Moore’s Law

The press is full of superlatives these days – biggest market, largest bond, most sponsors, lowest yield. As records seem to be falling increasing rapidly we take a look at the market trajectory

ComputerGordon Moore famously predicted that the number of transistors on integrated circuits would double every two years. This forecast of rapid, exponential growth has remained remarkably accurate for almost 40 years.

The size of the natural catastrophe bond market has been doubling about every three and a half years (23% per year) since January 2000 – a little slower than computer technology but pretty fast. The rate was quicker immediately before the financial crisis and slower in the years after.

The amount of premium paid to support coupon spreads has increased even more quickly as tranches became less remote – about 28% per year over 14 years. Swiss Re estimate that real growth of global, non-life insurance premiums has been less than 3% per year in recent years.

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The first few months of this year have been unusual – the total principal has increased by about 7% but the total coupons has decreased by about the same amount.

One metric that seems to have plateaued over the last five years is the proportion of bonds with exposure to Atlantic hurricanes. Measured by principal, it is over 70%. Measured by coupon it is over 80%.

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But pricing is what many observers are most interested in and it is clear that prices are falling at least as fast as the market is growing.

Few things illustrate current market conditions as clearly as the bonds that Florida Citizens issued in 2012, 2013 and 2014. For a very similar level of risk, investors demanded coupon spreads of 17.75%, 10% and 7.5% in consecutive years. The expected profit (coupon less expected losses) fell by over 40% each year.

Data from RMS tells a similar story using secondary market pricing and seasonality adjustments. The 'Cat Adjusted Spread' for US hurricane fell by over 40% in the 12 months to March. Registered users can click here for the full chart.

These figures may prove to be useful leading indicators for commentators looking for guidance on the outcome of the upcoming Florida renewal season.

The average tenor of securities has been creeping up – most bonds launched this year have been have had terms of four or even five years. Perhaps this is an indication that sponsors and their advisors feel that the pricing is close to its floor and they are trying to lock in prices.

Mr Moore once pointed out, "It can't continue forever. The nature of exponentials is that you push them out and eventually disaster happens". If banks are successful at bringing diversifying (non Atlantic hurricane) bonds into the market then there is no reason why it couldn't double in size once again. But perhaps there is a natural limit to how long yields can continue to fall.

    

A note about our data – data has been gathered from private and public sources but InsuranceLinked is unable to verify its accuracy. But we do aspire use data that is as accurate as possible – if you spot an error or omission, please write to editor@insurancelinked.com and it will be corrected quickly. Where exposure information was not available, conservative estimates have been made. In this article, exhibits have been filtered to include only public cat bonds with exposure to natural catastrophes.

Adam Alvarez works as a consultant for insurance linked funds and their investors. He can be reached at adamalvarez@adamalvarez.com

Posted: Monday, May 12th, 2014