Unlocking investor confidence: the power of ILS valuations
In the dynamic landscape of financial markets, insurance-linked securities (ILS) have emerged as a captivating investment opportunity. These financial instruments allow investors to tap into the world of insurance risks and embrace risk like never before.
But how do we determine the true value of these intriguing securities?
Enter the realm of ILS valuations. Picture this: a team of experts analyze historical data, catastrophe models, and market conditions to assess potential losses lurking in the insurance market. They're like detectives, piecing together the puzzle of risk and reward. But it doesn't stop there. They also consider factors like interest rates and investor demand to paint a complete picture.
To understand more about ILS valuations, we sat down with JB Crozet, a leader on Artex’s Capital Solutions team, to get insights into these assessments.
Why do investors care about ILS valuations?
Investment managers really depend on robust and frequent valuations to make sure everything's fair and equal for investors entering or exiting their funds. It's not just about setting a price, it's about establishing track records and measuring performance. When it comes to ILS, it can be a whole different ball game compared to stocks or government bonds. A large section of the ILS asset class can't be "marked to market" based on market prices like those other assets. Instead, they're "marked to model", which means their valuations come from financial models.
This can be a bit tricky because not all models are created equal, and that can raise some credibility concerns for investors. That's why it's important for investment managers to use reliable and transparent models to get accurate valuations in the ILS market.
For example, the financial model may not adequately reflect the significant uncertainty just after an event happens, thereby underestimating the potential for losses to some transactions. This would flatter the valuations of these assets, and disadvantage potential buyers.
Could you expand on the challenges and potential issues with the “mark to model” approach?
When it comes to valuing assets that aren't actively traded, an ideal "mark to model" approach would be using all the available information and fair value principles to come up with an unbiased estimate of the market price. Sounds pretty straightforward, but sometimes things can get more complicated. In rare cases, valuations can be manipulated for personal gain, like pumping up performance-based pay or making track records look better than they actually are.
I always say that it is important to stick to three key principles: independence, consistency, and transparency. Independence is all about mitigating conflicts of interest. We want those valuations to be fair and unbiased. Consistency helps us compare things over time and across different assets. And last but not least, transparency; we want to be able to audit and validate those valuations.
2023 was fairly benign in terms of catastrophes affecting ILS, has that changed the investors’ perspective on valuations?
The year 2023 proved to be a remarkable one for investors. We have seen impressive returns, ranging from the mid-teens to over 50% for those with a taste for adventure. This exceptional performance was driven by a combination of a challenging market for property catastrophe reinsurance, even reaching distressed levels in some segments, and a fortunate absence of major catastrophe events affecting the ILS segment. While robust valuations remain fundamental, their role has expanded to support investment decisions as the industry shifts into a "fundraising mode”.
What do investors want to see when looking to deploy funds in ILS?
Investors aren't just interested in looking at historical returns. They also want to dig deeper and assess the volatility of those returns in relation to the level of risk taken. It's all about understanding how much risk was involved in generating those returns over a specific period. This risk-adjusted perspective gives a more complete picture of investment performance. This is also where the three key principles come back into play – investors are relying on independence, consistency, and transparency.
Benchmarking is another critical thing that investors need. They are used to using benchmark indices like the S&P 500 as a reference point to assess how their investments are performing. But in the current ILS world there's a gap in robust and widely accepted benchmark indices. This makes it challenging for investors to gauge how their ILS investments are performing compared to a standard measure. However, there is optimism that in the near future, we'll see the emergence of more reliable benchmark indices in the ILS market. These benchmarks will provide investors with valuable anchor points to assess the performance of their ILS investments.
In your view, is there much performance differential across ILS investments?
Yes, we conduct over 3,000 ILS valuations annually and we can see a pattern of outperformers on a risk-adjusted basis beginning to emerge. Portfolio management is both an art and a science and track records reveal that certain managers possess a stronger understanding of risk selection and portfolio construction compared to their peers. However, the challenge for these outperformers lies in effectively demonstrating their superior skills to investors. In the ILS asset class, where performance comparison can be opaque and complex, showcasing their expertise becomes crucial for attracting investor confidence and trust.
What should investors do to ensure they are getting a proper ILS valuation?
When investors receive an ILS valuation, it is essential to carefully analyze and consider the information provided. They should assess the accuracy and reliability of the valuation by evaluating the methodologies used, the quality of data inputs, the expertise of the valuation provider and the frequency of the independent valuations. Investors should also compare the valuation against their investment objectives and risk tolerance to determine if it aligns with their portfolio strategy. Additionally, investors should seek professional advice if needed and consider the broader market conditions and trends before making any investment decisions based on the ILS valuation.
JB Crouzet is Senior Vice President of Advisory Services and is Head of Artex’s London office.
About Artex
Artex, Gallagher's wholly-owned subsidiary for alternative risk and capital, including fund administration, is a trusted leader and provider of diverse alternative risk and capital solutions.
The Artex Capital Solutions team provides market leading expertise at all stages in the process, from pre-incorporation concept development and structure design to regulatory application, incorporation and through to ongoing management and evolution. Our market-wide experience, insights and eye for the path forward, enable us to respond promptly to market cycles and industry-changing events.
We’re here to help you find a better way to reduce your total cost of risk and improve your return on capital. For more information visit www.artexrisk.com.
