June 29, 2021 by Greg Meckbach
Record-low interest rates are making insurance-linked securities attractive to some investors, and this could be good news for primary insurers.
ILS includes but is not limited to catastrophe bonds, said Marcos Alvarez, Toronto-based senior vice president and head of insurance at DBRS Morningstar.
“If investors put more capital into the ILS market, this could put downward pressure on reinsurance pricing,” Alvarez said in a recent interview.
“Worldwide, the ILS market comprises about 20% of the total reinsurance capital available. That is a big chunk of the capital available to the insurance industry.”
Interest rates dropped significantly after the 2008 financial crisis and have been low ever since, he observed. Interest rates got even lower during the pandemic. There has been some recent uptick in interest rates but they are still relatively low.
If insurance-linked securities have interest rates a couple of percentage points above those of government bonds, that is one factor that would make ILS attractive to investors versus the additional risk those investors are assuming, said Alvarez.
Cat bonds pose a risk to investors because if the bond is triggered (by a wind storm for example), the investor loses part or all of their investment.
Returns on ILS are generally not strongly correlated to the overall financial markets, Alvarez noted.
There is an exception for one category within ILS, which provides coverage for mortgage default. ILS includes but is not limited to cat bonds. The ILS market also includes mortgage insurance-linked notes (MILNs) and securities linked to life insurance (extreme mortality).
MILNs are more correlated than other types of ILS to the state of the economy, because MILNs are triggered by defaults of the mortgage portfolios of banks in the United States, said Alvarez. MILNs are going to be correlated to the state of the economy, including unemployment levels.
There are no insurance-linked notes covering Canadian mortgage insurers so far. But this is something that could come to the Canadian market, said Alvarez.
ILS are available only to institutional investors and not to individual retail investors. Investors of ILS include insurance companies, pension plans and large asset managers who want to diversify, said Alvarez. Typically, no more than about 2% of an institutional investor’s assets would go into ILS.
The ILS market, including P&C, MILNs and life (extreme mortality), issued about US$16 billion in 2020 in new instruments, Alvarez reported.
Every year there are ILS instruments that mature or are triggered.
By the end of 2020, there was about US$46 billion in ILS securities outstanding.
“That is a record level. That is about 14% higher than the total ILS securities outstanding as of the end of 2019. It may be skewed by MILNs, which are becoming a larger part of the overall ILS market,” said Alvarez.
Feature image via iStock.com/Traimak_Ivan