Dedicated investment funds dominate catastrophe bond and ILS market

Yesterday we wrote about Aon Benfield Securities latest annual insurance-linked securities and catastrophe bond market report, which shows that in the twelve months to 30th June 2012 the ILS market has experienced a stellar year of performance. As usual we will highlight some interesting points from the report over the coming days, the first of which is a look at the mix of investors currently active in the ILS and cat bond market.

Aon Benfield says that the investment case for cat bonds and ILS has remained strong through much of the year covered in the report. Of the investors involved in the sector, participation increased from dedicated catastrophe and ILS funds, who became the dominant form of capital in the market. At 30th June 2012 dedicated ILS and catastrophe funds made up 51% of the invested capital in the market, up from 34% a year earlier.

Direct investment in the space from institutional investors decreased in the last year, from 44% in 2011 to 34% in 2012. Mutual fund participation decreased from 10% to 5% over the year, however Aon Benfield note that there is opportunity for this direct participation level to increase in coming years.

Investment from reinsurers also decreased, dropping from 7% to just 5% which Aon Benfield says is mainly due to the capital penalty associated with the collateralized nature of cat bonds as this can make participation in cat bonds less attractive than traditional reinsurance for reinsurers balance sheets. Hedge fund investment in the sector remained roughly flat, in line with the opportunistic nature of their involvement, although perhaps also showing more longterm commitment we would say.

ILS investor by category (Years ending 30th June) - Source: Aon Benfield Securities

The majority of this capital which flows into and around catastrophe bonds and ILS deals continues to come from investors in the U.S., according to the report. Interestingly, participation from Swiss investors declined from a peak of 33% at 30th June 2011 to 19% at 30th June 2012, which Aon says is inline with historical averages. We wonder whether this shows that the new capital that has entered the market has tended to come from U.S. based investors? Bermuda participation has increased, and Aon says a large investor there with strong capital inflows increased its cat bond and ILS purchases.

ILS investor by country (Years engine 30th June) - Source: Aon Benfield Securities

It’s interesting to see where these numbers have changed. The fact that dedicated catastrophe and ILS fund managers are seeing increasing success in becoming the source of capital in the market is no surprise and is testament to the attractive returns they offer to investors, despite their being management fees. The capital that flows into the market will hopefully become more of a permanent fixture in the hands of a dedicated ILS fund manager who has the experience to keep the portfolio diversified. Previously, capital directly invested has often been more transient and has left the market as quickly as it entered.

With more ILS funds slated to launch in the coming months, likely around the renewals, and others increasing their capital base all the time (leaving them with a need to deploy capital), the next year or two will be very interesting to watch and dedicated fund managers could increase their dominance of the space. Conversely, we may see other institutional investors becoming more comfortable with the ILS asset class as an investment alternative and take more management of their capital in house.