Co-head of alternatives, Gareth Abley, has been investing in insurance-linked securities (ILS) since 2007 – through calm periods and catastrophe cycles alike.
“It’s an asset class that provides reinsurance against natural catastrophe events. You get paid as the provider of capital, a coupon or an interest rate, above cash, for being exposed to things like hurricanes and earthquakes,” Abley told InvestorDaily.
“The thesis for an investor, whether it be a retail mum and dad investor or an institutional investor, is that it allows you to access an attractive risk-adjusted return.”
He believes ILS still offers compelling value, even after years of elevated losses and capital outflows.
“A lot of investors suffered losses between 2017 and 2022. MLC made money every year – that’s partly because we’ve designed the portfolio to be quite risk controlled, so you can still make money even if there are a large number of events.”
“The period from 2017 to 2024, where you’ve had much more events, much more losses at the industry level, returns have been cash plus 5 per cent per annum. So the returns interestingly have been consistent, so that’s partly just the intersection of higher losses with spreads getting wider, particularly in the last couple of years to compensate us for those risks,” he said.
Abley said events generally have to be extremely large to impact most of these instruments, with hurricanes being the most dominant risk for investors in the asset class.
“Having more hurricanes is an issue, but one of the quirks of the space is that very few hurricanes make landfall – and very few hurricanes make landfall in a way that causes material damage,” he said.
Abley suggested that a one in 30 or one-in-fifty-year event is what typically causes material damage to a portfolio.
“For example, MLC is only one investor, but we’ve made money every year for 18 years and in the 18 years, there’ve been lots of hurricanes.
“You can still construct a portfolio that makes money.”
The increased focus on climate change risk is prompting investors to ask whether they’re being adequately compensated for all the risks they’re exposed to.
“You’re getting very well compensated for that risk, given where pricing is. It’s quite a cyclical industry. Pricing changes through time, so that’s driven by how many events there are,” he said.
Media reporting of disasters can sometimes be a barrier to capital entering ILS markets, Abley observed.
“These are obviously like major events that cause a lot of trauma and damage to people and deaths. They’re obviously worth reporting on respectfully and proportionately, but I think because they appear on the news and because they’re in the mind’s eye for a lot of people ... there’s a bit of an aversion to [investing in ILS],” Abley said.
"That headline risk, the optical risk, the climate change narrative in some ways, it’s easier not to do it for some investors [but] I think in some ways that’s what creates the kind of risk premium for people who are willing to go into this class.”
He said that if investors feel climate risk is increasing, they have the flexibility to exit.
“If you look over a big sweep of history, 100 years, it’s a little bit harder to say that climate change is materially changing in a dramatic way, the number of catastrophes – I think there’s a general recognition it is definitely likely to increase the probability of things like wildfires and hurricanes.”
“If you get uncomfortable, you can exit the asset classes. It’s reasonably liquid so you can get out.”
Abley argued the beauty of insurance-linked securities lies in their lack of exposure to equity market risk, interest rate risk or macroeconomic risk – factors that dominate nearly every other asset class.
“This is one of the very few asset classes that is very uncorrelated to everything else. The next layer of subtle diversification, you can have exposure to different natural catastrophes.”
“So a Florida hurricane might be one exposure, California earthquake might be another exposure. A Japanese typhoon might be another exposure. All of those individual natural catastrophe events are also completely uncorrelated with each other. So you’ve kind of got two layers of very deep diversification within the portfolio,” Abley said.
MLC focuses on property catastrophe risk and Abley sees value in adjacent areas within the insurance and reinsurance industries for investors to gain exposure to.
“Cyber risk is one that’s often talked about. Marine risk, aviation risk, terrorism risk,” Abley said.
He said the simplest way to access the ILS market is via catastrophe bonds – publicly traded instruments – and through the private reinsurance market.
“Within the private reinsurance market, there are more sophisticated ways to access that risk, which, as you become more experienced in the asset class, you get more comfortable executing on those different ways of getting exposure, so you can build a better portfolio through that experience,” he said.
He further stated he anticipates larger players entering the insurance-linked securities space over the coming years.
“I think we would expect more institutional capital to plough into the space because there’s such good strategic logic as to why diversified fund investors should allocate to something that’s diversifying,” he said.
“We would expect an increased proportion of capital to come from capital market investors, like MLC, as opposed to specialist reinsurance businesses.”
Abley said a multi-asset manager approach is preferred for this asset class.
“I think multi asset management is the easiest way to just take that unrewarded risk off the table. How do you create good alignment?
“Our view is you want people who have got their own money at stake,” he said. “To be alongside people who’ve got skin in the game.”
When it comes to the role geographic or peril diversification plays in constructing a resilient ILS portfolio, Abley said it’s nuanced.
“The reinsurance industry’s got this concentrated exposure to particular areas, which we call the peak perils, and as a result, you get paid massively more for those risks than you do for other risks,” he said.
“Our view is, you want to selectively allocate the areas where you’re getting paid disproportionately well for taking the same level of risk.”
