Insurance-linked securities (ILS) and catastrophe bond investors who cashed-out their holdings during March, as the world’s financial markets declined in the face of the Covid-19 coronavirus threat, are likely to return and may bring more investors with them, Lane Financial LLC believes.
As we’ve been documenting, in recent weeks some ILS funds have been receiving redemption requests and the secondary catastrophe bond market has been particularly busy, as more generalist investors sought to liquidate ILS positions and sell-off catastrophe bonds in search of cash.
This flight to cash was a direct reaction to the coronavirus effect in financial markets as almost all other asset classes seemed to be declining in terms of value, but ILS and catastrophe bonds held up due to the fact they are relatively uncorrelated to broader financial market factors.
In its latest report, Lane Financial LLC, a specialist consultancy focused on the insurance-linked securities (ILS) market, discussed this “dash for cash” but positively believes that once again the ILS market has demonstrated one of its core values for institutional investors, which may only serve to increase interest in the ILS and reinsurance-linked asset class.
While all assets across financial markets declined significantly, ILS and catastrophe bonds held their values much better than most other investments.
“All assets saw their prices decline. At some point during March – Large Caps were down by 30%, Small Caps by 40-50%, High Yield Bonds by 20%, Investment Grade Bonds by 17%. Gold, the ultimate safe-haven, suffered 6-10% drops in an otherwise up-trending month.
“In contrast, ILS suffered a 2-5% swing in prices to the downside, with yields pushing higher,” Lane Financial explained.
In fact, while outstanding ILS are currently at a discount to issue, Lane Financial notes that “New issues will necessarily have higher coupons, implying higher rate- on-line reinsurance prices,” suggesting rising return potential in ILS and cat bonds.
In addition, the tightening of ILS capacity right now, due to this “dash for cash” and the investor redemptions seen, may only serve to support reinsurance rates at renewals, making ILS returns even more attractive.
Lane Financial explains that the “dash for cash” seen in 2020 closely replicates what happened in 2008, during the financial crisis.
“While most bonds were down by 40%-60% in the depth of Q3 2008, ILS were down by only 5%-10%,” they said.
The performance of insurance-linked securities (ILS) in the face of adverse financial market conditions is something the market should view positively, Lane Financial believes.
“Natural catastrophe ILS market participants should feel good about the market performance,” they explained.
Especially so as going forwards, “We believe that it will encourage more to enter the market.”
“Lying towards the Investment Grade end of the spectrum of risks up to and including corporate High Yields, ILS is not without risk. But because of its low correlation it offers a better alternative to Investment Grade investors that reach out for higher yield than going to standard High Yield corporate market alternatives,” Lane Financial said.
Not only does Lane Financial believe that the performance of ILS will underline its attractiveness, the investors who have cashed-out may well return and may not be alone.
“Even though many have, of necessity, cashed out of ILS, we believe, MacArthur-like “They will return” and bring others with them, if for no other reason than the higher yield.”
The coronavirus pandemic is a major threat to global economic and financial business as usual. But the disruption it causes may eventually provide a springboard for the next phase of ILS market growth, for all of the reasons of performance, lack of correlation and diversification that Lane Financial highlights.
The consultancy explained, “Never in our history have economies been put on hold to stamp out a disease, although several diseases in the past have stamped on our economy. But return to a new normalcy we will. And in that new normalcy we expect that new ideas that have found success will expand the business in which we find ourselves.
“The ILS market has used every reversal as a base for its future growth. We expect it will again.”