Further diversification away from cat bonds expected in ILS: Report

The insurance-linked securities (ILS) market is expected to continue to diversify itself away from more traditional catastrophe bonds, with continued growth of collateralised reinsurance expected and a gradual push into new perils and emerging markets.

With catastrophe bonds alone not providing sufficient opportunities for large institutional investors to allocate capital to insurance risks, the continued push into collateralised reinsurance structures is not unexpected.

Also with the ILS market remaining largely focused on U.S. perils, the need to further diversify into new and emerging regions of the world is clear. Bringing more perils and classes of risk into the ILS sphere will aid diversification for ILS funds and investors and help ILS capital to broaden its reach.

So says the latest report from specialist financial services, pensions and investments publisher Clear Path Analysis, titled ‘Insurance-Linked Securities for Institutional Investors 2015‘, which has been published today.

The report contains whitepapers, interviews and roundtables with leading ILS market participants, featuring insight and discussion “Examining the evolving insurance-linked securities marketplace to assess the impact of capital inflow on yields and how CAT bond evolution and private transactions can safeguard market longevity.”

The report discusses the fact that ILS continue to offer an appealing investment opportunity for large institutional investors, such as pension funds.

As well as the ILS fund managers an increasing number of reinsurance firms are now offering investors structures that allow them to access the returns of insurance risks. The range of risks on offer is also broadening, with a focus on specialty and other classes of business now offering some diversification away from pure catastrophe risks.

However, the cat bond market continues to see more interest from investors than there is supply to meet, meaning that both managers and investors continue to look more widely for opportunities that can help them to allocate capital to insurance and reinsurance risks.

Dirk Lohmann, Chief Executive Officer of Secquaero Advisors commented on where some additional diversification may come to be found by ILS managers; “In terms of weather related risks I would say flood, whether European or U.S., is likely to impact the most in the next 5 to 10 years and as a result models are currently being developed to measure that. Specific area are likely to become more relevant, including natural catastrophe risks in China where they regularly experience earthquakes and typhoons.”

The growth rate of ILS and alternative reinsurance capital has been particularly impressive. Marcel Grandi, Head of ILS Underwriting and ILS Life, at Credit Suisse Asset Management, stated; “Since 2011 the amount of convergence capital provided by ILS managers has seen an impressive growth rate of more than 100%.”

However the rapid growth has led to a lack of opportunities, particularly as catastrophe bonds have not been able to meet investor demand alone. This has led to continued innovation among ILS managers, seeking to find new ways to put capital to work.

Market conditions have also led to disciplined approaches by investors to their allocations to the space, with some even reducing their capital allocations as they wait for more opportunities to deploy and gain diversification to appear.

Adam Beatty, Business Development Director at Nephila Advisors, said; “With regards to the point about investors pulling back, we think it’s rational that investors who have sophisticated knowledge of the opportunities they face should increase or decrease their allocation to the asset class at various times to match that opportunity.”

The report discusses where the diversification that is necessary to allow continued inflows of new investors and new investor capital will come from, with topics such as China’s continued economic development and high exposure to catastrophe perils, weather risks such as drought and temperature, emerging market opportunities and other ideas mentioned.

As the ILS market continues to mature a move to new structures, products and ways to access the returns of insurance and reinsurance risks is a natural progression. With evidence today that ILS managers are accessing property risks through partnerships with insurers and brokers also showing how the market may expand in the future.

All of these innovations provide institutional investors with new ways to access risk and new opportunities to benefit from the asset class. As the portfolio benefits to investors remain clear and new opportunities and innovations help the market to grow, the ILS sector looks poised for continued growth.

The report from Clear Path Analysis is available to download today.

Visit the Clear Path Analysis website to register to download a full copy of the report ‘Insurance-Linked Securities for Institutional Investors 2015‘ including all of the interviews and roundtables.