Swiss Re Insurance-Linked Fund Management

Original Risk: A Society for Change Agents

ILS investors happy to flex allocations, move with the market


There is a fixation with the staying power, or stickiness, of capital from investors in reinsurance investing and insurance-linked securities (ILS), but this discussion often overlooks the fact that investors in ILS are, in the main, a very sophisticated bunch.

As we wrote last week here, the ILS investor base does need to demonstrate its staying power by remaining in the reinsurance market after major loss events, something which has already been proven in a number of examples we cited in that article.

By doing this, showing reinsurance and retrocessional clients that they can be relied upon to provide top-up risk capital post-catastrophe loss, ILS investors will reap the benefits of building strong relationships, which although perhaps not as permanent as those associated with reinsurance historically, will ensure a continued flow of risk to the ILS investor community.

This is one of the ways the ILS market can ensure its continued success and growth. Should investors not return to support insurers and reinsurers protection needs post-event, you can be sure that the traditional reinsurance market will be there to step in and win back the business it has lost in recent years.

Growth through relationship building and by proving its staying power is perhaps one of the most important things that ILS investors can do, if indeed they want to secure an ever-increasing share of global reinsurance business.

But of course, as those who operate in ILS circles on a daily basis will know, the investors backing the ILS market who provide the third-party and alternative capital to support catastrophe bonds and collateralized reinsurance, are in the main a very sophisticated, institutional pool of capital.

Yes, there may be some naive capital in the market. We’d ask you to show us a market which doesn’t have an element of this, or a supposedly institutional asset class that clever hedge fund managers have not found a way to bring to some retail investors, in this way ILS is no different to other growing investment sectors.

But in the main, this is a sophisticated market with investors who want to learn and understand the ebb and flow of reinsurance market cycles and who are happy to flex their allocations to ILS accordingly.

This is important to note for observers and commentators on this market. Continued rapid growth of ILS is not assured and any investment manager in this market would tell you that there could be a pull-back, slowing down growth, if market conditions become less conducive to allocating capital to it.

But equally important to note is the fact that the sophisticated investors in the asset class, those allocating to multiple asset classes with billions under management in the pension fund, hedge fund, fixed income or private equity space, are increasingly committed to ILS, but also very realistic about allocating at the right time and in the right amounts.

As we’ve said before, there are investors we speak to regularly who are not invested in ILS currently. Some wait on the sidelines, watching the market, wanting to pick the right time to deploy their capital into it. These investors like ILS as an asset class but want the boosted returns that may (it is not guaranteed) come after a large catastrophe loss event.

Still other investors have pulled back in recent months, as catastrophe bond yields and reinsurance pricing have declined so far that the asset class no longer meets the risk and reward targets of the specific investors. An example of this to come to light in recent weeks is the pull-back by asset manager Blackstone, which has pulled back on cat bonds and reinsurance in one fund at the advice of its ILS sub-advisor Nephila Capital.

That’s the thing, any asset class can lose its shine for one investor but at the same time become attractive to another. There are fixed income investors for whom ILS and catastrophe bonds is a very new asset class and they are not put off by current returns. Neither are many pension funds and a host of other investors for whom the risk rewards remain attractive, particularly those who put a diversification and correlation benefit on the assets.

But allocations will be flexed and that could slow the market down at times, the key thing to remember is that this is normal and happens across the institutional asset world, particularly in bonds and fixed income classes. Pensions & Investments published this article last week which discusses some of this trend with a few of the ILS sectors managers and some end-user investors as well.

Pricing is having an impact on new inflows, commented Rob Procter, CEO of Securis Investment Partners LLP, who said; “New interest from investors, particularly pension funds, has slowed a little bit in 2014, compared with last year. I think that is related to pricing — there is a perception that it is less well priced than it was, which to some extent is true.”

Dirk Lohmann, of Zurich based ILS specialists Secquaero Advisors Ltd. said that the asset class remains attractive to many investors; “The investment case remains compelling, and adding this asset to your overall strategic allocation still gives improvements to the efficient frontier.”

Robert Waugh, Chief Investment Officer for the Royal Bank of Scotland Group pension fund, told Pensions & Investments that he had pulled back a little; “We have reduced our exposure as return expectations have fallen.”

Representatives of Danish pensions giant PKA and the New Zealand Superannuation Fund, both told the reporters that they had pulled back to a degree on their allocations, particularly on catastrophe bonds, due to the tighter spreads and lower overall returns.

So there has without a doubt been some flexing of allocations that has gone on over the last year and yet still the market is growing, perhaps at a rate as fast as ever before.

The article also gives some examples of investors who remain as committed as ever to ILS. Stacy Apter, director of global benefits, financing and asset management at Coca Cola, said that 5% of the firms $6 billion U.S. pension plan remains committed to  ILS, citing the low-correlation of the risk and the ‘equity like’ return potential.

Another end-investor, Yoshisuke Kiguchi, CIO of a Japanese pension fund for the Okayama Metal & Machinery company, said that ILS remained an important asset class and that his fund has as much as 9% of its assets allocated to ILS.

So as you can see, different investors have different requirements and so flex their allocations to an asset class according as they move with the market. This is natural and is to be expected in an asset class such as ILS, particularly in a time when it has clearly experienced a lot of attention and new capital inflows.

The other key thing to note is that the majority of these investors who have flexed their capital allocation to the space cite it as pulling-back, not pulling-out, and they keep some capital in the space just on a small allocation for the moment. These allocations could be ramped up dramatically should the asset class become more attractive to these investors again or as new opportunities arise, which effectively leaves more capital on the sidelines of the reinsurance market waiting for the right time to come in.

And still the ILS market keeps growing.

Yes, the rate increases of the past may not be seen again, due to capital and convergence in reinsurance. But for that to happen it would likely require the capital markets to keep growing its share of the overall reinsurance market, the most likely factor to flatten the reinsurance cycle. That would imply more allocations and more money flowing in and the passing of a tipping point at which the reinsurance market becomes a capital market where the major investors of the world increasingly participate alongside reinsurers.

Where lies the tipping point? That is hard to say, but with record growth, record issuance of new catastrophe bonds and ILS and no sign of things really slowing down at this time, it may not be a very long way off (or we may already have passed it).

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