The level of fees paid by end-investors in insurance-linked securities (ILS) are often too high, but this is due to the inefficiencies of the overall reinsurance market and the trend is also exacerbated by the asset class still being treated as alternative, according to ILS market investors.
The discussion on ILS investment market fees took place during a roundtable debate moderated by Clear Path Analysis, which was documented in the firms latest ILS report.
The roundtable featured panelists Eveline Takken, Investment Director, Credit & Insurance-Linked Investments, PGGM, Philippe Trahan, Portfolio Director for ILS, Ontario Teachers’ Pension Plan and Bob Swarup, Principal, Camdor Global Advisors, all of which asserted that the level of fees charged by some ILS managers can be too high.
According to Takken, the level of fees that flow through ILS fund managers to investors, “Are still on the high side of the asset management spectrum and this doesn’t only hold true for ILS management fees, but for all other intermediaries in the insurance distribution chain as well.
“In our opinion, fees should be a function of the cost an ILS manager incurs, including a fair profit margin to compensate for entrepreneurial risk,” she continued.
Adding, “We believe that the asset class does not lend itself to incentive fees. Incentive, or performance fees could also lead to wrong incentives, such as aggressive risk taking.”
Trahan shared a similar view, explaining that the “fees are on the high side” and that the novelty premium received by investors like OTPP for being early adopters of the asset class is “by and large gone.”
He continued to explain that the speed and ease at which the alternative, or third-party reinsurance sector reloaded after 2017 events wasn’t a surprise, and actually supports the argument of a structural change to the market cycle, as well as “a reduction in the forward-looking returns that investors can expect from catastrophe (re)insurance risks.”
“The fees necessarily must adapt as well, as their current structures and levels are not reflective of this new reality and are no longer warranted,” said Trahan.
“The asset class is by and large becoming more of an alternative beta play and it is much harder to consequently generate alpha. While there remain pockets of alpha available that are worth paying for, investors must ensure these are indeed alpha and not just other risk premia masquerading as alpha, for example illiquidity or credit,” Trahan warned.
Interestingly, Swarup suggested that part of the reason for high fees could be driven by how the asset class is still viewed, despite its increased sophistication, maturity, and size.
“I do feel that the fees are most definitely too high right now and to a large extent this is because people are trying to treat this as an alternative asset class whereas it is large enough now to be part of the general mix,” said Swarup.
“As an asset class matures it inevitably creates its own cycle and beta. At this point you expect fees to decline both as a function of the benefits of scale but also as it becomes more understood, less of it becomes alpha and more of it becomes beta,” Swarup continued.
All three of these investor representatives said that the ILS asset class is becoming more beta-like, making fees more difficult to charge and stomach, while real alpha becomes harder to identify as well.
As the ILS and reinsurance market becomes increasingly efficient, particularly through the use of technology in future, this beta-isation of ILS is likely to continue, making it increasingly important for ILS investment managers to be able to succinctly explain why they can offer their investors a different type of insurance-linked return and where their particular alpha comes from.
Of course there are plenty of layers of fees that are passed on through the risk-to-capital value-chain that ILS managers are likely to increasingly look to minimise, as a way to support their own ability to charge fees of their investors.
It is by making the market more efficient overall that the end-investors will benefit from lower-costs to access insurance and reinsurance linked returns.
A copy of the seventh annual ILS for Institutional Investors report from Clear Path Analysis can be downloaded from its website.