Key challenges to ILS allocation revealed in investor survey

Fees charged, the education of stakeholders and understanding the risks are key challenges investors in today’s sophisticated insurance-linked securities (ILS) market are faced with when allocating to the space, according to a report by Clear Path Analysis.

The report is the culmination of a survey, conducted by Clear Path Analysis, of 100 institutional asset allocators and highlights some interesting trends witnessed in the ILS space.

As at the end of 2016 the volume of alternative reinsurance capital in the global reinsurance industry had been reported to grow again, reaching between $75 billion and $80 billion, and again outpacing the growth of traditional market capacity.

While the entry of ILS capital into the global reinsurance industry has slowed in recent times, in response to the soft reinsurance landscape and resulting pressure on rates, the investor base continues to expand and grow in sophistication and maturity.

But as with any asset class, be it alternative or more traditional, certain challenges can hinder the ability of investors to allocate to the space. And according to the report, titled Insurance Linked Securities – Asset Owner Insights, for ILS investors the fees charged, having an understanding of the risks, and educating trustees/stakeholders are three key challenges to making an allocation.

Survey participants were asked to rank, on a scale of one to five (with one representing the lowest concern and five the highest), how significant a number of challenges are when making an investment into ILS.

Interestingly, all the challenges suggested in the survey scored an average score of above 3, but a few scored noticeably higher than others. As reported previously by Artemis investors highlighted educating and getting trustees and stakeholders comfortable with an ILS investment as the top concern, scoring an average of 3.8.

‘Understanding yourself the nature of risks’ scored 3.58, and ‘fees charged’ scored an average of 3.57, explains the report.

“First, fees are of high importance to today’s investors, even for a relatively small asset class such as ILS. Because ILS offers fixed-income-type returns, a relatively small difference in fees can make a fairly sizeable difference in comparative performance,” says the report.

Interestingly, the report continues to explain that a good ILS asset manager might be able to justify higher fees, and regarding understanding the risks and ‘selecting a manager’ (which scored 3.51), the report says this supports the notion investors are keen to utilise a manager they feel will outperform the market, a trend highlighted throughout the survey responses.

“However, a true standout response is found in ‘Educating and getting trustees/other stakeholders comfortable with the asset class’ (3.80). As the ILS market continues to mature, many investment professionals have acquired reasonable degrees of comfort with the risks and opportunities associated with the class.

“At that point, comfort of the trustees and/or investment committee becomes one of the most important variables in determining whether an allocation is made,” says the report.

Furthermore, says the report, that this factor scored so highly might suggest that numerous potential ILS investors are “in the pipeline for ILS, ” possibly waiting for stakeholders or trustees to become comfortable enough with the sector to start investing.

Other challenges put forward by the survey include’ liquidity concerns’ (3.27), ‘identifying role of ILS in a portfolio’ (3.09), and ‘fit with liability MGMT objectives’ (3).

The ILS space continues to expand its remit across the risk transfer landscape, looking to access a broader set of perils across an increasingly larger area, in both mature and emerging markets. Despite the market being far less niche than it was in the past, it remains relatively small and specialist within the alternative asset space.

However, investor comfort and understanding of the asset class is improving all the time, and while the fees charged might be a concern to some, the diversification and low correlation benefits of the ILS space continues to fuel investor and sponsor appetite for insurance and reinsurance linked business.

You can purchase a copy of the Insurance Linked Securities – Asset Owner Insights survey report over at the Clear Path Analysis website (free for asset owners such as pensions, family offices, endowments etc).