Insurance-linked securities (ILS) managers are unlikely to invest much time in developing products linked to new types of perils and will instead focus on attracting new capital and managing their own costs, according to Brad Livingston, ILS director at Willis Re Securities.
Livingston played down the importance of developing ILS based on new types of perils in the short term, noting diversification within the ILS asset class is less important to many investors than the diversification ILS provides with other asset classes.
“The typical end investor has a massive portfolio, and ILS might be a relatively small percentage of the alternatives basket, which itself a relatively small percentage of the overall portfolio,” explained Livingston.
“That end investor may not require significant diversification within ILS, there is already good diversification in the portfolio. It is about holding something that does not correlate with other fixed income and equity investments.”
Livingston said 2020 has been a phenomenal example of the merits of ILS as an asset class, with liquid cat bonds in particular demonstrating their value to investors.
Cat bonds have outperformed other ILS products recently, with other structures experiencing problems driven by expanded peril definitions and multiple years of collateral being trapped.
“In late March and April investors were trading cat bonds which saw no detriment to their underlying value due to COVID-19, only a bit of pressure due to the rising reinsurance rate,” he said.
“From the investor perspective that is absolutely key, it is all about liquidity and diversification, about being non-correlated with other asset classes that investors might hold,” Livingston added.
“Nat cat offers that in a way other perils such as cyber do not to the same extent.”
“It is all about liquidity and diversification, about being non-correlated with other asset classes.”
Brad Livingston, Willis Re Securities
A back seat
For these reasons, new perils are likely to take a back seat in the short-term, while ILS managers focus on other issues, Livingston said.
ILS managers will be focused on understanding loss costs, attracting new capital, thinking about how to calibrate their models and analysing which structures are working and offer most efficiency, he said.
“ILS managers will be more focused on their core competencies,” Livingston added.
“In the near term I think we will see steady growth in the ILS sector overall, but predominantly in cat bonds. In the medium term we expect growth in ILS to accelerate.”
Livingston warned of the significant challenges the industry faces in developing a more liquid and electronic secondary market for ILS, noting this has been an industry goal for many years.
“It is something everyone would love to see and would bring significant advantages, but it will be very difficult to get there,” said Livingston.
“The problem for a secondary market is that you need a high degree of standardisation, and most of the underlying insurance contracts are very structured, with each contract being tailored to the needs of the buyer.
“Even index deals tend to be very tailored,” he concluded.
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