There has been a lot of discussion lately about whether pension funds would be among the first investors to lose their attraction to the current market environment of lower reinsurance and catastrophe bond pricing by turning heel and exiting the sector.
However the opposite appears to be largely true, with some pension fund investors keen to increase their allocations to the space, when market conditions allow, while still more want to enter the sector (as evidenced by new mandates) and others continue to do their research into insurance and reinsurance linked investments.
There have been a number of cases in recent weeks of pension funds which have been invested in insurance-linked securities (ILS) for a number of years pulling back as a reaction to the lower pricing environment. For some investors, who entered the ILS asset class purely due to the returns of the last few years, the decline in pricing makes the sector less attractive. This is an expected consequence of the lower price environment, but not all pension funds are the same or have the same motivations.
Typically, when anyone discusses ILS from an investor point of view the pension funds are placed into one bracket, while hedge funds, insurers and reinsurers, family offices, endowments and high-net worth investors are placed into others. In this way pension funds are often thought to have the same motivations, the same return hurdles and the same appetite for catastrophe and insurance risk, but this isn’t true.
When it comes to pension funds it is not a simple classification that can be applied with a broad-brush. They have very different risk appetites, treat asset classes in different ways, have different return hurdles and are also much more forward-looking than some would give them credit for.
Pension funds span a huge range of investment motivations, from the ultra conservative and long-term investment horizon to the much more speculative, from those looking to bear as little risk as possible, to others who see bearing risk as a worthwhile consequence of investing in a low-correlation asset class like ILS.
While some pension funds have pulled back in recent weeks, we understand there have been new mandates in the second quarter won by a number of ILS managers. The longer-standing ILS managers have continued to grow their assets so far in 2014 and the amount of alternative capital in the reinsurance market has increased as well. This does not reflect a picture of retreating assets and shrinking appetite at all.
Just yesterday, Investment & Pensions Europe announced a new mandate via its IPE Quest system from a Swiss pension fund looking for a $250m allocation to ILS through its investment consultant. The mandate will be benchmarked against the Swiss Re Global Cat Bond Index. For every mandate broadcast in such a way there are likely five (or more) others that we never get to hear of. Again, this does not reflect an environment of waning pension fund interest.
In fact, some pension funds are looking much longer-term to the future of ILS and the reinsurance sector itself. They see the disruption caused by the inflows of capital markets money and see more disruption coming in the future. Some pension funds see this as an opportunity to position themselves in such a way as to be able to capitalise on changing market conditions and to grow their investment in ILS and reinsurance.
This longer-term view is important as it shows that seasoned institutional investors can see the value in an asset class, as well as the potential for its continued development (an initiative such as the ARC climate catastrophe bonds announced today is a prime example). Many pension fund investors we speak with are more excited for the coming 20 years in ILS, than the 20 we’ve already had, and see real potential for the asset class to innovate and expand its remit.
Pension funds take a long-term view of investing in any asset class. With so many now looking at ILS, becoming aware of the qualities that this asset class can provide to their portfolios and becoming increasingly knowledgeable about how to access the returns of the reinsurance market more directly than through equities, further growth in pension fund assets in ILS would seem assured.
The continued growth in collateralized reinsurance, as ILS becomes more aligned with traditional reinsurance in some areas of the market, is another driver of continued growth. However, this does seem to be resulting in more than one path which can now be taken, the matching of reinsurance products and the stepping away from indemnity to provide contingent disaster capital, the two of which can, of course, be very nicely blended within a strategy.
Often ‘dwindling’ returns are cited as a reason for pension funds to leave the ILS space, but most ILS managers remain on target with their returns keeping within investors expectations. While they achieve this investors are unlikely to pull-back on what are typically very small allocations in the grand scheme of their overall portfolios.
Pricing is just one factor in market inflows. It is a factor that can slow the inflows of capital, as ILS managers and reinsurers need the opportunities to deploy the capital they are allocated, but access to business is perhaps the most important one here. Judging by the way alternative capital keeps growing, reaching $59 billion recently according to Aon Benfield and now makes up as much as 20% of global property catastrophe reinsurance, it is hard to see this number shrinking while ILS managers continue to work to secure greater shares of the market.
With pension funds still researching ILS and reinsurance, continuing to access the market for the first time as evidenced by recent mandates, others looking at how to position themselves for growth in ILS assets in the future and still more remaining happy with the returns their managers achieve, it seems clear that the attraction of the ILS asset class remains strong.