Direct investment into reinsurance transactions better than equity: Twelve Capital

We’ve written a number of times recently on Artemis about the benefits of investments in reinsurance-linked strategies such as catastrophe bonds, insurance-linked security funds, collateralized reinsurance vehicles and other instruments versus investments in insurance and reinsurance firm equity. Equity investments have seen a reduction in interest, as have most sectors equities, thanks to the financial market upheavals of recent years.

Reinsurance linked investment strategies have, conversely, been increasing in popularity over the last year or two, helped largely by the attractive returns the instruments can deliver and also by an increasing level of understanding among the community of sophisticated institutional type investors. The advice from many in the sector right now is to put capital to work directly in reinsurance investment opportunities that give access to the premiums earned within reinsurance transactions, rather than in the company equity which has returns linked to the firms performance and that of the sector.

Zurich, Switzerland based insurance-linked securities investment manager Twelve Capital, have echoed this sentiment in their latest Twelve Perspectives report. The report discusses some of the issues that were discussed at the recent Monte Carlo Rendez-vous event, with topics such as collateralized reinsurance, rate rises and the impacts of low investment yield on reinsurers income highlighted.

Twelve Capital said that the discussions at Monte Carlo in 2012 helped to confirm their conviction that they operate the right investment strategy for their investors within the insurance and reinsurance space. Twelve Capital believe that investing in the equity of insurance or reinsurance companies at this time puts investors at a competitive disadvantage versus those who invest directly into reinsurance transactions.

We should caveat here that reinsurance equity valuations have actually been on the increase lately, showing some recovery and more value to their shareholders, however with many suggesting that shares may be bought back as re/insurers look to make use of their excess capital equity investing remains less popular. The non-traditional reinsurance space of cat bonds, collateralized reinsurance and ILS funds has been seeing the most interest from investors in its relatively short history, with reports of capital being sidelined due to a lack of opportunities to put it to work in the space. For some investors, it is preferable to wait out a lack of access to the space rather than deploy capital into other reinsurance opportunities such as equity.

Twelve Capital give away some of their thoughts on where investors can find the most value (return) in the reinsurance-linked investment space right now.

Twelve says that current reinsurance pricing trends suggest that investment strategies need to concentrate more on U.S. business, a trend that is certainly apparent in the cat bond market right now, and writing diversifying perils only very selectively where returns would be attractive. They give the example of European windstorm exposure which is currently priced at less attractive risk return multiples, possibly as we haven’t seen a major loss from a European windstorm for a number of years. They say that this is even more pronounced for industry loss warranties (ILW) for which protection buyers are not willing to pay technical rates. Over all Twelve Capital say that they anticipate a reinsurance pricing climate which will see rates holding firm in the U.S. but there will likely be some softening in Europe and Japan.

Interestingly Twelve Capital give some insight on where their own investment strategy has moved to in the current climate as they seek to maintain their target returns for investors. They say that they have shifted their investment strategy more towards writing indemnity books of business. Twelve Capital have initiated talks to build partnerships which would allow them to gain access to new U.S. business in the future. They also continue to invest time into sourcing attractive, diversifying business as long as it is adequately modelled and in regions and risks where returns are attractive.

Also of interest is Twelve Capital’s sentiment on each of the different types of reinsurance-linked investment assets. Twelve Capital say that they are overweight in portfolio consideration of retro reinsurance, indemnity business, U.S. risks and well modelled diversifiers. Twelve Capital are underweight in portfolio consideration of cat bonds, ILW’s, European risks and more common diversifiers.

The sentiment on portfolio considerations clearly reflects where the market expects the most attractive rates to be at the January renewals and Twelve Capital will not be the only investment manager to be looking at those areas as ones which they’d like to boost in their portfolios. It’s also no surprise to see a managers say they are underweight on cat bonds. With the pricing dropping on most recent cat bond deals some ILS managers will be looking to reduce their exposure to some regions through cat bonds and increase it through direct collateralized business. Of course that is good for the majority of investors interested in cat bonds as it means there may be more opportunity for new investors seeking to enter the space.

While insurance and reinsurance equities aren’t seen as particularly attractive investments right now they will likely bounce back. There is evidence of some innovation occurring in the sector which over the course of a few years could see some re/insurers grow rapidly while others may suffer if they fail to adapt to the changing market. There will always be good opportunities to profit from equities but spotting them may become much more difficult. Meanwhile, for the moment anyway, those investing directly into reinsurance transactions are likely to see much more stable, long-term returns.

Here’s a few other recent articles which relate to this topic:

– Goldman Sachs goes neutral on reinsurance, capital flow into alternatives a factor

– Investors seeking yield need look no further than catastrophe bonds

– Investors largely uninterested in a ‘reinsurance class of 2011′: S&P

– New capital and ‘competitive convergence’ credit negative for reinsurers: Moody’s

– Investors more interested in catastrophe bonds and sidecars than new reinsurers: S&P

– Non-specialist investors increasing allocations to insurance-linked securities (ILS): A.M. Best