A recent survey of 200 Chief Investment Officers (CIO’s) and investment team members from the life, property and casualty, insurance and reinsurance sector found that 18% of respondents are already holding some insurance-linked securities (ILS) within their investment portfolios.
The survey undertaken by Natixis looked at what is driving insurance and reinsurance investment teams strategies and the challenges they are currently facing in the macro investment environment.
Yield is clearly a challenge right now and continues to be, with no sign of a turnaround and re/insurer investment teams constantly battling to make up ground in this low yield environment.
Given the lack of yield more and more investment teams are turning to asset classes in the alternative arena, willing to take on more liquidity risk to improve returns, but these moves are also facing regulatory limitations.
As regulation becomes increasingly tight and complex, how insurance and reinsurance firms allocate their investment portfolios comes under increasing scrutiny.
At the same time, the world of investments is offering an increasing range of alternative classes and private assets, the majority of which come with less liquidity and a different risk profile, to the historically longer-duration and fixed income focused re/insurer CIO teams.
Among these asset classes sits insurance-linked securities (ILS), including assets like catastrophe bonds.
Catastrophe bonds have been a popular investment for some re/insurers for many years, filling a useful gap in their portfolios with an asset class that delivers on yields, has some liquidity risk but is still tradable a lot of the time, and for which the underlying risks are actually well-understood in a lot of cases.
Given ILS and cat bonds are originated out of the insurance and reinsurance market, or cover risks that re/insurers understand, investing in them, where it makes sense from a portfolio fit and regulatory stand-point, makes a lot of sense.
Re/insurers have proven big buyers of some of the most diversifying cat bond issues that come to market, particularly issuances from the World Bank and similar deals.
But more broadly there are re/insurers that find investing in catastrophe risk linked assets a diversifying asset, given their underwriting business may be focused on other risks and perils, such as specialty lines, or life risks such as mortality.
For these underwriters adding ILS assets like cat bonds to their investment portfolios can be beneficial from a top-down diversification view of risk across both sides of their balance-sheet, making a portfolio of these assets sometimes core.
There are also re/insurers that view investing in cat bonds and some other ILS assets as a way to pick up diversifying underwriting risk as well, treating them more as a premium than coupon driving asset and as a balanced piece of the overall underwriting risk profile of their business.
Overall, ILS offers insurance and reinsurance investment teams with an opportunity to generate alpha, given they often understand the risks within the assets much better than other large institutional investors can and have a natural pool of risk to diversify them within.
Natixis’ survey had responses from 97 life insurers, 70 property and casualty insurers and 33 reinsurance firms, providing a broad mix. Geographically, 40 investors were from the United States, 40 from Asia Pacific and the rest from Europe equally split between the UK, France, Germany and the Nordics.
Regulatory differences will have been a factor here, as some countries have tried to stop, for example, life insurers investing in catastrophe risk assets over the years, Bafin in Germany made this very difficult historically.
Given the low interest rate and yield environment globally, it’s no surprise that three-quarters (75%) of respondents said that it is essential to invest in alternative asset classes to diversify their portfolio risk and seek returns that are less correlated.
Two-thirds said that traditional asset classes are too correlated, making it necessary to find other sources of alpha.
62% of respondents said that alternatives help to diversify portfolios and lower correlations, 53% said they use alternatives to replace fixed income assets in their portfolios, while 51% said alternatives enable them to source alpha.
They are also seen as a way to mitigate risk and volatility in their portfolios, given their uncorrelated return profiles.
But at the same time as re/insurer investment teams look to alternatives, their regulatory environment is increasingly driving them towards lower-yielding fixed income assets.
75% of the U.S. investors expressed frustration over how regulations are hurting their ability to generate investment alpha on their portfolios, with France at 70% and Germany 67%. While a huge 89% of respondents said that regulations prevent them from investing in higher-risk asset classes.
In fact, in Germany and France 97% complain that regulation prevents them investing in the alpha-producing assets they need to be able to meet future liabilities.
Natixis found that these pains are increasing, with higher percentages citing these challenges this year than in 2015 when the survey was last undertaken.
Overall, the majority of re/insurer investment teams expect to increase their allocations to alternatives in 2020.
Within this, private assets or investments are an increasingly important part of the puzzle and 98% of life insurers reported they allocate to some private assets, and 89% of P&C insurers and reinsurers.
More recognisable asset classes such as real estate, private equity, private debt and infrastructure are the most popular, but on insurance-linked securities (ILS) 18% of respondents said that they hold some of these assets already.
More investors expect to increase their ILS allocations than decrease them over a three-year horizon, although the majority expect the allocations to ILS will stay roughly the same.
This is likely a reflection of the regulatory environment, especially as in some areas re/insurers may not be able to invest in ILS or catastrophe bonds at all.
Interestingly, the biggest challenge with alternatives is cited as their complexity and the lack of understanding of them.
That’s one area where ILS and cat bonds may find increasing favour, as re/insurer’s CIO teams will likely have a much greater appreciation of ILS assets than other large institutional investors, given they originate from the same industry.
ILS is also an area that many re/insurers can invest directly if they choose, particularly in catastrophe bonds, as their understanding of the risks and the fact these are bonds can make them relatively straight forward to add to existing fixed income portfolios (compared to other investor types).
There is a lot to be said for re/insurers investing in ILS assets such as cat bonds that can deliver positive yield and also be a positive contributor to their overall risk profile, in terms of diversification.
For example, life insurers that hold a majority of mortality or longevity risk, may find investing in fixed income assets that are exposed to natural catastrophes actually a very good fit from a diversification stand-point.
For large investors like this, the correlation that could happen would tend to be at the very extreme ends of the tail, at which point their asset portfolios would likely have taken a major hit anyway.
ILS is likely to remain a very attractive investment option for many insurance and reinsurance firms around the globe, but adopting ILS as a private asset class may continue to be held back by regulation in the space, with regulators still having a job to do in terms of gaining a true appreciation for how ILS assets can be leveraged by re/insurer CIO investing teams.