On Thursday, November 29th, CFA Society NY hosted the 1st Annual Insurance as an Asset Class Conference as part of the Alternative Investments event series. The event provided a unique opportunity to learn about one of the few asset classes that remains largely independent from correlation to financial markets, and was particularly timely as the recent slump in both stocks and bonds has heightened concern for investors seeking to diversify and insulate portfolios from turmoil in traditional assets.
The event was organized by Gabriel Garcia Daumen, CFA, Head of Research and Direct Investments at Stelac Advisory.
Discussion and agenda focused on investing in two distinct segments of insurance investments: Life Settlements and Catastrophe Insurance. The evening featured a diverse and distinguished set of panelists:
- Andrew Plevin, Co-CEO & Founder, BroadRiver Asset Management
- Jim Pugliese. Chief Development Officer, RiverRock Funds
- Brian O’Grady, Managing Director, Vida Capital
- Peter J. Difiore, Ph.D., CAIA, Managing Director, Neuberger Berman
- Brian Weatherholz, Managing Director, Leadenhall Capital Partners
- Eric Nelson, US Alternatives Director, Schroders
- Caleb Wong, Portfolio Manager, Oppenheimer Funds
The evening opened with a segment presented by Andrew Plevin, Co-CEO & Founder, BroadRiver Asset Management. Mr. Plevin has a long history in and around life settlements, and was among the early pioneers to deploy capital into life settlements as an investable asset. He chronicled the progression of life settlements over the past 15 years as it moved from an embryonic investment into an asset class with institutional acceptance.
What began 20 years as a narrow opportunity set, with limited policy origination and pool sizes comprised of a few hundred underlying policies picked up institutional traction as the market matured. Going back 10 years to the period pre-financial crisis, the life settlements market came to be dominated by investment banks and hedge funds seeking to benefit from the attractive net returns, low volatility, and relatively high protection and credit quality (likened to investment grade credit) afforded by life settlements.
The financial crisis in 2008 and the period that followed brought about further changes in the market for life settlements. Investment banks exited the space driven by new regulatory measures, risk, and liquidity classifications (EG Volcker Rule). Many of the hedge funds that had dipped their toes into life settlements investments faced substantial redemptions and a disorderly winddown out from their life settlements investments.
Today’s life settlements market is characterized by an investor base that includes pensions, family offices, and specialty asset managers for life settlements many which utilize a more closed-end private equity type product structure.
Institutional standardization, shifting regulatory backdrop
Counterintuitive to what one might expect, today’s life settlements market and investing asset class has benefitted from increasing regulation and standardization within the insurance industry. Today there is relatively uniform regulation across nearly all 50 states in the US, which has standardized contracts, terms, conditions, fees, and rights to rescind. This has been supportive for expanding policy origination and policy pool sizes, helping to create an investable asset class of over $20 billion in life settlements. The regulatory posture and view of life settlements has generally been in the lens of ‘pro consumer’, as it creates an additional option and benefit to the consumer policyholder than would otherwise be the case.
The next segment of the evening focused on catastrophe insurance, which includes catastrophe bonds and what more broadly can be termed insurance-linked securities (ILS). The segment opened with an overview of how the catastrophe ILS market and 3rd party investor capital was born in the wake of Hurricane Andrew in 1992. For the insurance industry, a desire arose to diversify its protection market and vulnerability to concentrated capital risks. This led to a new market via securitization and new 3rd party capital base, whereby investors could earn a premium for assuming transferred re/insurance risk.
Today ILS has grown to become a $100 billion market, with 1/3 in securitized catastrophe bonds, and 2/3 in private capital structures which can include so-called quota shares and side cars. The advancement of 3rd party investor capital has room to grow, with only $100 billion of the $500 billion insurance risk market currently securitized by outside capital at present.
The peak peril market for reinsurance risk events tends to be in North America (Florida / Gulf Wind, California Earthquake, US Flood, Etc.), but includes similar natural perils in Europe, Asia, and South America, as well as non-natural perils for commercial risks to insured business lines.
Diversification, Growing Popularity
The main draw for investors entering into the ILS market has been the relatively strong level of past returns, minimal interest rate risk from floating rate collateral structures, and returns that are uncorrelated to financial markets. ILS ‘tail risk events’ historically have had a tendency to occur in a different period from ‘tail risk events’ in financial markets.
The past several years has seen increasing flows of capital by institutions and private wealth investors into the ILS asset class. This has coincided with a period of relatively poor returns during the past 18 months in ILS compared to the past 10 years, as a number of recent triggering events have occurred at greater frequency and severity. Recent events included several destructive hurricane seasons in the Gulf of Mexico, and the Fall 2018 wildfires in California which are much more difficult to price and model as compared to weather related disaster phenomenon.
An Inconvenient Truth: Renewal Premiums, Collateral Trap, Climate Change
Historically, ILS premiums (and thus expected investor returns) have increased meaningfully during the renewal season period that immediately follows trigger catastrophe events. However, the more recent renewal season pricing has been relatively soft versus history. Panelists noted that this is likely the result of more investor capital committed into the ILS market as a long-term strategic asset class holding.
One potential concern for ILS investors to evaluate and monitor is the drag and liquidity risk from “Collateral Trapping”. When triggering events do occur, investor capital tied to the specific event peril gets tied up and held in a trust for 5-6 years in order to determine the actual loss for payout versus the estimates that had been used in the ILS modeling process. The drag from “collateral trapping” is not well reflected in the return history of popular indices such as the Swiss Re Cat Bond Index, given the index assumptions and also the past history of relatively benign trigger events up until recently.
Questions arose from the audience as to how climate change and global warming would affect ILS and pricing catastrophe risk. The panelists acknowledged that climate change is a phenomenon expected to effect certain ILS risks over the course of time, and that asset managers and risk modeling firms do seek to be forward looking in pricing risk. That said, there is a meaningful timing mismatch between the impact of climate change and the catastrophe risk in which investors earn premiums for bearing ILS related risk. The tenor is very short-term comprised of 1-3 year time frames for ILS risk instruments. In contrast, climate change is a multi-decade phenomenon.