Institutional investor appetite for insurance linked assets remains strong

The expectation among senior figures in the insurance linked securities (ILS) and insurance or reinsurance linked investments space is that more institutional investors will allocate to the asset class as the reinsurance capacity it provides grows, according to a new report.

With forecasts suggesting that the amount of alternative or third-party capital in reinsurance could double over the next five years to $100 billion, institutional investors stand ready to take advantage of this opportunity while insurance linked fund managers and service providers are preparing to facilitate the entry of new capital to the space.

The new report from specialist financial services, pensions and investments publisher Clear Path Analysis, titled ‘Insurance-Linked Securities for Institutional Investors 2014‘, is published today. It looks at the state of the ILS asset class today and discussed key opportunities and issues faced by both new and existing investors in the asset class today.

The report features a number of articles, interviews and roundtables featuring senior figures from the ILS and insurance linked asset class, both from the investment management and service provision side of the market. Artemis editor Steve Evans moderates a few of these and we will be publishing some of the interviews and roundtables in full over the next week or two, so look out for them as they contain some valuable insights from key players in the market.

The report discusses the maturity of the insurance linked asset class and ILS, some of the issues hindering growth and where the future growth will be found. The consensus of participants in the report is that further growth is ahead and the investor base in ILS is set to grow and become a permanent feature of the reinsurance market.

John Whiley, Head of ILS Administration at SS&C GlobeOp provides further context on the markets potential; “Pension assets are worth around $30 trillion globally, hedge fund assets are expected to top US$3 trillion in 2014, compared with the traditional reinsurance limit of $300 billion. As pension investors are attracted to potential ILS returns they are likely to deploy capital that has been sitting on the side lines.”

An absence of yield in the broader investment markets continues to make ILS and insurance linked investments an attractive proposition from a return perspective. Add in the ever-present diversification factor, with catastrophe risk or other insurance and reinsurance risks broadly uncorrelated with wider financial markets, and the ILS and insurance linked asset class remains as popular as ever.

Increasing maturity and transparency in the ILS market is also helping to grow the adoption of insurance linked investments by institutional investors.

Michael Halsband, President of Sirius Capital Markets, explained; “The market is no longer considered exotic, but maturing and innovative. Enhancements in catastrophe risk modeling tools over this time period have contributed to greater investor knowledge and understanding. And much has been done – both in respect of direct investments and managed funds – to increase transparency on risk and exposure, simplify structure, and improve disclosure regarding valuations. Such advances are paramount to investor education and comfort with the asset class and its continued growth.”

ILS investment instruments are increasingly being pulled towards the investing mainstream by a growing level of education and investor knowledge about the asset class. Despite the recent reduction in yields on catastrophe bonds and other catastrophe reinsurance linked investments, caused by a softening reinsurance market, high levels of capital and low levels of catastrophes, the asset class remains attractive.

Investment managers also report a significant volume of capital sitting on the sidelines, either still assessing the space and waiting for board approval to allocate to it, or waiting for the next large events and a turn in rate trajectory, with some pension fund managers reportedly having signed up to supply capital when this occurs and ILS managers need it.

Dr Urs Ramseier, Chief Investment officer at Twelve Capital commented; “We’ve seen an increasing number of pension funds tracking and analysing the risk and return of the ILS investments and many of these may well invest in the next 2-3 years.”

ILS investments continue to make up a small percentage of a pension funds overall assets under management, at 1% to 3% in total, but this is aligned with the size of their investments in other alternative asset classes such as real estate or gold.

Michael Stahel, Partner at LGT Capital Partners notes the continued inflows from institutional investors into ILS; “Our clients are typically pension funds looking to allocate between 1-3% of their total assets to ILS. There has been increased capital flowing into this market from institutional investors which has boosted investor demand.”

The low correlation with broader financial markets and economic indicators remains a real draw for institutional investors looking to access ILS, with the portfolio diversification benefits seen as one of the key attractions. However in the current low yield environment the returns possible from insurance and reinsurance linked investing are also attractive to investors.

The report discusses this but also highlights that diversification within the ILS or reinsurance portfolio is also key in some managers eyes. “Without diversifying within the proportion, a pension fund manager can be susceptible to losing as much as 50% of their ILS allocation with a single US wind storm event,” stated Michael Stahel from LGT.

Adam Beatty, Business Development Director at Nephila Advisors, also noted low correlation of catastrophe risk as a key selling point for the asset class; “The CAT bond market can be characterised as a relatively small pond in a vast ocean of available risk, but new capital coming into the market is fundamentally attracted to the lack of correlation of catastrophe risk, something which is very valuable to investors.”

Of course one of the side-effects of a growing ILS and insurance linked asset class will be further erosion of reinsurance firms core business. This could become an increasing challenge for reinsurers as efficient sources of institutional capital continue to be attracted to ILS.

Dr Urs Ramseier from ILS investments specialist Twelve Capital explained; “As insurance investors focus on those lines of business that are favourably priced and soundly modelled, reinsurance companies might end up losing their most profitable lines to the ILS market. And it is this source of profit that reinsurers have traditionally relied upon to support and cross-subsidise substantial volumes of business that generally only break even. With profitable lines taken away by more efficient investors, reinsurance companies are left with business models that cannot sustain conventional cross-subsidisation.”

The efficient nature and lower-cost of ILS capital is set to drive further opportunity for investors in the space, as reinsurers struggle to compete and increasingly provide access to the ILS asset class themselves.

Dr Ramseier continued; “Given that ILS capital has lower cost of capital than reinsurance equity, the shift from reinsurance equity capital to ILS will continue. Reinsurance companies will be forced to optimise their balance sheets in order to lower their cost of capital. Only those with efficient balance sheets will survive.”

Looking ahead, the ILS, insurance and reinsurance linked asset class has further to go, the reports participants all agree, with growth ahead and further inflows of institutional capital likely to be seen. The potential is huge, most agree, but work will need to be done on structures, investment vehicles and further broadening the ILS market in order to accommodate all of the available capital.

Dirk Lohmann, Chairman and Managing Partner at Sequaero Advisors commented on the potential for the asset class; “We would argue that the potential is enormous. Given the size of the global debt market, this represents a challenge for institutional investors wishing to make a meaningful allocation to reap the diversification benefits offered by the asset class.”

Questions remain over the sustainability of ILS capital from investors who have yet to be fully tested by peak catastrophe events such as a major Florida hurricane, however participants in the report believe that investors stand ready to support the market with much greater inflows after a market moving event.

The evolution of insurance linked securities and the reinsurance linked asset class has the potential to change the way the insurance and reinsurance market transfers peak catastrophe and non-catastrophe risks forever. It is a fundamental change to reinsurance which now seems irreversible and for institutional investors the opportunity to participate will only grow.

“This influx of risk capital, if prudently managed, has the potential to transform long term the way risk is transferred and investors participate in the asset class,” stated Michael Halsband of Sirius Capital Markets.

The report from Clear Path Analysis is available to download today.

Visit the Clear Path Analysis website to register to download a full copy of the report ‘Insurance-Linked Securities for Institutional Investors 2014‘ including all of the interviews and roundtables.