Almost 1/4 of pensions consider ILS investment, trustee comfort is key

Almost one-quarter of pension plans canvassed in a recent survey said that they are actively considering making new investments into the insurance-linked securities (ILS) asset class, but half of those surveyed said getting trustees comfortable with the asset class is the largest hurdle they face.

Investing in insurance and reinsurance linked assets continues to be an increasingly popular way to access alternative sources of return, which are considered diversifying with low correlation to wider financial markets.

The ILS investment market continued to grow in 2017, with estimates suggesting the ILS market now nears $80 billion in size, while the outstanding catastrophe bond market reached a new record high of $26.82 billion at the end of 2016.

While growth in ILS or alternative capital in reinsurance has clearly slowed in the last year, the level of awareness in the asset class and interest in investing into it among pension funds and other large institutional investors is reported to be continuing to increase.

In a new report released this morning by Clear Path Analysis the results of a survey of 100 institutional asset allocators reveals that almost a quarter of them are keen to make new investments into the ILS sector.

The survey report, titled Insurance Linked Securities – Asset Owner Insights, found that 22% of respondents said they were very likely to begin investing in ILS within the next 12 months.

Increasing numbers of pension plans are looking to the alternative asset classes as a way to source attractive yields, while diversifying their portfolios and accessing returns which are relatively uncorrelated with wider equity and bond markets.

However the survey also finds that there is work to do for the ILS market in helping institutional investors gain a greater understanding of ILS and more comfort in making the first allocation, with half of respondents saying that the major challenge is getting their pension trustees comfortable with the asset class.

Adam Beatty, Managing Director with Nephila Advisors, said in the survey report; “It can be difficult for investors to discern true risk adjusted performance and whether a manager is delivering good value for the downside risk they are taking on.”

Beatty, who works for the largest insurance-linked asset manager in the world Nephila Capital, also suggested that the investor base is likely to continue to broaden.

“We do feel that over time more of the investor community will find the asset class attractive and so we might expect to see some broadening out into the larger asset managers, perhaps adding it as part of a multi-asset portfolio of investments for their clients,” he explained.

Other key findings from the survey also suggest that pensions need a lot of education and hand-holding if they are to make their first allocations to the ILS asset class.

78% of pensions responding said that further recommendations by investment consultants is a key driver of initial or further allocations to ILS, which shows the critical role that the major investment advisors have in driving ILS inflows.

Also 64% of respondents said that if ILS was included in more multi-asset class funds it would help to generate greater interest in the asset class as well, which again suggests that pensions want to see broader adoption and more mainstreaming of ILS into global investment strategies to give them comfort.

Interestingly, the institutional investors surveyed felt there are enough ILS fund managers to choose from, with 72% saying their isn’t a need for more standalone ILS managers for them to allocate to.

Also fascinating is the fact that respondents said that size and reputation of asset managers is a low priority among asset owners, only scoring 2 out of 5. This goes against everything you’d think was true of investing, but is perhaps only reflective that marketing can be as important as reputation or scale and getting your brand known is key for ILS managers today.

The small allocation size that most pensions make to ILS is typical it seems, with over 80% of respondents saying that any allocation to the ILS asset class would be 3% or less of their overall asset allocations over the next 12 months.

But once in ILS and investing, the large pensions and institutional investors gain comfort and of those already allocated to ILS 32% expect to allocate more than 3% of their overall allocations this year into the asset class.

ILS investors are targeting an average of 4% to 6% returns over the next year, according to the survey of institutional allocators, which is aligned with where the markets returns now sit after the average across a group of ILS funds reported 5.18% for 2016.

This target return is broadly similar to previous years and reflects the market average, in terms of risk and reward, but perhaps suggests that investors aren’t expecting dramatic changes in the asset classes risk profile over the next year either.

Niklaus Hilti, Head of Insurance Linked Strategies at Credit Suisse Insurance Linked Strategies, commented on this; “Market participants can buy reinsurance at a relatively low cost, so why should there be a push for innovation? Innovation occurs when there is some pain, which means it becomes very expensive to transfer risk.”

However Hilti sees life reinsurance risks as an area that ILS could innovate further, and that there is an opportunity now to help life insurers to offload more of their risks.

“Life risk, in the long run, can only be profitable if investment returns are higher in the future than they are at the moment. This already creates a certain pressure on insurers to offset at least part of the risk that they hold,” Hilti explained.

The report demonstrates some of the reasons that ILS continues to be a very attractive asset class to these large pension fund investors, with interest still growing and an increasing number looking to allocate.

But it also shows that there is work to do in explaining the insurance and reinsurance linked asset class to these potential investors, marketing of funds and promoting the asset class.

For ILS fund managers it will in future become increasingly important to gain their own profile, as well as being promoted by investment consultants, to ensure they are in the investment allocation consideration set for institutions.

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).