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Ahead of the marcus evans European Pensions & Investments Summit  2017, 
Sidney Rostan discusses the Insurance-Linked Securities market

Copyright © 2017 Marcus Evans. All rights reserved.

15 - 17 May 2017

Fairmont Le Montreux Palace, Montreux, Switzerland

The combination of low correlation, low volatility and resilient performance makes the Insurance-Linked Securities (ILS) market very attractive to investors, according to Sidney Rostan, ILS Portfolio Manager, SCOR Investment Partners. The asset class has demonstrated unique diversification benefits, he believes.

SCOR Investment Partners is a portfolio management company at the marcus evans European Pensions & Investments Summit 2017, taking place in Montreux, Switzerland, 15 - 17 May.

Why is ILS drawing the attention of institutional investors? 

Since 2009, institutional investors have dealt with an environment of weak returns, slow-growth and geopolitical uncertainty. With the Central Bank policies keeping up with low interest rates and Quantitative Easing, they have been forced to add alternative sources of yield to their strategic allocation. Could ILS enter in this equation?

ILS is an asset class linked to natural catastrophes, such as hurricanes, windstorms or earthquakes, which has gained in popularity by offering attractive risk-return characteristics and diversification benefits. Sophisticated investors have naturally integrated the asset class into their allocation. So did some insurers, despite being issuers of these securities.

Even if ILS remains a niche asset class, it continues to grow and offer a large diversity of investment strategies to meet with the requirements of experienced investors and attract potential newcomers.

What drives the performance of ILS? What makes it so different from other asset classes?

While offered premiums are subject to the (re)insurance business cycle, the valuation of ILS instruments is by definition primarily linked to the occurrence of natural catastrophe events and the related insured losses and not the state of the economic environment or the risk of default of the issuer.

As a result, the asset class has demonstrated unique diversification benefits combining low correlation, resilient performance and low volatility. Throughout 2008, Cat bonds have for example registered a positive return of +2.28 percent and overall, an annualised performance of +8.15 percent (Swiss Re Cat bond index TR from inception, in January 2002, to September 2016).

The low correlation, the low volatility and the resilient performance indicate that ILS can be a true and unique diversification instrument as part of a global asset allocation.

What is the best way of gaining access to this asset class? What are some of the intricacies that investors should be aware of? 

The benefits of ILS are undeniable as it responds to institutional investors’ main concerns: yield and diversification. Nonetheless, the asset class is governed by its own rules and has significant fat tails. Investors must keep in mind that one single event may generate a substantial drawdown. Consequently, they need to sensibly diversify across insurance risks in order to manage the risk.

The first level of risk diversification is the obvious peril/region nature of a deal. A tornado/hail in Florida has indeed no link with an earthquake in Japan. Additional risk diversification is also achievable by appropriately calibrating the inherent technical features of ILS instruments such as trigger type, event sequencing and attachment point. Two Cat bonds covering a similar peril/region such as US Florida Winds can be affected very differently by the same event, one being hit while the other remains intact, because of their respective technical features.

It is important to note that although the ILS market covers different types of natural catastrophe risks, it is mainly dominated by US hurricane risk when it comes to the sole Cat bond market. Therefore, OTC reinsurance/retrocession adds value to an ILS investment strategy.

What criteria should investors consider before allocating assets to ILS?

As a conclusion, the combination of low correlation, low volatility and resilient performance has made the ILS market look very attractive as it steadily drained significant inflows. If at first investors were mainly investing in Cat bonds, they progressively shifted towards OTC deals to benefit from enhanced risk-return and diversification.

Besides investment considerations, ILS also provide additional incentives for entities which are subject to, or apply solvency II treatment. The attractive features translate into an optimal risk profile which should result in a lower impact on the required capital.