The ongoing transformation of the life insurance-linked securities (ILS) sector is driving a shift towards more private, highly customised deal structures designed to provide investors with a truly decorrelated, attractive investment, says Luca Tres, Head of Life at Securis Investment Partners LLP.
“It is one of the not that many cases where you can really see and touch the true alpha,” he added.
Beginning in the late 90s, the life ILS market initially focused on embedded value financing and extreme mortality financing, and included deals like the Swiss Re sponsored Vita Capital Ltd. series.
In an interview with Artemis, Securis’ Tres explained that today, the standardised public market that is driven by investment banks’ and reinsurers’ deal making capabilities does still exist, but plays a lesser role than in the past.
“The bulk of the market and the real opportunities are truly on the private side now. We are seeing a strong shift to privately originated, highly customised, solution driven structures.
“This clear shift is being driven by a much stronger capital management awareness in the insurance industry and, of course, by the introduction of Solvency II.
“The more complex and ever changing insurance landscape is also requiring the leading ILS players to structure highly customized solutions, targeting specific problems our counterparties have. This is the future,” said Tres.
Expanding on what the future of the life ILS market might look like, Tres said that it will be a future of a fully-fledged ‘vertically integrated’ approach, which sees life ILS funds being able to originate, structure, analyse and price transactions. Adding that the role of intermediaries will be probably limited to very large, more public transactions that need syndication.
“The dichotomy between public tightly-priced transactions vs. private complex transactions will be there even more. On one side public fully funded transactions that, because of their remote risk nature, their liquidity and their rating will offer a very tight return and will see a flurry of capital from generalist investors that will value the decorrelated aspect of the deal.
“On the other side complex, customised deals with a vastly better risk-adjusted return that a much more limited amount of players will be able to source, structure and originate.
“If the first standardized group will be on ‘traditional’ life risks (extreme mortality, embedded value financing, maybe extreme longevity, etc.), the second one will feature a very wide range of structures driven by lapse, longevity and mortality risks, in completely different structures with completely different goals,” said Tres.
We pioneered the space more than 5 years ago where we started investing time and resources focusing on these more innovative solutions-driven approach. That choice is now bearing fruit and has seen our Life AuM more than tripling in size in the last few years.
The uncorrelation to wider financial market turmoil offered through the ILS asset class remains on of the key attractions for investors, both on the life and non-life side. Of course, non-life investors were hit by catastrophe losses in both 2017 and 2018, and Tres explained that this raised the profile of the life ILS space because of the stable, uncorrelated returns available in the life market during this time.
“External observers have recently been positively surprised by the fairly resilient return profile it has shown compared to the wider ILS space and, more widely, to the fixed income market,” he continued.
New players continue to try to enter the life ILS space, and while this is healthy for the sector although very often the new players underestimate the barriers to entry.
Tres suggested that, when approaching life ILS as investment opportunity, it’s best for investors to “scratch the surface” and become knowledgeable with the different types of life ILS that exists.
“We need to be careful with definitions: life ILS is a catch-all definition that includes transactions that can be very different from each other and – very worryingly – is often used to define transactions that are pure credit risk.
“A highly customized Solvency II derisking solution has for instance little in common with a liquid extreme mortality bond – even less to a complex and tailor made true embedded value deals. And all these have nothing in common with a transaction where the key risk is credit or equity risk,” he explained.
With this in mind, it’s important to remember what your specific investors want, said Tres: since Securis’ investors have shown specific appetite for truly decorrelated risks that excel from both a stand alone risk-adjusted return and from also a portfolio stand point, we keep turning down transactions that are sometimes called life ILS, but are essentially a pure, levered credit risk.
“Scratching the surface and investing time understand the deals offered is the suggestion we have for investors”, he said. “As an example, everyone talks about embedded value financing, but few people really spend time understanding the source of that value: is it decorrelated actuarial risk or is it levered asset side return? Nothing wrong with the second, as long as it it clear to the investors what they are getting.” Or “For instance, I struggle classifying “credit and mortgage (re)insurance” as life ILS. It’s just credit risk, there is nothing wrong with it and people should just call it what it is”.
Certain ILS funds, including the Securis I Fund, offer investors with a mix of life and non-life risk, something which Tres describes as “simply a great marriage, both from a return/risk distribution and a liquidity stand point”.
“It mixes up very effectively the higher median returning but riskier and more volatile non-life deals with the stable life deals profile. Equally, it pairs the short dated nature of non-life deals with a more illiquid life portfolio – giving a natural ALM balancing.
“Think about it: life deals deliver a very attractive risk-adjusted return and reduces massively the risk tail of non-life investments.”