ILS allocation sweet spot still seen as up to 5% of assets

There’s always been a lot of discussion about just how much of their capital an institutional investor like a pension fund should allocate to an asset class like insurance-linked securities (ILS), but research from asset manager Schroders suggests that up to 5% remains the sweet spot.

Global asset management group Schroders, which has its own specialist insurance-linked securities (ILS) and reinsurance linked investments unit Schroder Secquaero, recently looked at the increasing shift towards alternatives and in particular what it terms private assets, as large investors continue to look for diversifying sources of investment return.

The benefits of ILS remain strong for investors looking to allocate a portion of their assets to a source of return that has practically no meaningful correlation with broader financial market assets, such as equities.

Insurance and reinsurance risk-linked returns are derived from the premiums paid for protection and are tied to the catastrophe risks they, in the majority, provide coverage for.

Hence, investors get the returns from the risk they allocate to, which is also an asset class that demonstrates ESG or responsible investment like qualities, given the majority of the ILS asset class is actually providing disaster risk financing to support insurance consumers recoveries when the worst happens.

But, as a novel or alternative investment, major investors tend to only put a small amount of their assets into classes such as ILS and reinsurance and this looks set to be how use of ILS as an investment continues.

Schroders research found that overwhelmingly investors continue to only allocate a small percentage of their assets to ILS, with 92% of those surveyed saying their allocations to the asset class are below 5% of their total assets.

Just 5% of those surveyed allocate between 5% and 10% of assets to insurance-linked securities (ILS), while only 3% of institutional investor respondents to the survey said their allocations are greater than 10% of total assets.

Which clearly shows that the strategy remains to add a small amount of these diversifying asset classes to your overall return base, with up to 5% of total assets seemingly the sweet spot for investing in ILS and reinsurance linked returns.

Schroders survey also found that most investors are relatively happy with their allocations to the ILS asset class right now, suggesting that only steady growth is likely over the next year or so.

Just 4% of investors said they were likely to increase their allocations to ILS in the short-term, which is likely not a reflection of the popularity of the asset class but more a sign of the continued need for better education on ILS for end-investors.

Of course, it may also reflect the challenging two years that the ILS sector has faced to a degree, given the record levels of catastrophe losses.

Some institutional investors will be looking for further evidence of a recovery and of the steps taken to ensure returns are commensurate with the risks being taken on after that, to help rebuild their overall confidence in ILS once again before broader allocations return to the levels seen a few years ago.

The survey also found that generally allocations to private assets, which is where Schroders categorises ILS, are expected to rise as an impressive 71% of investors said they were happy to adopt new financial instruments and asset classes.

Which suggests that as the understanding of ILS continues to broaden among large and sophisticated investors, the allocations will continue and new allocators will also enter the sector.