Insurance-linked securities
Secondary market trading
status: draft
Secondary market trading
Cat bonds are tradeable securities, but the secondary market has distinct characteristics. Understanding liquidity, price discovery, and exit options matters when sizing positions and managing portfolios.
Market structure
Trading venues
Cat bonds trade over-the-counter (OTC) between dealers and investors. There’s no exchange or central order book.
Trading happens through:
- Voice negotiation (phone, Bloomberg chat)
- Dealer inventory provision
- Direct investor-to-investor trades (rare)
Key dealers
The primary structuring agents also make secondary markets:
| Dealer | Role |
|---|---|
| Swiss Re Capital Markets | Largest market maker |
| GC Securities (Guy Carpenter) | Strong primary, active secondary |
| Aon Securities | Growing presence |
| Gallagher Securities | Selective market making |
Dealers hold inventory and provide two-way pricing. Bid-ask spreads range from 0.25% to 1.0%+ depending on deal size, familiarity, and market conditions.
Trading volume
| Market Condition | Monthly Volume (Est.) | Bid-Ask Spread |
|---|---|---|
| Normal markets | $500M-1B | 25-50 bps |
| Post-event uncertainty | $200-400M | 75-150 bps |
| Hard market rally | $1-2B | 25-40 bps |
| Flight to quality | Variable | Widening across board |
Illustrative. See pricing disclaimer.
Most bonds trade infrequently. A liquid bond might trade 3-5 times per month. Many bonds trade only a few times per year.
Price discovery
Pricing references
| Source | What It Provides | Access |
|---|---|---|
| Lane Financial indices | Monthly return calculations, price levels | Subscription |
| Dealer runs | Indicative bid/offer levels | Dealer relationship |
| Primary issuance | Current market clearing levels | Public/broker access |
| Artemis secondary data | Transaction reports | Free (sporadic) |
| Bloomberg BEILSTRR | Total return index | Bloomberg terminal |
What moves secondary prices
| Factor | Direction | Magnitude |
|---|---|---|
| Near-miss event (storm approaches, no trigger) | Prices drop, then recover | 2-10% temporary decline |
| Trigger event confirmed | Prices drop to recovery value | 20-100% decline |
| Hard market (capacity shortage) | Prices rise above par | 2-5% premium |
| Model update (higher EL) | Prices decline | Roughly proportional to EL |
| Interest rate moves | Prices stable (floating rate) | Minimal |
| Sponsor downgrade | Prices may decline slightly | 0-2% unless structural |
| Soft market (excess capacity) | Prices may soften | 1-3% discount |
Mark-to-market practices
ILS funds typically mark positions monthly using:
- Dealer quotes (average of 2-3 dealers)
- Model-based valuation (discounted expected cash flows)
- Recent comparable trades
Marks can diverge from actual executable prices, particularly for less liquid issues. Always ask about mark-to-market methodology when evaluating ILS fund returns.
Executing trades
Normal market exit
To sell a cat bond position:
- Contact 2-3 dealers for bids
- Compare levels to recent trading history and model value
- Execute with best bidder
- Settlement typically T+3
- Expect to give up 25-50 bps on normal-sized trades
Large position exit
For positions >$20M or >10% of outstanding:
| Approach | Characteristics |
|---|---|
| Block trade | Negotiate with single dealer, wider bid-ask |
| Worked order | Dealer sells over days/weeks, lower impact |
| Auction | Contact multiple buyers simultaneously |
| Direct | Negotiate with other buy-side holders |
Expect wider bid-ask (50-100+ bps) and longer execution time.
Entering positions
Primary issuance is the most efficient entry point. Secondary purchase considerations:
| Factor | Primary | Secondary |
|---|---|---|
| Pricing | Market clearing | Bid-ask spread cost |
| Size | Allocations may be limited | Whatever is offered |
| Timing | Deal calendar driven | Available anytime |
| Due diligence | Full offering memo | May have less info |
| Relationship | Helps with future allocations | No relationship benefit |
Many ILS funds prefer primary issuance to build sponsor relationships and secure future allocations.
Distressed trading
Post-event price action
When a trigger event occurs, prices drop immediately based on estimated loss:
Example: $100M bond with $50B attachment
- Event occurs, initial industry loss estimate: $60B
- If exhaustion at $65B, implied recovery: 33%
- Price drops from par to ~35 cents (recovery + uncertainty premium)
Distressed exit options
| Option | Characteristics |
|---|---|
| Hold to commutation | Receive known recovery, capital trapped |
| Sell at distressed price | Crystallize loss, redeploy capital |
| Negotiate with sponsor | If structural ambiguity exists |
Distressed buyers
Specialty buyers purchase triggered or uncertain bonds:
- Deep discount (often 10-30 points below estimated recovery)
- Willing to wait for commutation
- Expertise in loss development and disputes
- Capital efficiency from position consolidation
If you need to exit a distressed position, expect significant discount to estimated recovery.
Extension period trading
If a bond is in extension:
- Limited buyer interest (uncertain timeline and outcome)
- Prices heavily discounted
- Some funds specialize in extended paper at deep discounts
- Liquidity worse than normal distressed trading
Liquidity considerations for portfolio management
Position sizing framework
| Liquidity Tier | Characteristics | Suggested Position Size |
|---|---|---|
| Tier 1 (liquid) | Large deal ($300M+), repeat sponsor, BB rating | Up to 5% of portfolio |
| Tier 2 (moderate) | Mid-size deal, established structure | 2-3% of portfolio |
| Tier 3 (illiquid) | Small deal, niche sponsor, complex trigger | 1-2% of portfolio |
| Tier 4 (very illiquid) | Cat bond lite, unusual peril, first-time sponsor | <1% of portfolio |
Matching fund terms to asset liquidity
ILS funds typically offer quarterly or annual liquidity with notice periods (30-90 days).
Matching considerations:
- Fund redemption frequency should not exceed ability to liquidate
- Hold liquidity buffer for redemptions (10-20% in liquid names)
- Avoid concentration in illiquid names
- Model stressed redemption scenarios
Forced selling dynamics
When ILS funds face redemptions:
- They sell liquid names first
- Tier 1 bonds become more volatile than expected
- Bonds with smaller or more patient holder bases may be more price-stable
- “Crowded” positions face the most selling pressure
Dealer relationship management
Secondary liquidity depends partly on dealer relationships:
| Factor | Impact on Liquidity |
|---|---|
| Primary allocation history | Dealers favor active clients |
| Trading frequency | Regular flow improves bid-ask |
| Position disclosure | Helps dealers anticipate |
| Commission rates | Competitive rates maintain coverage |
| Information sharing | Two-way dialogue helps |
Finding current market data
Cat bond spreads move with reinsurance market cycles, loss events, and investor appetite.
Primary data sources
| Source | What You’ll Find | Access |
|---|---|---|
| Artemis.bm | Deal announcements, spread data, loss reports | Free (registration) |
| Swiss Re Sigma Reports | Annual ILS market size, growth trends | Free (PDF) |
| Guy Carpenter ILS Report | Quarterly issuance, spreads, sentiment | Client access |
| Aon ILS Annual Report | Market overview, pricing trends | Free (PDF) |
| Lane Financial LLC | Secondary trading data, return indices | Subscription |
| Bloomberg ILS Index | Total return index for tradeable cat bonds | Terminal |
What to track
| Metric | Why It Matters |
|---|---|
| New issuance spreads by EL range | Shows where primary market clears |
| Secondary vs. issuance spreads | Indicates demand strength |
| ILS fund flows | Net inflows/outflows affect capacity |
| Reinsurance renewal pricing | January 1 and July 1 set the tone |
| Outstanding volume | Market depth |
| Loss events | Price-moving catalysts |
Market cycle context
Spreads are highly cyclical:
- Post-loss years see spreads widen 30-50%
- Capital exits, survivors demand higher returns
- Extended loss-free periods compress spreads
- Capital floods back in
Always interpret current pricing in context of cycle position.
Before you buy
Ask dealers about secondary trading history for the specific bond:
- How often has it traded?
- What size trades have occurred?
- Who else holds the position?
- Any expected supply or demand?
A bond that’s never traded will be hard to exit at a reasonable price. Factor this into position sizing and required return.
Collateralized reinsurance and ILW liquidity
Collateralized reinsurance:
- No secondary market
- Annual contracts run to expiration
- Exit only via negotiation with cedent (rare)
- Factor into liquidity planning
ILWs:
- Bilateral contracts, not securities
- Novation possible but uncommon
- More liquid than collateralized re, less than cat bonds
- Dealer inventory in standard attachment points
status: draft
For overall market size and structure, see Insurance-linked securities. For how to evaluate specific positions, see ILS diligence guide.