridge 2, with new features such as allowing reinsurance contracts to be funded by debt securities.

Schultz said London Bridge 2 benefits in that a lot of the approvals to participate in the programme are done on a pre-approved basis.

London-based companies will likely take part because ’it’s just in their backyard and so they’d be happy to use it’.

He likened London Bridge 2 to Bermuda which has flourished as a domicile for insurance-linked securities.

“Bermuda is obviously a domicile where a high percentage of the transactions get done, in part, because Bermuda has created a streamlined process for review and you have a lot of the expertise for in Bermuda,” he said.

“London Bridge 2 is a little bit Bermuda-esque in the way that it is streamlined and so I think there’s a high probability it will be used.”

Cyber

Schultz told GR he was “very bullish” on cyber risk being transferred over into the cat bond market.

He compared cyber risk transfer and the growth of third-party capital to the early days of the property casualty market when alternative capital began to flourish.

Schultz said: “I think you can draw similar analogies there. Cyber risk doesn’t appear to be getting any less, if anything, it just appears to be getting more complex around us.

“You can make the case that we’re getting into a similar situation where the risk transfer market today might be outgrown in the future.”

He said the inflexion point is being reached, even without a major catastrophe.

“We’re driving to the point, nearly, without a cat. This is simply the demand for cyber protection outstripping the supply and it is natural that the bond market is an alternative to that.”

Reflecting on the lessons from the property casualty market boom in third party capital, he said:

“But in the early days of the property cat market, the market took a simplistic approach.

“It tried not to be everything to everyone, it tried to have a much more narrow focus on what coverage terms were. A much more defined set of risks that an investor could say with certainty ‘this is covered, or this isn’t covered’.

“I think for the cyber market to really take off in the bond market, we’re going to have to get a tight definition of what loss is and what is recoverable. That event definition is really what is taking the time to get results to work.”