With Catastrophe (Cat) Bonds set for significant growth in 2012, the latest report on Insurance Linked Securities (ILS) by Clear Path Analysis, the independent publisher, highlights that institutional investors are increasingly considering allocating to the asset class as they seek to diversify their portfolios away from other, more mainstream financial market instruments, such as equities and fixed income.
Several significant global disasters happened in 2011; US tornadoes and earthquakes in Japan and New Zealand made it one of the costliest years to date, in terms of economic losses. Following this, the first quarter of 2012 saw the issuance volume for Cat Bonds hit close to record levels of $1.7 billion[2]. Pension funds are increasingly looking to invest in these non-traditional debt instruments - which are used to provide insurance and reinsurance capacity to underwrite risks of natural disasters - as a diversification tool.
At a time when global financial market volatility continues to challenge allocators to traditional equity and fixed income, funds and institutional investors are targeting new sources of reliable return. The report investigates the wealth of potential ILS opportunities including Cat Bonds, the traditional reinsurance and private transactions markets.
The Clear Path Analysis report Insurance Linked Securities for Institutional Investors looks at the market from a pension scheme and endowment fund perspective, examining the key issues and opportunities involved with investing in the sector. It includes insight from pension, endowment, asset management and consultancy professionals such as AXA Investment Managers, Nephila Capital, Clariden Leu and Secquaero.
Christophe Fritsch, Head of Insurance Linked Securities at AXA Investment Managers comments “At a time when institutional investors are grappling with the challenge of making economic predictions and taking long term bets on asset classes, Insurance Linked Securities could provide an attractive investment opportunity. An investment particularly in Catastrophe Bonds can offer an important source of diversification on the asset and on the liability side for pension funds which have exposure to longevity risk on their liabilities but are not exposed to natural catastrophe.
“Given their appealing risk-return profile which is dependent on the occurrence of natural events and not linked to economic factors, inclusion of insurance linked securities in a portfolio of traditional asset classes could enhance the efficient frontier of the portfolio. Furthermore, by nature of their unique underlying risks and their low frequency, extreme loss distribution profile, catastrophe bonds are likely to remain a truly uncorrelated asset class yielding stable investment returns.”
Michael Stahel, Director at Clariden Leu Insurance-Linked Investments (will join LGT Capital Management in Q2 2012) remarks that timing is key when considering ILS: “The best time to invest in Cat Bonds is typically in the year after a very severe insurance catastrophe and 2012 is providing investors with a very interesting point because 2011 to date is one of the worst years on record in terms of insurance losses.”
“Many don’t realize that 2011 was actually worse than 2005 which saw hurricane Katrina devastating the shores of the US south coast. Last year, we saw several extreme events, the Japan earthquake and tsunami, the New Zealand earthquake, a very severe tornado and hurricane season, as well as the flooding in Thailand, which all together, based on Munich Re’s latest assessments, totalled approximately 110 billion dollars of actual insured losses.”
Meanwhile Dirk Lohman, Managing Partner at Secquaero highlights the value of other ILS possibilities: “Cat Bonds only represent about a third of the total outstanding volume of insurance linked assets. Even if one were to include so-called private collateralized reinsurance transactions and side-car investments in vehicles writing the risk as part of the broader ILS space, they would still only represent about 50% of the market’s current universe.”
“An issue with limiting one’s focus to catastrophe risk is that the risk being offered to the capital markets is relatively concentrated. Beyond alternative catastrophe instruments the largest potential lies in ILS where the underlying insurance risk is linked to the performance of life risks. This could be event driven, such as the risk of pandemic mortality or it could be portfolio based, such as the risk of a higher than projected mortality, morbidity or lapse behaviour.”
Greg Hagood, Founding Principal at Nephila Capital also looks at the wider ILS market: “When people hear ILS their minds immediately go to the Cat Bond market. Catastrophe Bonds started in the late nineties and are certainly a meaningful market, worth somewhere around $12-13 billion range in terms of outstanding issuance.”
“However, the traditional reinsurance market represents about $200 billion in risk that trades each year compared with the Cat Bond market, making it far larger. There are a number of additional risks in this market, which can also help diversify or complement a portfolio. These can present new opportunities to investors than you would otherwise get from the Cat Bond market.”
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