The performance of the Mercury investible Catastrophe Risk Index (or MiCRIX for short) demonstrates that stable and attractive returns are possible by investing purely in industry-loss warranty (ILW) instruments, according to Mercury Capital Ltd. CEO Charlie Griffiths.
The MiCRIX, which was created by Bermuda based insurance-linked securities (ILS) and industry loss warranty (ILW) investment manager Mercury Capital, tracks the performance of a diversified portfolio of peak peril ILW’s, creating broad, diversified exposure to the reinsurance sector and emulating the returns an investor could make if following an ILW only investment strategy.
As a result it’s a useful benchmark for reinsurance linked investment returns and Mercury Capital operates a fund that invests solely in ILW’s, the performance of which closely mirrors the MiCRIX.
With peak wind season upon us the premium allocation from ILW’s rises significantly, making this an opportune time for Artemis to speak with Mercury Capital CEO Charlie Griffiths in a pre-Monte Carlo Reinsurance Rendezvous 2016 interview.
First, Griffiths explained to Artemis why ILW’s are an attractive investment option in ILS and reinsurance.
“ILWs bring numerous benefits to an end investor. They avoid the idiosyncratic risk associated which individual cedant’s own portfolios and the model and data risk that comes with it. Their contractual definition of both the region of coverage and the peril(s) covered allows simple communicable portfolio construction, as well as transparency over the size of an insured event required to trigger losses and the potential loss impact if triggered,” he explained.
There are also reasons to consider an industry-loss trigger over an indemnity, from an investors point of view, Griffiths continued, saying; “Industry Loss based instruments also avoid the expansion of coverage and broadening of Terms and Conditions that is plaguing the indemnity reinsurance market at the moment. It’s difficult to restructure a Florida 20bn ILW to quietly include additional risk.”
It’s interesting as often all you hear about ILW’s and industry-loss triggers is related to basis-risk and the fact that a ceding company could find its loss is not closely matched to the industries. However, if bought intelligently as strategic protection designed to fit with the overall reinsurance or retrocession program, the cost of ILW coverage could be very reasonable as the investor benefits for the capital providers, be they ILS funds or other institutional investors, are clear.
Mercury Capital’s MiCRIX Index delivered a very impressive 1.98% return in August 2016 alone, taking the year-to-date return to 5.2%. When compared to the performance of catastrophe bond funds, which are averaging around 1.75% to 2.5% year-to-date, it’s clear that attractive returns are possible with the same kind of stability as the cat bond market, on the whole.
Griffiths explained; “The MiCRIX portfolio is evenly weighted over the peak insurance exposures and then market weighted across a range of attachment points for each. By equal weighting, the index is not overly exposed to any individual loss event – whether it’s USD20bn or USD200bn.
“This can be seen in 2011 and 2012 where despite paying a full pillar in each year the index returned -1.3% and +1.1% respectively. By focusing only on peak exposures the index avoids the small attritional cat losses which seem to pop up so regularly, be they Canadian Wildfires, Texan tornado, hail and rain events or European flooding, as were seen in the first half of this year.”
Because of the way the MiCRIX is constructed it can deliver returns on the majority of years, as evidenced by recent history.
“The index has a 10.5 year track record. In that time it has paid two full pillar losses (Tohoku earthquake 2011 and hurricane Sandy 2011) and one partial pillar loss (hurricane Ike 2008). That’s 3 down months in 128. Annualised performance is 10.2% at a Sharp Ratio of 1.4, all with no (or very low) correlation to the broader investment universe,” according to Griffiths.
ILW’s are a risk transfer instrument that has always been in favor with some ceding companies, particularly those able to really analyse what an industry-wide loss means for them. As buyers of reinsurance and retrocession become increasingly sophisticated in their methods it is to be hoped that ILW’s will gain increasing adoption across the market.
Basis-risk can often seem like an excuse for having a rigid, inflexible and perhaps poorly designed reinsurance program, but after the recent trend towards centralisation and rationalisation of protection buying, there does seem some evidence of an uptick in ILW buying and greater acceptance of the protection an industry-loss trigger offers. However these instruments do tend to come in and out of favor.
Finally, Griffiths gave us his outlook for ILW’s and the potential returns possible from the MiCRIX over the rest of this year and towards the January renewal season.
“Looking ahead, I believe pricing has largely stabilised in the ILW market. In 2015 the index returned 10.6% without any loss impact, this year would be 10.2%. In June 2015, a spike in demand was met with a spike in pricing to secure capacity.
“This inelastic price response is a strong indication that the market is finely balanced at current pricing. As for loss events, they’ll happen, but I’m not going to try to predict when,” he told Artemis.
Thanks to Charlie Griffiths for his time and his insight into ILW returns, the MiCRIX and Mercury Capital.
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