The Growth of Insurance-Linked Securities
A Report from the Seminar on Reinsurance hosted by the Casualty Actuarial Society, June 1-2, 2015
By: Lee Van Slyke
Three managers of Insurance-Linked Securities (ILS) funds projected that the volume of in-force contracts would double to $120 billion by 2020 from $60 billion at the end of 2014. Indeed, the typical growth rate has been twenty to twenty-five percent each year since 2009, which would imply doubling in just four years.
Bill Dubinsky, Managing Director & Head of ILS, Willis Capital Markets & Advisory, John Seo, CEO, Fermat Capital, and Lixin Zeng, CEO, AlphaCat Managers Ltd., a Validus company, explained that ILS grew most quickly after a catastrophic event. The reason, Seo said, is that the investors expect that premium rates will be stronger if reinsurers have just suffered a financial loss. The anticipation of future earnings is more important in liquid markets than the memory of recent past losses.
Seo noted that Fermat’s assets under management (AUM) more than doubled in less than 18 months after Hurricane Katrina. He reasoned that the ILS market could reach $120 billion within 18 months of the next a major event.
Seo emphasized the liquidity of the over-the-counter market for catastrophe bonds. He pointed out that Hurricane Ike made landfall in Cuba on Monday, September 8, 2008, and in Galveston, Texas, on September 13. The secondary market remained active all week, he said, even though this was the week of the collapse of Lehman Bros and the opening week of the worst part of the collapse of global financial markets. (On September 9 Lehman shares plunged 45% and on September 15 the firm filed for bankruptcy protection.)
Most investment in ILS has come from pension plans, the panelists said. Seo reported that Fermat’s clients are typically pension plans with major asset allocations in bonds, for whom the returns on cat bonds look attractive. Pension plans invest more than $70 trillion, so investments of $60 billion or $120 billion are not even one percent of their assets. Zeng said that AlphaCat’s clients are equity buyers with sophisticated investment strategies for which the lack of correlation with other equities make ILS attractive. In short, the cost of capital is not a single number, but depends on each risk and each investor’s risk appetite.
Tomorrow’s investors in ILS will be different from yesterday’s investors, Seo said. High net worth individuals are coming into the market when products suit their risk appetites. Life insurance companies have tens of trillions of dollar and AAA credit ratings but have yet to enter the ILS market. When they begin to invest in ILS, their risk appetite will be more clear and more products will be designed for them.
Moderator Aaron Koch of Tillinghast asked about the sources of risks for this increase in ILS. Growth areas include flood and tsunami, especially in Asia, and greater coverage of natural disasters, particularly as the market in China opens to global capital. Liability insurance, including General Liability and Products Liability, may be a source of growth, the experts agreed, but, “It’s trickier,” Seo said. Zeng said the potential is there. Dubinsky pointed out that there are significant accounting and contractual issues in securitizing liability insurance risks.
Geographically, China presents the greatest opportunity for new insurance and new ILS. “China is deeply underinsured,” Seo said.
When asked if the conventional wisdom among reinsurance executives is that investors in ILS represent “naïve capital”, Dubinsky answered that pension fund managers that invest in sidecars may be very sophisticated investors. The sense was that little of the investment in ILS has been done without careful research. The conventional wisdom may still regard ILS to be new and untested, but, Seo said, “In a 300 year old market, when anything new arises, adoption is going to be slow.”
The panelists then left the conference. ILS had grown $10 billion, to $70 billion, in the five months ending June 1. They had work to do.