An acceleration of significant weather events are impacting the risk premium earned from insurance-linked securities, providing a significant inflation hedge for institutional investors, says Bernard Van der Stichele, senior portfolio manager of insurance-linked securities at the Healthcare of Ontario Pension Plan.
“ILS investments earn a risk premium that is directly proportional to the level of risk assumed, in addition to a rate of interest on the supporting principal. The latter responds to the level of interest rates in the markets; however, the former is fixed and thus immune to changing interest rates.”
Investments in this asset class, particularly in catastrophe bonds, strengthens the resiliency of insurers and their policy holders when it comes to severe loss events caused typically by climate disasters.
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A recent report from Aon found during the 12-month period ending June 30, 2024, there was a record US$17.9 billion worth of catastrophe bonds issued across 76 transactions, up 18 per cent from the previous year. It noted the overall insurance-linked securities market reached a total volume of US$110 billion, attributed to capital inflows following the landfall of Hurricane Ian in Florida in 2022.
“Inflation, evolving weather trends, and ambitious moves to close the protection gap have all driven demands for greater insurance and reinsurance capacity,” said Richard Pennay, chief executive officer of insurance-linked securities at Aon, in a press release.
The risk appetite of institutional investors has changed in the past three years, says Chin Liu, managing director and director of insurance-linked securities and fixed income solutions at Amundi Asset Management, adding this shift is pushing investors to pursue initiatives with reduced volatility.
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“Investors are concerned about the very tight valuation in a broader financial market,” he says, noting institutional investors are diversifying their portfolios to mitigate the impacts of a potential recession or market selloff event.
Depending on the size of their portfolio, institutional investors typically allocate between one and five per cent to this asset class, says Liu. Moving forward, he expects to see increased adoption of insurance-linked securities through the number of investors considering their own allocations, compared to an uptick in the size of the investment.
Despite the increase in deal-making in this sector, Van der Stichele says institutional investors need to keep in mind the risks associated with the asset, particularly the exposure to underwriting losses and the liquidity limitations of some positions within the space.
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