Insurance Linked Securities (ILS) is an opaque market with many opportunities for investors, as well as challenges.
This was the view of participants at a recent webinar, which featured Gordon Woo, Catastrophist, Risk Management Solutions, who emphasised that the market was more established than people thought, and that education was necessary for success.
Woo was speaking at the ‘Risk Mitigation with Insurance Linked Securities: 2023 Outlook for Institutional Investors’ roundtable, hosted by Clear Path Analysis, in association with Tangency Capital, which has just been released as a report. In it, ILS experts from Egan-Jones Ratings, Albourne Partners, and Columbia Threadneedle Investments joined Woo in discussing the future of the market.
“Over the years, risks that have been completely untransferable have become easier for an investor to swallow. We are seeing a gradual increase in maturity.”
Participants were asked about the opportunities around ILS as an asset class, especially in times of macroeconomic or geopolitical volatility.
“Having been in this market since the end of the last century, there were a few deals back in the 1990s that, with hindsight, would have been rethought. However immature the market is now, it was a lot more immature 20 years ago,” Woo said. “What is encouraging is that over the years, risks that have been seen to be completely untransferable have become easier for an investor to swallow. We are seeing a gradual increase in maturity.
Woo said this process is “fairly slow”, adding that it won’t happen overnight and “does depend on market conditions.”
ILS has had several more profitable years after a slump over the last decade, which matched with heavy hurricane seasons on the Atlantic coast. “As ILS became more understood as an asset class, more capital entered the market,” said a paper from Woo’s own RMS, which tracked the profitability of the asset class. “Multi-asset investors, such as pension funds, were attracted to the diversification benefit and the relatively attractive spreads when compared with other opportunities in a low-interest, 'money-is-cheap' world.”
Woo was asked if the future of ILS was looking brighter, after several years of being covered less than favourably by analysts and the market in general.
“People are happy to be invested in any of the funds that I do risk analysis for,” he said.
“There are a lot of attractive points to this investment class, but one
does need to be prudent.”
However, changes to ILS in the future, especially concerning how it is shaped, are becoming more apparent. Whilst investment approaches often change, one key strategy is going ‘all in’ on a single peril and another is diversifying.
In a paper Woo wrote in conjunction with experts from Lloyd’s of London called “Counterfactual Risk Analysis” on the back of Hurricane Matthew, he noted that “investors should assess not just what the losses were to their portfolio but what the losses might have been if some of the near misses had turned to the worst,” a process that should be repeated each year.
“I have this phrase ‘downward counterfactual’, which is about the past when things take a turn for the worse and, as mentioned, there are a lot of attractive points to this investment class, but one does need to be prudent,” he said.
Woo explained that one action investors could do is to look at their portfolio, not only at the losses that have occurred but also those losses that might have occurred. “This thought over the last few years might have saved investors a bit,” he said – referring to the near-miss of Hurricane Matthew, which for a time was thought to heading straight for Miami and could have created a Hurricane Katrina-style citywide devastation event.
“We’ve had Hurricane Matthew, Hurricane Irving – which might have hit Miami – and Dorian, which skirted Florida, so investors can run their portfolio with these names in mind,” he said.
"Investors should be looking at these near misses over the past few years [knowing] that the rewards they are getting outweigh the risks.”
In the National Association of Insurance Commissioners (NAIC) 2023 report on ILS activity, it said that in Q4 2022, cat bond and ILS issuance fell to $1.6 billion, which is roughly $560 million below the 10-year average for Q4. “The $1.6 billion of total new risk capital issued in Q4 came from 15 transactions, consisting of 18 tranches of notes. In the last ten years, only one issuance in Q4 (2018) hasn't exceeded the $1.5 billion mark,” it added. “Combined with the previous three quarters of the year, Q4 2022 issuance took the total outstanding market size to a high of $37.9 billion.”
This means that the risks are still there, but many have their strategies in place now and are going big on ILS going forward.
Woo added that the market still needs to be prepared and do its homework thoroughly and that a key aspect of investing in Florida would depend on what the rewards were over time. “There has been an increase in prices, which is good news, but one has to weigh that against the risk. Investors should be looking at these near misses over the past few years [knowing] that the rewards they are getting outweigh the risks.”
