Swiss Re Insurance-Linked Fund Management

Xactanalysis Insights and PCS

ILS hardening to continue, but ILS managers’ have lessons to learn: SIGLO

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The insurance-linked securities (ILS) marketplace is looking particularly attractive at this time, with returns rising on the back of hardening reinsurance rates and greatly improved contract terms having been enforced through recent rounds of renewals.

siglo-capital-advisors-logoThis attractive investment situation may continue, with the hard market even set to become more accentuated in places, but analysts from alternative asset advisors SIGLO Capital Advisors AG caution that ILS fund managers need to demonstrate that they have learned their lessons from the last soft market phase.

SIGLO Capital Advisors AG is a key investment advisor in the ILS fund marketplace, working closely with major institutional investors such as pension funds to help them understand the ILS asset class and the ILS fund manager landscape.

In a recent paper, the investment advisor highlighted some of the shortcomings it has noted in the ILS market, as the company believes ILS managers lost their focus on delivering technical returns during the last soft market phase of the reinsurance cycle.

“Some of today’s ILS managers and strategies must (rightly) accept the reproach that the reinsurance cycle and especially the last soft market phase has not satisfactorily been taken into account in the underwriting and investment process,” SIGLO explained.

Going on to state what it believes the correct response to a softening cycle should be, a flexible approach to putting together ILS portfolios using the best quality assets available at the time.

“In our view, an adequate handling of the cycle requires an adaptation in allocation across the various (more attractive) (sub-)segments, contract structures, type of peril and region, but more importantly and above all, across the level of assumed investment risk,” the investment advisor said.

Providing more detail by explaining that, “In a soft market phase, such as prior to 2017, “de-risking / hedging” is generally sensible in order to stay as far away as possible from certain (undesired) risk factors and to exploit the relative attractiveness of the lower- risk transactions. In a hard market phase, on the other hand, depending on the strategic orientation / flexibility, it makes more sense to consider a gradual increase in allocation to riskier transactions, as more premium is paid per unit of risk.”

However, this approach, that SIGLO refers to as active management, so a matching of opportunities to the cycle itself and a more selective way of investing into ILS across market cycles, has not been followed as rigorously as it should have been.

“In our view, this active management approach to the cycle was not implemented timeously nor consistently and consciously enough in all ILS products and by all ILS managers. Thus, we see a general need to improve the investment awareness (and with that the level of transparency and comprehensibility of certain investment decisions) and, where needed, the design and implementation of the investment approach of certain ILS products to adapt to prevailing market circumstances,” SIGLO states.

Of course, the insurance-linked securities (ILS) spectrum is increasingly broad and encompasses a wide range of reinsurance linked assets and insurance securitization products.

So results are not all equal and there is also a wide dispersion of manager strategies and results as well.

“Some managers and products have been more successful in actively managing the cycle, delivering attractive annualised returns even during the more challenging and recent eventful insurance years,” SIGLO continued to explain.

Adding, “Other managers are still in the process of drawing the “right” lessons.”

Before going on to explain what it sees as an ideal manager strategy “Successful ILS strategies have been able to combine high selectivity across different ILS segments with capital-efficient execution, even during the more difficult recent years.

“The investment philosophy, broad market access and disciplined underwriting combined with a robust investment process, following clear investment criteria in line with well-thought-out product design, have been key to achieving these results.

“In our opinion, these aspects will continue to define successful ILS strategies and managers in the future.”

SIGLO is very constructive on the ILS asset class at this time, seeing a good opportunity for investors in the space right now, but making manager research and selection all the more important to ensure allocations back the right teams in the space.

SIGLO said that current market dynamics provide, “Strong indications that the current hard market phase will continue and may even become more accentuated in certain market segments in the near- and medium-term future.”

Leading the investment advisor to state, “Even if this may go against the current gut feeling of a (disappointed) ILS investor or a critical ILS observer, the ILS asset class is today (even) more attractive than it has been in the last 10 years.

“Facts and observations tell us that risk premiums and risk margins have risen (in some cases significantly) over the last five years. In addition, the insured risks are generally more narrowly defined.”

Concluding that, “In view of the current uncertainty in the financial markets and the fact that the basic diversification approach between equities and bonds no longer holds true, we consider a carefully and thoroughly implemented ILS allocation in the overall portfolio context of an institutional investor to be an extremely valuable and reliably diversifying building block.”

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