Some investors have began to experience advantages from the outperformance of investments within the private reinsurance segment in comparison with catastrophe bonds, after softening of pricing had been seen within the second quarter, Pascal Koller Partner and Portfolio Manager at LGT ILS Partners Ltd., recently commented.
Speaking with Artemis in an interview across the reinsurance conference season Koller stated: “The marketplace for cat bonds was in a position to absorb a big volume of additional transactions in the middle of the primary half 12 months of 2024. There was subsequently a healthy increase in capability within the cat bond segment, and as a consequence, pricing for brand new bonds has seen a softening in Q2.
“This allowed protection buyers to position bonds available in the market at more attractive prices in comparison with the normal reinsurance segment.
“End-investors allocating within the ILS space can thus capture the next level of return when specializing in the segment of personal reinsurance transactions. At LGT ILS Partners, we’re estimating this outperformance of the private market vs. the cat bond market (at unchanged risk levels) at as much as 200 bps.”
Moreover, roughly 80% of the cat bond market is allocated to covering the danger of US hurricanes. This concentration poses a considerable downside risk, particularly for the European wealth management segment of the UCITS cat bond funds, within the event of a big hurricane season.
Nonetheless, the private reinsurance segment enables a significantly more extensive diversification, Koller highlights.
Despite the potential advantages of investing in private markets, many investors remain hesitant to allocate funds to funds with a concentrate on this segment. Considered one of the first reasons cited for this hesitation is the lower performance of personal markets in recent times, particularly in loss-heavy years similar to 2017.
“Yet, such an assessment doesn’t include the indisputable fact that funds with the next allocation to non-public reinsurance transaction are typically managed at the next risk levels, to balance out the limited liquidity of the private segment vis-à-vis cat bonds,” Koller added.
He continued: “Also, investment managers similar to LGT ILS have reduced the allocation to a few of the tougher structures similar to aggregate placements and specific covers for secondary perils similar to floods, leading to far more robust portfolios.
“Many investors don’t realize that over 50% of outstanding cat bonds are still structured as aggregate placements, whereas at LGT ILS Partners, we’ve reduced this allocation to well below 10% within the private segment.
“And the remaining aggregate deals in our portfolios are only technically structured as aggregates once they require, in reality, a really significant first loss event, and are linked to elements similar to covering aftershocks for earthquake covers, and subsequently respond more like an occurrence cover would.”
For effective participation within the private reinsurance segment, an ILS manager needs an efficient fronting solution. To that end, LGT ILS relies on its in-house rated fronter, Lumen Re, which plays a pivotal role in its value chain.
Koller explained: “We will transact with insurers worldwide on the back of Lumen Re’s rating and without posting collateral. In truth, the recent recognition of Lumen Re as a Reciprocal Jurisdiction Reinsurer within the US further mitigates the requirement to post collateral for losses. Lumen Re allows for a really efficient transaction process for all involved parties; investors profit from zero drag or dilution in allocated capital from trapped collateral.”
He concluded: “At LGT ILS Partners, we already see a revived investor interest for the private insurance segment; similarly to a decade ago, it’s again investors with short decision processes, similar to foundations and family offices, which are currently allocating within the space and subsequently profit from the outperformance of the private segment vs. cat bonds.”