Diversify cat bond portfolios with direct reinsurance, ILW’s and retro

Much of our coverage on the investment side of the insurance-linked securities and catastrophe bond market discusses the opportunities the asset class presents to institutional investors seeking non-correlated assets offering diversification to their portfolio. It’s rare that we write about diversification within an insurance-linked portfolio, so some insight gleaned from investment manager Clariden Leu’s recent update should prove interesting.

While insurance-linked investment strategies have again demonstrated their “robustness and appeal” as an asset with non-correlation features in the second half of 2011, Clariden Leu say that while investment opportunities are available, the cat bond market is still overcrowded.

This tallies with other market participants who say supply still isn’t fulfilling the demand that investors currently have for a non-correlated insurance-linked asset at the moment, although this will improve over the next two quarters as issuance is expected to pick up. The trend towards private cat bond deals is also helping to absorb some of the excess capital waiting in the wings but it will take a few good quarters of issuance, with no major catastrophes, for the majority to be satisfied.

As a result of the overcrowding Clariden Leu say that they see limited opportunity to achieve “attractive excess returns for the next few months to come”. Again, this is inline with market wide sentiment and mainly an issue for newer investors wanting to enter the asset class or those with small portfolios, the larger players will hold their positions and look for other opportunities.

Clariden Leu suggest that there are investment opportunities in some specific markets and investment types which continue to offer attractive premiums. In their opinion the most interesting insurance-linked investment opportunities can be found in the area of financial insurance contracts, as direct reinsurance and retrocession contracts. As a result, Clariden Leu believe that a prudent investment strategy would be to diversify a cat bond portfolio with strategic allocations to direct reinsurance, industry loss warranties and carefully selected retro programs.