Two-thirds of ILS investors in for the long-haul

Roughly two-thirds of ILS investors are believed to be making long-term strategic allocations to the sector, recognising the diversifying and uncorrelated nature of the asset class.

That is the view of Henning Ludolphs, director, insurance-linked securities at Hannover Re, who told Bermuda:Re that as such there was unlikely to be any grand exodus following an improvement in interest rates and rising ROEs in the fixed income market.

Ludolphs said that the remaining one-third of investors in the space were “chasing relatively better performance within the ILS space”, with a number of those likely to exit when the fixed income market normalises. However, he added that there may yet be a realisation among this third regarding the diversification benefits of ILS and the establishment of a more permanent allocation.

He suggested that perhaps the more significant question is what would happen to investor appetite following a major catastrophe event. “How will the ILS community respond”, Ludolphs asked. He said that much as with a change in wider economic conditions, “most investors are comfortable with the class and will stay following a major event”.

Others may leave post-event, but Ludolphs was confident that there would be still others on the sidelines “who have kept their powder dry” more than willing to step in. He said that while it has been a benign catastrophe season, a major event would likely encourage another influx of capital looking to exploit pricing post-event. A major gap in the market is unlikely to result from a peak peril event.

Can 2014 top 2013?

Not that the sector is short of attention. Interest in ILS has been strong and sustained throughout 2013, said Ludolphs, “and there have been no signals indicating a downturn in interest in 2014”. Rather, there continue to be investors waiting on the sidelines keen to put more money into the space, he said.

“The most significant limitation to ILS growth is that there is simply not enough risk to satisfy demand”. Two issues are playing into this dynamic, namely the pressure on traditional reinsurance pricing and the level of risks that are presently underinsured.

Ludolphs said that with prices coming down in the traditional market, he anticipates this putting pressure on risks entering the ILS market, as cedants will be able to place risks more competitively in the traditional reinsurance market.

The number of risks where insurance take-up rates are still low —such as California earthquake—suggest that there may be “sufficient demand for further ILS capacity” in the long term.

The return is the return

Ludolphs agreed that investor returns have weakened of late, but said that they are simply a function of demand. “Cat bond prices have declined far more steeply than the traditional market”, he said, with pricing being in some instances cheaper than traditional reinsurance.

“A few years ago cat bonds enjoyed  higher spreads and were more costly for cedants”. That has now changed. While this has been good news for cedants, investors must now accept a lower return on cat investments. However, due to its uncorrelated nature most are prepared to continue to invest in the space despite the squeeze on returns, said Ludolphs.