Insurance-linked securities (ILS) and reinsurance linked investment funds reported their strongest performance since September, returning an average of 0.54% in February 2016, as some adjustments to loss reserves flowing through to boost the months performance.
In fact the average ILS fund return in February was more than double the figure seen a year earlier in 2015, also higher than the February 2014 return and not far behind the long-term average of 0.59%. To put it in perspective, the only months with higher performance in 2015 were the seasonal return drivers of August and September.
The reason for the impressive average return across the catastrophe bond and ILS fund sector in February 2016? Adjustments to side-pockets, allowing loss reserves to flow back to benefit the fund returns, as well as the final determination that the MultiCat Mexico 2012 Class C cat bond notes were only a 50% loss, allowing the almost half of the written-down value to be recouped by cat bond investors.
For February 2016, the Eurekahedge ILS Advisers Index reported its second highest performance since 2010, with the group of 31 constituent insurance-linked investment funds that the Index tracks returning an average of 0.54% for the month.
Stefan Kräuchi, founder of ILS Advisers, commented; “The February return of Eurekahedge ILS Advisers Index is 0.54%, very close to the average historical February monthly return of 0.59%. All funds represented in the Eurekahedge ILS Advisers Index made positive returns. With the lowest single fund return 0.01% and the highest one 2.00%, the monthly performance difference was 1.99%.”
Pure catastrophe bond investment funds as a group again saw the lower return, despite having been boosted by the MultiCat 50% recovery, reporting performance of 0.4% as a group. Meanwhile, the subgroup of ILS funds whose strategies include private ILS and collateralised reinsurance contracts returned 0.65%.
As a result of improved returns from the cat bond subgroup, the performance gap, between private ILS funds and pure cat bond funds, narrowed slightly from the previous month to 3.11 percentage points on an annualised basis.
February proved a relatively quiet month in terms of losses for the ILS fund sector, ILS Advisers explained, although the firm said that it believes that the M6.4 Tainan earthquake in Taiwan at the start of February may have caused a small loss to some ILS funds.
Aside from that February saw a number of other events, such as windstorm Imogen in Europe, cyclone Winston hitting Fiji and severe weather in the United States, but no meaningful losses were observed in the ILS market according to ILS Advisers.
The main story of February is the recovery of some loss reserves, in the form of releases from side-pockets and the MultiCat 50% bounce back.
Kräuchi explained; “Slight adjustment from side pockets were seen from some of the funds, which was related to the UK floods at the end of last year and the U.S. severe weather early this year. Such revaluation has some impact to some private ILS funds.
“The cat bond MultiCat Mexico Ltd., which was triggered by Hurricane Patricia last year, was once thought to be fully paid out, which wiped out most of the value of the bond. However, the recent and more determining report indicated the payout should be only half. As a result, some cat bond funds saw significant mark to market gain.”
On the Tianjin port explosions in China, some ILS funds are maintaining their side-pockets on that event, as the final loss determination remains uncertain. Reinsurance firm Swiss Re said last week that the property insurance loss from this event could be as much as $3.5 billion.
One other factor worth noting for February 2016 was another decline in catastrophe bond pricing in the secondary market, with the Swiss Re cat bond price return index down by 0.05% for the month. The total-return rose by 0.45%, likely reflecting the recovery associated with the MultiCat Mexico payout.
The stronger month is testament to the prudent manner in which ILS and cat bond fund managers handle reserving for potential losses. This enables value to be unlocked in the future when loss totals are determined and also secures investments against further loss creep.
With MultiCat, the fact that the market marked the cat bond down for a 100% loss after the event meant that investors were prepared for the worst and when the 50% loss determination was reported the remainder of the value flows back into funds.
The side-pockets for the UK floods and U.S. severe weather, which saw some value flowing back into private ILS funds this month, are established based on best estimates which were clearly for a larger loss than was actually suffered by the insurance industry. As a result the loss affected investments were segregated and as the loss total becomes clearer some of the value of these assets can be released, to the benefit of the funds return and its investors.
These practices protect ILS investors from the impact of difficult loss events and the potential for loss creep. They also prepare investors for the worst case scenario, which is far preferable to a loss that keeps rising. A good example of ILS investment managers looking after their investors interests.
Of course March’s performance is likely to look a lot lower, as the benefits of these releases have already been accounted for. With March also seeing a number of severe weather events that could cause further attritional loss reserves to be established, ILS fund performance could look a lot lower.
You can track the Eurekahedge ILS Advisers Index on Artemis here, including the new USD hedged version of the index. It comprises an equally weighted index of 31 constituent ILS funds which tracks their performance and is the first benchmark that allows a comparison between different insurance-linked securities fund managers in the ILS, reinsurance-linked and catastrophe bond investment space.