Pension funds investing direct to drive future ILS growth: Schultz

An increasing number of large pension funds are expected to invest directly in the insurance-linked securities (ILS) asset class and this will be a big component of the ILS markets future growth, according to Paul Schultz of Aon Securities.

Speaking today at an Insurance Institute of London (IIL) lecture at Lloyd’s, Schultz the CEO at insurance and reinsurance broker Aon’s investment banking unit Aon Securities, explained that the future of the ILS market will see an increasing number of pension funds directly accessing the asset class.

“The reason that we think pension funds will start to go direct is, if you start to go direct you can actually start to lower the cost, you can have a greater net return because you’re not paying as many fees to third-party managers,” Schultz explained.

He acknowledged that this may not be seen as great news for ILS managers or reinsurance firms managing third-party assets, but explained that as pension fund investors become increasingly educated and experienced in the asset class this is likely to be the trend we see.

Schultz continued; “When we look at growth and when we look at the opportunity for this industry to grow over time, pension funds going direct is a big component of that.”

The ILS and reinsurance linked investments asset class is “still attractive on a relative basis,” Schultz said, explaining why ILS when compared to other assets still attracts the likes of the largest pension funds.

“It’s an indication of the times,” Schultz said, as despite the decline in pricing in reinsurance and the declines in returns above expected loss from instruments like catastrophe bonds, there has still been “more rate compression in other asset classes” which continues to make ILS attractive to pension fund investors.

The fact that ILS continues to outperform the main comparable fixed income type benchmarks, as a low volatility, low correlated, stable return asset class, is the reason that capital keeps flowing in.

Schultz said that financial market dynamics continue to drive pension fund interest as well; “Pension funds, with what’s happened in terms of interest rates for them, the funding gap between what a pension fund earns on their asset portfolio and the cost of their liabilities, keeps increasing.

“Pension funds are looking for ways to create additional yield in their portfolios, and this has proved to be one way of achieving that.”

Schultz explained that to pension funds and other investors such as high-net worth investors, the fact that ILS offers a fixed income asset class with such low volatility and attractive returns is going to continue to make it compelling to them.

“The sector has managed to make this return second only to cash in terms of volatility,” he said, adding that this will continue to drive capital into the space.

Schultz explained that new pension funds are coming into the market on a weekly or monthly basis and that while some investors may be cycling out of the market, if the returns no longer meet their requirements, new investors are always ready to replace them.

A marked shift in the size of allocations that pension funds make to alternative asset classes is expected to continue to drive capital and interest in ILS, Schultz said, something he said has doubled in recent years.

“As pension funds are looking for that increased yield opportunity, they’re increasing their allocations to alternatives broadly speaking and this (ILS) should get its share of that allocation,” he said.

Additionally investor education and sophistication is expected to drive this trend of direct investing in the future. He commented; “Pension funds themselves are growing in sophistication and this should enable this trend towards direct investor participation.”

Finally, Schultz said that another unit of Aon, Aon Hewitt, which deals with pension funds as investment and advisory consultants, are seeing an increasing number of enquiries from pensions looking for alternatives and considering ILS as an asset class.

There are already a small number of pension funds that do invest directly, with many more investing via managers. Direct investing in ILS, while certain to increase, may only be suitable for the larger funds that have the resources to hire dedicated specialists in the near future.

However, looking further ahead, if the ILS market continues to see reinsurers and others (even brokers) providing services directly to investors, we could see a trend where underwriting, risk analysis and pricing services are made available to pension funds, enabling them to manage their own portfolios of ILS and reinsurance using service providers.