Property reinsurance investing offers more manageable tail risk than perceived: Agecroft

While property reinsurance and insurance-linked investment strategies are often viewed as carrying significant tail risk, Agecroft Partners believes that carefully constructed portfolios and disciplined underwriting can help to manage downside volatility more effectively than headline risk profiles may suggest.

Don Steinbrugge, Founder and CEO of Agecroft Partners, the hedge fund consulting and marketing specialist, recently published an article that examines why institutional investors should be considering property catastrophe reinsurance as an asset class.

Amongst the primary benefits, Steinbrugge highlights how property reinsurance investments can offer a more attractive and manageable tail-risk profile than commonly perceived.

The majority of the insurance-linked securities (ILS) asset class remains focused on investing into property reinsurance opportunities through catastrophe bonds and private ILS or collateralized reinsurance arrangements.

“Reinsurance is commonly caricatured as attractive returns sitting on top of an unquantifiable tail. The caricature has it backwards,” Steinbrugge explains.

The CEO continued: “Although the probability of hurricanes, earthquakes, and other natural disasters does not change much each year, actual loss outcomes vary widely year to year, and the distribution is explicitly modeled and explicitly priced. Managers can and do present a full exceedance probability curve at current market pricing: the no-loss return, the median, the 1-in-10, the 1-in-20, the 1-in-100. Investors tend to fixate on the 1-in-100 and stop there. What investors miss is that almost no other asset class or strategy can tell you what its 1-in-100 year looks like before you invest. Equities, credit, and hedge fund strategies all carry tail risk; theirs are simply undisclosed.”

Steinbrugge emphasises that the multi-year picture is stronger because the asset class contains its own recovery mechanism.

“A major loss year withdraws capital from the market, which tightens capacity and raises pricing, so that the years immediately following a large loss are typically the best-priced years available. Equity and credit drawdowns require a market to change its mind. Reinsurance drawdowns are repaired by a supply response that follows from the loss itself,” he explains.

Steinbrugge further added: “While property reinsurance is often viewed as carrying significant tail risk, carefully constructed portfolios and disciplined underwriting can potentially manage downside volatility more effectively than the headline risk profile might suggest.”

In addition, the CEO affirms that property reinsurance can also offer modeled forward returns that outperform many traditional fixed-income strategies.

Illustrating this dynamic, historical cycles demonstrate how supply and demand drive pricing across the asset class.

Following Hurricane Katrina in 2005, reinsurance pricing began to increase significantly as insurers and reinsurers sought to rebuild capital and capacity following the catastrophic event. That pricing subsequently attracted a substantial amount of institutional capital into the market, which over time increased capacity and pushed risk-adjusted pricing lower.

“Beginning around 2016, lower pricing coincided with a period of above-average catastrophe losses, resulting in weak reinsurance returns through approximately 2022. Those mediocre returns caused capital to leave the industry, reducing available capacity and eventually pushing risk pricing higher. That dynamic helped produce the strong reinsurance returns of recent years,” Steinbrugge said.

He continued: “The market has softened somewhat from its most attractive levels, but current forward modeled returns in the high single digits to low double digits remain reasonable estimates for appropriately structured property catastrophe reinsurance portfolios. These expected returns compare favorably with many fixed-income-oriented strategies when you consider that the yield of the 10-year treasury is below 5% and BBB rated bonds only yield about 100 basis points more.”

Steinbrugge also underscored that property reinsurance has historically demonstrated low correlation to many traditional investment strategies and asset classes, providing meaningful portfolio diversification, driven by physical events rather than market sentiment

“None of those outcomes are conditioned on discount rates, credit spreads, earnings revisions, or investor risk appetite. That is a far more durable foundation than a low observed correlation coefficient, which is an empirical artifact that can and does break,” Steinbrugge noted.

Lastly, Agecroft acknowledges that property reinsurance can also provide a source of liquidity during prolonged market stresses, when other asset classes tend to become less attractive or more difficult to monetise.

The company also underscored the importance of the reinsurance industry’s renewal calendar, stressing that for investors with diversified portfolios, these renewals create a relatively predictable pattern of contractual run-off, with a substantial portion of the portfolio maturing around year-end and another significant portion doing the same in mid-year.

“This liquidity gives investors the dry powder to take advantage of dislocations within other markets or provides cash to help fund the operation without having to sell securities at depressed prices,” Agecroft explained.