Swiss Re Insurance-Linked Fund Management

PCS - Emerging Risks, New Opportunities

ILS market to double in size within five years, according to study


A new academic empirical study, undertaken by the University of St. Gallen in Switzerland, concludes that the insurance-linked securities (ILS) market can be expected to double in size over the coming five years.

The study authors found that further growth of the use of ILS for risk transfer and as an investment opportunity is to be expected, with the low correlation to other financial products and the relatively high yields likely to drive investor demand.

The study authors estimate the size of the ILS market at roughly $44.7 billion of invested capital. This is below many other estimates, but their work focused on specific investors, was based on empirical evidence and was completed in late 2014.

For the study, titled “Insurance Linked Securities: Trends, Challenges and New Market Opportunities”, 56 potential investors from 15 countries were surveyed in total, from investors such as hedge funds, specialist ILS funds, pension funds and asset managers.

Prof. Dr. Martin Eling from the University of St. Gallen commented; “For the first time, a survey concerning ILS addresses various types of investors. Thanks to our study, we can now give an empirically backed outlook of the asset class’ future development.”

The surveyed investors estimate that $44.7 billion are currently invested in ILS. Eling noted; “This perspective of investors on the ILS market is noteworthy. Our study indicates that the ILS market might actually be bigger than assumed so far.”

The forecast for the market is even more positive, with investors surveyed expecting that the market will double to a volume of $87.3 billion by the year 2019.

Expansion of the investor base is predicted to drive this growth forwards,with the appreciation of the relatively uncorrelated nature of the asset class and relatively high returns likely to drive the asset class forwards.

Investors surveyed said that these factors were “highly relevant” to them. 65% of those surveyed are already invested in ILS or plan to do in the near future. Those already invested said that they would likely allocate more and the average portfolio size was already $1.7 billion.

Respondents to the survey said that they plan to increase their ILS portfolio sizes by more than 9.5% in the near future to an average of almost $1.9 billion.

The survey found that there are impediments to the markets growth however, with the lack of understanding of the asset class and instruments being the key that may hold back growth. This shows that education remains absolutely key for investors as well as transparency in the asset class to encourage interest.

On the sponsor side of the market, the survey found that regulatory issues that can drive acceptance and use of risk transfer instruments such as ILS would play a key role in its development. The authors cite Solvency II and IFRS 4 as key issues here.

Additionally, greater liquidity through exchange trading of ILS instruments could be expected to drive further growth, as investor access and transparency will help to bring more investors and capital to the ILS market.

New risks are also cited as an opportunity for growth, with un-off business, cyber risk, political risk, microinsurance and liability insurance all cited.

Arndt Gossmann, CEO of the run-off insurer DARAG, commented; “We see an emerging potential in the securitization even of special risks like run-off. Especially long-tail run-off offers reduced volatility in a long term non correlated investment. So far, there are only a few experts among the sponsors who are familiar with the possibilities of all securitization structures like microsecuritization. Nonetheless, the demand on the investors’ side is increasing.”

The survey highlights a number of key market trends which will help to stimulate further market growth, including the growing number of ILS investment funds, new ILS risk transfer structures such as cat bond lites and the ongoing convergence of ILS and traditional reinsurance by the use of indemnity based triggers and variable reset mechanisms. Overall, the authors of the study expect an increasing price competition between traditional reinsurance and ILS as this convergence continues.

The study is a wealth of data and information on the ILS market after its roughly 20 year life so far, including many insights into the asset class, the investor base and the instruments used for risk transfer.

One particularly interesting finding is that having skin in the game is a driver of investment, with a 5% to 10% sponsor investment leading to large increases in the willingness to invest in ILS. The study also found that investors in the main do not see ratings as necessary, so no rating at all is better than a bad rating.

The study highlights the importance of transparency for investors and how standards could be a driver of future market growth as well. This should help to drive liquidity, which is a requirement of many investors not yet vested in ILS and so should drive further market growth.

The study concludes that, given the ongoing low interest rate environment ILS, perhaps more than ever before, is an attractive proposition for institutional investors. The growing number of funds and investors accessing ILS demonstrates the ongoing interest and growth potential.

“It is safe to state that these instruments have firmly established themselves in the risk transfer domain,” the study authors wrote. “If the market manages to improve on some of the critical aspects mentioned in this study its future perspectives look bright.”

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