ILS market returns approaching ten year annual averages: Aon Benfield

Despite the severe catastrophe loss burden from 2011, which saw a number of catastrophe bonds impacted by events in Japan and the tornadoes in the U.S., the insurance-linked securities (ILS) market continued to provide investors with competitive returns when compared to other similarly rated securities. These events caused a relatively steep dip in returns immediately after the catastrophes hit and the impact on cat bonds understood, ever since which the returns have been gradually recovering.

As part of their latest annual insurance-linked securities market report, Aon Benfield Securities provide some insight into their own set of ILS and cat bond market indices which track the return of outstanding ILS and cat bonds, the Aon Benfield ILS Indices. This insight shows how robust the market for cat bonds is, as Aon Benfield note that the returns offered by ILS and cat bonds are now moving closer to their ten year annual averages. This recovery has happened in a relatively short length of time, as the data below shows.

At the 30th June 2012, the date Aon Benfield Securities annual report runs up to, all of the Aon Benfield ILS Indices had posted gains during the twelve month period. The U.S. Hurricane and U.S. Earthquake Bond indices returned 7.60% and 4.38% respectively. This compares to a ten year annual average of 8.44% for the U.S. Hurricane Index and 6.45% for the U.S. Earthquake Index. The All Bond and BB rated Bond indices posted returns of 7.40% and 7.86%, which compares to ten year averages of 8.34% for the All Bond index and 7.85% for the BB Rated Bond index respectively. It’s interesting to note that the BB Rated Bond Index has actually surpassed the ten year annual average return in the last year, while all the other indices are recovering ground. Aon Benfield notes that this demonstrates the importance of a balanced and well diversified portfolio.

It should be noted that the All Bond Index was hit by a hardening of rates, particularly at the start of 2012, which Aon Benfield believe knocked as much as 1.05% off the returns. By the middle of April 2012 pricing had started to rebound and Aon Benfield expect this to continue while there are no severe catastrophe events. This is helping all of the indices to move back towards their ten year annual average return rates. If you’re interested in how the cat bond and ILS market returns move from month to month, you should read our regular fortnightly updates on the outstanding cat bond markets returns.

Aon Benfield shows just how much higher the returns of their ILS indices are than comparable securities in the report. The ten year annual average return of the All Bond index is shown in the graph below, compared to a number of securities benchmark indices. The All Bond index return is superior to all of the others and you can also clearly see that it does not suffer as much due to broader economic and financial market upheaval. This graph clearly demonstrates the value of reinsurance as an asset class and insurance risk as a diversified, relatively uncorrelated alternative investment proposition.

Aon Benfield All Bond ILS Indices versus Financial Benchmarks - Source: Aon Benfield Securities, Bloomberg

This second chart shows the historical performance of each of the Aon Benfield ILS Indices over the last ten years. What’s interesting in this chart is the way the U.S. Earthquake index has diverged from the others and tracks much lower over the last five years, perhaps showing that earthquake risk is more remote and therefore pays a lower return. The All Bond and U.S. Hurricane index track very closely together which demonstrates the influence that U.S. hurricane risk has on the return of the overall ILS and cat bond market. With BB Rated bonds tracking somewhere in the middle this again shows the benefits that a diversified portfolio of insurance risk offers institutional investors.

Historical Performance of Aon Benfield ILS Indices - Source: Aon Benfield Securities

Graphs and insight like these, and Aon Benfield Securities report, help to underscore the attractiveness of an investment in the ILS, cat bond and reinsurance space right now. With market beating returns, a growing sponsor and investor base, reports of additional capital raising from dedicated funds and a number of new investor players entering the space recently, the ILS and cat bond market looks set to continue to approach these ten year annual averages.

Aon Benfield Securities says that the investment case for ILS remained strong in the last year. We suspect the investment case may only get stronger as we head towards the end of the U.S. hurricane season without any major catastrophe events.

You can read more about Aon Benfield Securities annual report in our article from 6th September.