Dramatic Growth Ahead For ILS, But Investors Seek Transparency: Report

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by: Steve Evans

There's opportunity for insurance-linked securities (ILS) capacity to grow dramatically into other areas, and while investor response to 2017 events shows they clearly remain attracted and committed to the space, increased manager transparency would be welcomed, according to a report from Clear Path Analysis.

Despite the impacts of 2017 catastrophe events, described by some as the first major test for the ILS community, institutional investors have responded positively and are increasing their allocations to the space, suggesting further market expansion.

According to the seventh annual report on ILS from Clear Path Analysis, increased investor interest in the space is in response to improved pricing as a result of 2017 losses, greater awareness of ILS as an applicable asset class within an ESG portfolio, and also the fact fund managers are expanding into new risk areas outside of the highly competitive property catastrophe arena.

Dirk Lohmann, Chairman and Chief Executive Officer (CEO) of ILS manager Secquaero Advisors, commented on the potential for ILS to play a more meaningful role in other areas.

"There are other areas for the ILS market to grow into. In these areas we will see very dramatic growth perhaps like what we saw in the catastrophe bond space 5 - 6 years ago.

"It is also a function of product development and adopting structured reinsurance transactions for distinct types of uses."

ILS growth in other areas of the same magnitude witnessed in the catastrophe bond space would certainly be dramatic. The catastrophe bond market reached new heights in 2017 with a record level of issuance, and, so far in 2018, issuance remains strong, with Q1 numbers once again breaking records, as shown by the Artemis Deal Directory and ILS market reports.

As the marketplace continues to mature and the investor base becomes increasingly sophisticated and understanding of the asset class, ILS has increasingly looked to participate in new risk areas, ultimately searching for greater diversification and yield in a very competitive and pressured insurance and reinsurance landscape.

As an example of its growth potential, Barney Schauble, Managing Partner with Nephila Advisors, part of the largest ILS fund manager in the world, Nephila Capital, discussed with Clear Path Analysis the growing participation of ILS in the renewable energy industry.

"By introducing a hedge that says, 'over a ten-year period we will provide an injection of capital to the extent that there is a shortfall in energy generation because of low wind activity', it provides more certainty to all participants, and a better capital structure. That enables more of these projects and makes the market for renewable energy more efficient, which is a proactive way of enabling an ESG-positive outcome."

Both fund managers and ILS investors appear willing and able to expand their remit and participate in other areas, and it will be interesting to see where alternative reinsurance capital looks to in the weeks, months and years ahead.

One area that does look set to experience a greater flow of ILS capital is disaster relief and schemes such as the CCRIF SPC and the African Risk Capacity, for example, a trend highlighted by Alex Bernhardt, Principal US Responsible Investment Leader, Mercer.

"The Caribbean Catastrophe Risk Insurance Facility (CCRIF) and its regional counterparts around the world… utilise some form of ILS in their reinsurance programs… Building on these concepts is a huge opportunity for both the ILS market as well as for public entities and communities that are in desperate need of catastrophe risk support," said Bernhardt.

However, regardless of the exposure, some more experienced investors in the space have expressed a desire for greater transparency surrounding fees, suggesting a need for a standardised system to be established, reports Clear Path Analysis.

"Fees should be a function of the cost an ILS manager incurs, including a fair profit margin to compensate for entrepreneurial risk… it would be great to have this transparency standardised as it requires a lot of demanding work in convincing and negotiating to receive the information we require," said Eveline Takken, Investment Director, Credit & Insurance-Linked Investments at Dutch pension plan, PGGM.

A need for greater transparency is something that has been discussed numerous times in the ILS space, and Philippe Trahan, Portfolio Director for ILS at the Ontario Teachers' Pension Plan, suggested a lack of clarity could be a result of managers not wanting to reveal their portfolio positions.

"We do sometimes wonder whether the opacity and complexity are primarily there to mask the fact that some managers add very little alpha and are concerned we might replicate the bulk of their portfolio directly if we knew what their positions were. Ultimately, it is impossible for all the managers in this space to generate alpha," said Trahan.

It seems the ILS market is poised for continued growth in existing areas as well as expansion into new risks, something that will likely increase competition and pressure in these areas for traditional players, while potentially bringing greater diversification and yield to fund managers and investors.

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