Resilience bonds uncertain but rising corporate interest in cat bonds likely: Sidley

Resilience bonds, which are catastrophe bonds with an incentive to invest in infrastructure by offering premium rebates, are being promoted by many as a key new way to help protect infrastructure against the risk of rising climate volatility. But experts at US-based law firm Sidley Austin point out that problems with modelling and timing are hindering the development of this potentially critical market, and the use of traditional cat bonds by bodies such as the World Bank may be a more fruitful route. In its 2022 Global Insurance Review, the law firm also sees rising potential within the insurance-linked securities (ILS) market to help the traditional insurance and reinsurance markets help deliver badly needed fresh capacity for this equally fast-rising risk. And it expects an increase in interest among corporates in the catastrophe bond market, following the entry of Google holding company Alphabet into the market in 2020 and others such as logistics firm Prologis. “Resilience bonds…have been gaining attention recently, with high-profile individuals advocating on their behalf… Samantha Medlock, senior counsel on the US House Select Committee on the Climate Crisis, told the BBC that ‘resilience bonds are, in [her] view, the next exciting and innovative frontier in infrastructure and resilience finance’,” points out the law firm. “Despite the potential benefits, these bonds have failed to take off, largely in part due to problems in modelling and timing. Some critics think that such bonds could work only on a local scale. Others suggest that standard catastrophe bond or ILS structures could be used to achieve similar goals, by having the sponsoring entity use a payout for reinvestment rather than to pay insurance claims,” continues the report. Sidley points to several catastrophe bonds issued on behalf of countries by the World Bank, as well as sovereign catastrophe risk pools for the Caribbean (CCRIF-SPC), Africa (ARC), and the Pacific (PCRIC) that support government rebuilding efforts. “Whether resilience bonds gain more traction in the future is not yet certain, but the ILS market may be able to participate in addressing growing concerns over damaged infrastructure due to climate volatility,” suggests the law firm. Overall, Sidley expects the alternative risk transfer market will continue to attract capital for specialty risks and sees greater involvement of corporate sponsors following the entry into the market recently by Alphabet, the holding company of Google and its units. “We also expect that the use of alternative risk transfer mechanisms in the P&C market, including in the casualty and specialty sectors, will continue to grow in the year ahead, and the insurance risk asset class as a whole will continue to attract new participants and new capital, despite the losses experienced in recent years,” says Sidley. “Corporate sponsors may become more significant participants in the catastrophe bond market. Following Alphabet’s entry into the market in 2020, other new corporate sponsors entered in 2021, including logistics firm Prologis, as well as a Blackstone entity,” continues the law firm. Sidley predicts that traditional insurers and reinsurers will continue to explore new ways to use third-party capital to their benefit, with cyber risk being one potential opportunity for growth. “Some predict that cyber risk will overtake property catastrophe reinsurance before 2040. Overall, the ILS market will continue to look for new and innovative ways to meet the needs of cedants and investors,” states the law firm. Sidley points out that the Covid-19 pandemic also continued to affect the ILS market. “Some segments of the market experienced a tightening of terms and conditions in response to Covid-19, with protection providers seeking to include communicable disease exclusions to expressly exclude further losses relating to Covid-19 or similar events,” it notes. Despite the impact of the pandemic, catastrophe bonds and other ILS issuances – including mortgage ILS deals – set a new annual record in 2021 at just under $20.3bn. The year 2021 also saw a record number of catastrophe bond transactions (84). The first half of 2021 proved to be busy, with 50 transactions, and 34 followed in the second half, continues Sidley. “In the first six months of 2021, catastrophe bonds and other ILS issuances reached $9.5bn. ILS fund managers continue to actively pursue new inflows of capital, and managers are attracting additional capital from a combination of new investors and existing investors topping up their positions. All of these factors signal a favourable catastrophe bond market environment,” states the law firm. “The relative stability of the ILS market throughout this period, compared to that of other asset classes, further illustrated the value of the ILS asset class, which was previously evident after the 2008 financial crisis and the 2010-2012 European debt crisis. These characteristics of the ILS market have been well received by investors and are expected to continue to attract capital into this market,” adds Sidley.

Resilience bonds uncertain but rising corporate interest in cat bonds likely: Sidley

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