Despite lower expected return, ILS risk premium remains attractive: VP Bank

Given the softening of reinsurance rates and compression in risk spreads across catastrophe bonds and insurance-linked securities, the expected return of ILS investments is generally at a lower level, but private bank and asset manager VP Bank AG has noted that the risk premium available to investors is still attractive.

VP Bank has been recommending catastrophe bonds and ILS investments since 2022, when it saw the post-hurricane Ian market environment as an opportunity.

The Liechtenstein-based private bank and asset manager continues to see ILS as an asset class to remain neutral on at this time, maintaining allocations at this stage of the market cycle.

Previously, VP Bank had explained exactly why that is. The company sees catastrophe bonds and insurance-linked securities as the “best asset class from a diversification perspective,” offering significant benefits as a portfolio component.

Even as spreads have compressed of late, VP Bank sees the value of ILS allocations persisting, given the risk premium investors can be compensated with in the asset class remains attractive.

VP Bank highlights that ILS can deliver diversification in turbulent times, something any investor is all too aware of right now given geopolitical and market volatility.

The private bank sees the ILS asset class as more suitable for investors with a longer-term horizon and also notes that fees are comparatively high compared to other asset classes, which is understandable given the complexity of insurance and reinsurance underwriting.

Overall, ILS performance is declining but still attractive on the back of three very strong years that delivered cumulative performance of 45%, or around 13% per-annum, VP Bank explained.

“This result won’t be repeated in 2026,” VP Bank said. Noting that, “The yield to maturity is 8.9% with a modelled risk of 2.3%. If claims came in as modelled, the performance would be 6.6%. In reality, however, damages are often significantly lower or higher than the model predicts. Despite the lower expected return, the risk premium remains attractive.”

The private bank went on to state, “The main advantage of this asset class lies in diversification: ILS perform independently of the equity and bond markets and remain unaffected by turbulence on the stock market.

“After an eventful start to the year, this provides stability to the portfolio.”

In its latest update, VP Bank also cited the power of diversifiers in an increasingly uncertain and volatile world. Saying that with the Middle East conflict ongoing, “diversification remains the order of the day”, and can protect investors in uncertain times.