Some investors ‘blinded’ by cat bond & ILS yields: Swiss Re CFO

Some investors in catastrophe bonds and insurance-linked securities (ILS) have been blinded by the relatively high yields available to them from the asset class, reinsurer Swiss Re’s CFO David Cole told Bloomberg yesterday.

In a telephone interview with Bloomberg, Cole who only officially began his new job as Swiss Re’s CFO on the 1st May, said that the catastrophe bond and ILS asset class might attract investors that do not have the experience or skills necessary to analyse the transactions and fully understand the risks they are assuming.

“The fact that no major natural catastrophes have occurred over the last two or three years doesn’t guarantee losses won’t occur in the future. Some people are chasing yield and may accept risks that they are not prepared for. Some of the new capital that comes into the market may be not as experienced or able to create a diversified portfolio,” Cole told Bloomberg in the interview.

Cole becomes the latest senior reinsurance executive to suggest that there are some investors in the ILS market which lack the experience or perhaps discipline to be sources of long-term capital for the sector.

The relatively high levels of return achievable by investors in cat bonds and ILS are not set to continue, Cole explained, saying; “We don’t expect those returns to continue at the levels that we’ve seen, simply because we have benefited from relatively benign loss experience. Over time we expect that to revert to the mean.”

With pricing on catastrophe bonds having reached new lows in recent months, as every cat bond which came to market both grew in size and saw its pricing decline, as investors strongly supported sponsors bringing new deals to market. The reduction in cat bond and ILS pricing is set to reduce the overall return of the outstanding cat bond market, as higher yielding bonds mature and are replaced by lower yielding new issues.

Investor appetite shows no sign of letting up though and the last two transactions to come to market have both grown in size considerably. However, at the same time, the Everglades Re and Sanders Re cat bonds have both priced towards or at the upper ends of guidance, which suggests that investors may at last have found a pricing floor in the asset class.

Granted, some investors do hunt yield and will see catastrophe bonds as an attractive source of it, this is the same in any asset class and is not something that manifests itself solely in ILS. However the vast majority of investors in the ILS space are very sophisticated and perform considerable due diligence on ILS funds, managers and transactions before allocating any capital to them.

By now we would have hoped that the sector might have got past the allegations of ‘yield hunting’, but sadly, despite the fact so many reinsurers rely on alternative capital and the same types of investors, apparently not yet. The allegation is not levelled so frequently at reinsurers hunting premium rate.

“We can clearly imagine a situation where under a significant loss event investors in some of these alternative capital structures will lose money,” Cole is quoted as saying.

We would hope that the vast majority of investors in these alternative capital and ILS structures are fully aware of that fact. The insurance linked asset class is built on the premise that investors receive an attractive yield in return for taking on the risk of losing all of their investments when significant loss events occur.

This is an asset class where investors need to be educated and to have their eyes fully open before investing, it is not an asset class where investors should stumble blindly in with zero or minimal advice.