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IPE special report May 2018

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Pension funds recommend diversification in ILS as rates fall

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Pension fund investors in insurance linked securities (ILS) expressed some concern over falling re-insurance rates and emphasised the importance of diversifying ILS exposure to mitigate the risks.

Speaking at the inaugural Securis ILS Investor Meeting at Llloyd’s in London on 22 May, re-insurance professionals played down the risk of a significant re-set in rates – at least due to any natural catastrophe.

The wall of alternative capital that has pushed rates so low over the past couple of years, from the likes of pension funds and hedge funds, will probably mean that they stay there, they said.

“We see no reason for property catastrophe insurance rates to increase, for many reasons, including the availability of capital,” said Nick Johnson an insurance-sector analyst at boutique investment bank Numis Securities.

Volumes will grow, not least thanks to the ongoing economic recovery, he added, but not enough to offset the amount of capital available.

“Clearly there is a tragedy that could re-set rates, but given the level of capital out there that would have to be consumed, that disaster would have to be a whopper,” said Matthew Fosh, of the insurance company Novae.

“There is no event in our models that would take up more than 60% of the capital available,” confirmed Ben Brookes of ILS risk analytics firm RMS Europe – who said that he would not be surprised to see the amount of peak peril risk backed by alternative sources of capital double from today’s levels of 10-15%.

“I don’t think we will see a traditional rate re-set again; if we do see rates go back up meaningfully it will be from some totally unforeseen event, and perhaps something out of ILS alteogether – perhaps something in fiscal policy.”

Johnson suggested a slight pick-up in rates might come as the new class of investors started to feel “a little less comfortable with the risk-reward equation”, but did not see that as an immediate risk.

“We worry a lot about capacity in an asset class like this – and you certainly don’t want managers you invest with to have to hoover-up whatever comes to market,” said Craig Baker, global head of investment research at Towers Watson.

“We couldn’t suddenly double our clients’ allocation, but we can still go a lot further. It depends on where rates are and what part of the market we are talking about.”

Pension funds at the event agreed that while some parts of the re-insurance market looked stretched, it was important to think of ILS as a long-term strategic allocation, and recognise there was more to the opportunity than property catastrophe insurance.

“ILS is an important investment class for us,” said Yoshisuke Kiguchi, CIO, Okayama Metal & Machinery Pension Fund, which currently has 9% of its $450m (€330m) fund allocated.

Kiguchi made the point that ILS is part of his fund’s “long-term” portfolio, and that the nature of the asset class means that losses will usually be accompanied by a rise in the risk premium, providing a good opportunity to invest more at better rates.

“This mean-reverting characteristic is important, and makes us happy to invest in this asset class in our long-term portfolio,” he explained.

“We certainly recognise that there are times when you need to pull back, and the flexibility is there to do that,” said Stacy Apter, director of global benefits, financing and asset management at The Coca Cola Company, which allocates 5% to ILS for “equity-like returns with uncorrelated risk”.

Apter insisted on a segregated account with Securis Investment Partners and its other ILS manager, to ensure it had the flexibility to define its mandate and its potential exposures.

Coca Cola also deliberately chose two managers to diversify its risk within ILS.

“One is very much focused on US catastrophe risk, while Securis is more focused on the alternative risks,” said Apter. “They are a good complement.”

Espen Nordhus, co-founder of Securis Investment Partners, which organized the event, also went on to emphasize the importance of having access to the full range of ILS precisely to retain the flexibility to avoid areas where rates are under pressure.

“We just put $50m into life, and that’s $50m that isn’t in Florida wind,” he said.

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