Despite the losses in the ILS market, the recent storms have alerted a number of new investors to the existence of ILS as an asset class and sparked interest at a time when rates are likely to increase.
Insurance-linked securities (ILS) are at a crossroads. The next few months will show whether, as some in the market have foretold for years, ILS was a fad that would not survive its rst major test – or whether, as others have said, it has become a core part of the future of risk transfer.
There are those who look at the recent hurricanes and the losses they will cause to ILS investors and predict many of those investors will abandon ILS as an investment class. The theory is the pensions funds and other capital market players who sought high-yield returns in a diverse investment class were not prepared for losses, having enjoyed almost a dozen years of benign hurricane activity.
Such a view does not exist solely in the traditional reinsurance market. Indeed, in one of the few references to cat bonds in the popular press, the Daily Mail recently described them as “toxic” investments.
This view ignores the sophistication of ILS investors and those who manage their investments.
Like insurance, ILS has a purpose and that purpose is to protect purchasers of its products against losses. Without losses, there is little point to ILS. The recent hurricanes have shown ILS can be extremely useful in protecting insurers and reinsurers from major losses and can ensure their solvency remains robust.
ILS rst emerged as a concept after hurricane Andrew in 1992. That Florida hurricane and the subsequent storm, Iniki, that hit Hawaii, imperiled well-established insurers that had signicant market share in the affected states. Capacity in the insurance and reinsurance markets was short and ILS was developed as a way to provide protection from future capital events.
That said, for the first 13 years of ILS, more speeches, articles, seminars and conferences were devoted to ILS than deals actually done. It was not until the next major capital event in the market in 2005, when Katrina, Rita and Wilma hit the Gulf coast, that ILS activity increased to the level it is at today.
Before that time, some investment in ILS may have been more opportunistic. Since then and the global nancial crisis of 2008, it has become more strategic. Sophisticated investors have looked not only for diversication into ILS but also diversication within it.