Lower volatility ILS funds continue to target growth, despite losses

Lower risk and volatility insurance-linked securities (ILS) and collateralised reinsurance funds have fared surprisingly well in the face of the aggregated impact of 2017 and 2018 catastrophe losses, positioning some to take advantage of investor appetite.

It’s clear that higher risk and return ILS funds, especially those investing in collateralised retrocessional reinsurance positions and some private quota shares, are set to experience the biggest dents to their return and also their capital from the combined effects of the losses over the last 18 months. And such funds may even continue to suffer into 2019 as collateral may be held back by counterparties and remains trapped for some time until the loss assessment has been concluded.

As we explained recently, the insurance, reinsurance and ILS market has now experienced around $200 billion of industry losses from major catastrophes and man-made disasters in the last year and a half, which has taken its toll on some.

But while a difficult renewal is ahead for some ILS funds, particularly those facing a reduction in capital to deploy because of trapped ILS collateral positions, others continue to find opportunity for growth and also reasons to be positive about the future.

Insurance and reinsurance linked investment specialists LGT ILS, a unit of the LGT Group’s alternative asset manager LGT Capital Partners, is one of those that expects to continue to grow its ILS assets under management, having reported positive returns for the year despite the recent losses.

While the ILS funds managed by LGT and those ILS fund managers running similar levels of risk in their strategies did experience their share of losses from 2017 and 2018 catastrophe events, their relatively low-volatility nature helped such ILS managers avoid the worst impacts.

Many of the lower volatility ILS funds, including LGT’s, are set to record positive returns in 2018 despite the losses, a healthier position to find themselves than the many other ILS funds that take riskier positions and have been harder hit.

LGT ILS Portfolio Manager Michael Stahel explained to Artemis that this has left his firm in a positive position as it negotiates the 2019 renewals.

“We see a solid pipeline of new investors and also some increased allocations from existing investors which aim to benefit from the more favourable pricing environment on the back of the loss-heavy year,” Stahel said. “So we expect to continue our growth path in 2019, albeit at a slower pace.”

He acknowledged that growth may not be at the rate seen in recent years (LGT reached almost $8bn of combined ILS assets at June 30^th), as the aggregate impacts of recent catastrophe events are digested by the ILS and institutional investor base.

But overall Stahel foresees a positive outlook for the ILS asset class as a whole and the LGT ILS funds in 2019.

“We see an uptick in pricing for reinsurance in the most loss-affected regions, such as the United States and Japan,” he continued.

Adding, “We also see at least a stable premium outlook for the non-affected regions, such as Europe.”

For the ILS funds operating lower volatility strategies the recent period has perhaps seen them overshadowed in the news by discussions of trapped collateral, reduced AuM, and challenges in renewing portfolios.

But these ILS funds have not been dented in this way and the fact that some of them are going to report positive returns for 2018 will reflect well on them in their discussions with investors over the next year.

While retrocession pricing discussions in the market are a different story right now, being challenged, the collateralised reinsurance providers that operate at higher levels in the protection tower appear to be having a better time of it.

But with retro often an opportunistic purchase, or at times even a case of arbitraging the lower-cost of ILS capital, Stahel said that he expects that larger reinsurers may simply increase their net retention, reduce their retro purchase and wait for more attractive pricing to emerge again.

With collateralised reinsurance participation in traditional excess of loss reinsurance programs, the negotiation process has been much easier if not rewarding, especially for those with plenty of capacity still available. There is also much less discussion round trapped collateral at such higher attachment levels in the reinsurance towers, allowing the managers of lower volatility funds for tougher negotiations and generally smoother renewals.

It’s encouraging to hear that demand for ILS investments continues apace at these lower volatility levels of the reinsurance tower.

It suggests that investor appetite will persist and that as we move beyond the challenging period the ILS market currently finds itself in, further growth of the asset class is likely as we move through 2019.