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ILS a “historically significant diversifier” from financial markets: Taylor, Nephila


The once niche insurance-linked securities (ILS) asset class has matured into an influential part of the global reinsurance industry, helped by its solid performance during financial market turmoil and it’s ability to efficiently allocate capital. In a recent paper, Nephila Capital’s Laura Taylor highlighted such benefits of the space.

At more than $75 billion in size, the majority of which comes from either collateralised reinsurance or catastrophe bond transactions, the ILS space is now widely viewed as a permanent and influential part of the re/insurance landscape.

Nephila Capital, the world’s largest ILS fund manager with assets under management (AuM) of around $10 billion has, along with others in the space, witnessed the evolution of the investor base and the overall growth of the market.

A key driver for ILS investment remains its very low correlation with broader financial market volatility. During the 2008 financial crisis the ILS sector performed well compared with relative alternative asset classes, and pension funds (the most dominant investor in the space) began increasing their allocation to ILS and investing more directly via ILS managers.

“ILS has proved to be a historically significant diversifier from broader financial markets,” said Taylor, CFA, Managing Principal and Chief Financial Officer (CFO), Nephila Capital. As a result of its ability to offer diversification and steady, albeit currently reduced returns, at times of financial market volatility, the asset class has expanded its investor base and acceptance.

‘”Mainstream’ might be an overstatement for the ILS asset class, but the class is certainly no longer a niche industry. We no longer have to explain the idea of reinsurance to clients. We have investors who come to us. They know the space. They may have already purchased some cat bonds on their own, and now they are looking to make an allocation to a manager,” said Taylor.

Along with the evolution of the investor base, the instruments available within ILS have expanded over the years, and as the marketplace continues to grow and seeks to get closer to the original source of risk, there’s potential for further innovation.

Add technology to the mix, which is expected to disrupt the entire insurance industry, and the chance for ILS capacity and mechanisms to have a meaningful influence in underserved existing, and emerging risks can be seen.

Most reinsurers now work with ILS or alternative reinsurance capital in some form or another, and the desire among the ILS sector to broaden its scope suggests further growth is possible and would likely be welcomed by the capital markets investors.

“The US insurance market (and other markets globally) have a need for capital, and this market was not being served by the existing structure in this century. So, ILS providers stepped in. ILS products allocate capital efficiently while providing positive returns for investors—returns that offer true diversification because they are not correlated with returns of the traditional asset classes,” said Taylor.

The diversifying benefits of ILS has seen it move into the mainstream insurance world, and with a growing base of sophisticated, increasingly understanding and aware investors it has every chance of continuing to expand.

Conditions in the reinsurance sector are challenging at the moment, especially in the property catastrophe area where the majority of ILS capacity lives. However, investors appear willing to continue to participate in the space. In fact, the outstanding catastrophe bond market again surpassed the $26 billion mark recently, as shown by data in the Artemis Deal Directory. So although returns might be lower than in the past, it seems that diversification and low correlation means the asset class is still attractive to investors.

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