AP3 grows ILS investments 6%, cites benefits to pension portfolio

AP3, the Swedish state sector pension fund, has increased its portfolio of insurance-linked securities (ILS) and reinsurance related assets to around $640 million in size by the end of 2019, up approximately 6% on the prior year.

The ILS portfolio delivered a total return of 4.4% to AP3 for the full-year 2019, much better than the prior year’s -0.3%, both in local currency, unhedged terms.

Hedged, for currency, the returns are lower for AP3, as the pension investor’s return from its ILS portfolio dropped to 1.5% after hedging costs are accounted for.

AP3 has been an investor in ILS and other reinsurance linked assets since 2008, with allocations to catastrophe bonds and different types of insurance-, climate- and weather-related securities.

At the end of 2019, almost 1% of the total AP3 investment portfolio was allocated to insurance risk investments, which contributed 0.2% to the overall return of the pension fund for the year.

For AP3, ILS and insurance or reinsurance risk investments, deliver a number of benefits.

The pension cites their low correlation with other asset classes, so how they help to add diversified returns to its portfolio.

But in addition and importantly, AP3 believes ILS is a “strategic, long-term” investment and also that ILS itself helps “to make insurance markets more efficient.”

As well as, “these investments help to increase the insurance coverage of people in less privileged parts of the world.”

“This strategy looked attractive when first designed 10 years ago. In hindsight, it has more than matched expectations. The Fund has done well even in peak disaster years like 2011 and 2017,” AP3 explained in its latest annual report.

Importantly, the pension also highlights climate change exposure, but notes that as ILS assets typically reprice at least every three years, it believes that “their pricing adjusts much faster than climate risk.”

That’s something not every investor can agree on these days, with some believing that while ILS has the chance to reprice, systematic undervaluation of climate exposure in reinsurance markets means they are often underpricing the risks they cover.

AP3’s position is quite clear, the pension investor does believe climate risk is accounted for and that ILS instruments are repriced to account for changes in it.

“Climate-related risk is incorporated into the price of ILS (insurance-linked securities) and partly determines the return to investors.

“New climate patterns have the potential to change the parameters for ILS, yet AP3 believes that these assets will continue to generate value despite the emergence of new weather-related risks,” the pension explained.

Insurance-related investments reached SEK 5.6 billion (around US$640m) at the end of 2019 for AP3, up 6% from SEK 5.3 billion a year earlier.