Espen Nordhus, Chairman and co-founder of specialist insurance-linked securities (ILS) investments manager, Securis Investment Partners, in an interview with Artemis, recently discussed certain aspects of the ILS market landscape.
As at January 1st 2017 Securis’ ILS assets under management (AuM) had increased to north of $4 billion, and Artemis understands that both its Securis I Fund and the Securis Opportunities Fund recorded returns of between 8.5% and 9% for the full-year, 2016.
Securis told Artemis that the January 1st 2017 renewal season was a tough one, but stressed that the market is still great to operate in, so long as you have the correct resources and mind-set.
Speaking to Artemis, Espen Nordhus expanded on the tough January 1st 2017 renewal period, stating that in a tough market environment, the “quality of the manager is more important than ever before.”
Nordhus’ thoughts on the 2017 renewal season and the dynamics of the current ILS market landscape are as follows:
“The 2017 renewal season has been a tough one. An increasing number of institutional investors are rapidly recognising that they need to have an ILS strategy. ILS offers the opportunity to make good risk-adjusted returns against a backdrop of very low interest rates and also significant portfolio benefits. The 2016 ILS results have been strong, again, even with natural catastrophe losses running at a 4 year high according to Munich Re, and this will only have fuelled the interest further. This interest continues to put pressure on prices in general.
“A lot has been said about a softening market, but most of the time the discussion is too simplistic. People tend to view the “market price” as either attractive or unattractive. Pricing is more challenging than it was five years ago, yes, but does that in itself say anything about its absolute attractiveness? Most institutional investors are, in our opinion, likely to experience marginal portfolio improvements by adding to its ILS strategy, even at this stage. More importantly, however, I believe investors should stop looking at this as a beta strategy. There is a lot of alpha here, but you need a manager with the commitment to extract it, and this requires significant resources and human talent. As such, rather than talking about an attractive or unattractive “market price” as if there is nothing that can be done unless prices are high, I would like to focus on attractive and unattractive investment opportunities.
“In the current market, the quality of the ILS manager is more important than ever before. I reject the often repeated idea that the reinsurance business is a commodity business. It is not. Each and every program and structure is different, and often complex, there are risks lurking everywhere, and the entire industry is still very much relationship driven. Without a lot of experience, expertise, significant resources, and a strong culture promoting quality over quantity, it is going to be very hard to build a good ILS investment portfolio. We see this “differentiation” manifest itself in a number of ways.
Nordhus continued to explain to Artemis five ways in which Securis has witnessed the noted “differentiation” among ILS managers manifest itself across the marketplace.
“First, we see players all the time that are not factoring in all the risks that are there. For example, we come across situations whereby some managers are not allowing for something as simple as FX. There have been some pretty big FX moves this year, not the least in Japan and in the UK. When you are getting your investment return in US$, but parts of your claims are in JPY or GBP, this has to be thought through and priced in. There is competition for good investment opportunities, but when we see other players competing like mad because they have either ignored or forgotten to factor in FX, then we are happy to “lose” an opportunity to a competitor. The same can often be said for opportunities where there is a significant proportion of risk coming from areas outside the peak zones. When we see players pricing an investment based on the peak zones only, and ignoring the un-modelled risks, we are also happy to see it go elsewhere. The exact scope of cover provided in the contracts requires close scrutiny, especially with “man-made” perils. Creating a culture where people question the information provided and look to understand what elements of the risk haven’t been captured enables us to spot and avoid the bad investments.
“Second, there are a lot more opportunities available than there are attractive opportunities available. What does that mean? It means we need to a have a broad origination footprint (so we see a significant number of investment opportunities across the insurance, reinsurance and retrocession markets) and we need to have the analytical resources (systems and people) that actually will enable us to select the best opportunities. There are some very significant differences in this market. Without broad origination, there is no selection, and it is not going to be possible to build an above average quality portfolio. Without strong analytical resources, one would be forced to take the rough with the smooth, and accept a beta portfolio at best.
“Third, while it may remain a mystery why the brokers retain such an important position in this market, the fact is that they do. Over time, there are reasons to believe that their positions will come under pressure, but because of the complexity and because it is so important for protection buyers to get their programs right, there is demand for the brokers’ services. A manager with strong broker relationships, who is a price maker not a price taker, will undoubtedly see more attractive opportunities than one that does not enjoy the same relationships.
“Fourth, it is possible to extract better terms and conditions than the “market” and it is possible to be allocated more than a “fair share” of an attractive program. Relationships, as discussed above, are one thing, but this also has to do with knowledge, the ability to invest meaningful size so as to be relevant and responsiveness, so that you know what to ask for, can justify the request and can do it quickly. All of which require extra resources and significant experience.
“Fifth, the ability to walk away. A “one trick pony” manager, say cat bonds only, does not have the opportunity to do something else if they do not like an investment. They can hand the money back, of course, and if they do, I will take my hat off to them. However, most of the time, they will grin and bear it, which is probably why cat bonds tend to be less attractive than private ILS opportunities. A manager with a broad investment mandate, or broad product offering, can steer away from the less attractive areas and focus more on the more attractive areas. For us, this is particularly pertinent as we have a strong life team. During the recent renewal, we concluded a significant private life investment that we considered very attractive, both from an absolute return perspective and a diversification perspective. In addition to being outright attractive, that also meant that we were forced to walk away from one or two more non-life opportunities. Thus providing the non-life team with real pricing power.
“All of this is not new, by the way. In a complex area like insurance, origination, segmentation, relationships and selection have always been sources of competitive advantage. My point is simply that in a tough market like this, it matters even more. Despite the challenging pricing environment, we can still build attractive investment portfolios for our clients,” concluded Nordhus.
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