Access to a rapidly developing asset class which offers unusually strong diversification impact
In their search for uncorrelated returns, institutional investors are increasingly looking to insurance-linked strategies (ILS) as a solution. As one of only a small number of alternative asset managers currently offering ILS investment solutions, we have been able to provide access to this rapidly developing asset class. With ILS, investors have been able to achieve the combination of stable, attractive returns with low correlation to other asset classes. This is because ILS returns are based on the possible occurrence of a catastrophic insurance event − like a hurricane in the southeastern United States, mass flooding in Europe or an earthquake in Japan – so they have little correlation with equities, bonds and other asset classes. In fact, ILS have among the lowest correlation to traditional asset classes of any investment type.
When investing with LGT ILS, the diversification impact goes beyond the addition of an uncorrelated asset class because we also diversify our portfolios across different kinds of weather-related perils. While investors have long had access to the catastrophe ("cat") bond market, they have had to make do with cat bonds' heavy exposure to US wind perils. LGT ILS has addressed this historic bias by spreading the risk in its portfolios geographically (by including Europe, Southeast Asia, Japan and Australia), across different peril categories (such as earthquakes, typhoons and cyclones), as well as across different trigger types and default probabilities. As a result, our investors have benefited from uncorrelated risk exposures across the full set of possible catastrophe risks, resulting in well diversified portfolios, which are optimized to mitigate tail risk.
Investors also have the ability to choose their preferred level of risk, with three different strategies available. Our Conservative, Balanced and Enhanced strategies provide three distinct levels of risk and return, depending on the investor's return requirements and appetite for risk. Each strategy has a specific risk budget defined by its maximum expected loss and maximum exposure per peril. This constant-risk approach provides a high level of transparency to investors, as they are exposed to the same level of risk over time.
LGT ILS is further distinguished by the strength of its team and the length of their track record. The team's four founding partners come from the reinsurance industry, where they mastered the complex field of catastrophe risk management, with an average of 16 years of experience in the field. They are part of a larger team of 20 professionals from a wide range of backgrounds, who together have a large network for sourcing investments and securing relationships with counterparties. As one of the oldest teams in the industry, its track record extends back to 2005, and it has delivered positive returns for nearly 90% of the months the team has been investing.
Every year, meteorological institutes publish forecasts for the upcoming North Atlantic hurricane season. For 2017, the forecasts were indicating a “average” or even “above-average” North Atlantic hurricane season. US hurricane risk counts amongst the key exposures for insurance-linked strategies and as such, a major hurricane making landfall on US territory has the potential to cause significant losses in an ILS portfolio. However, one has to keep in mind that the forecast of a hurricane season is no indication of the actual performance of insurance-linked strategies.
Hurricane Irma was the fourth hurricane system of the 2017 North Atlantic hurricane season. The storm system originally developed over Western Africa around 26 August but underwent rapid intensification: The system developed from a tropical storm into an intense hurricane within a mere twelve hours. Irma then continued its northwestern path and was soon tracked as a major Cat 4 hurricane.
By Tuesday, 5 September, Irma increased further and ultimately produced wind speed measures of more than 280 km/h which is well above the 250 km/h of a Cat 5 listing on the Saffir-Simpson Scale. On 7 September, the models showed Irma continuing to move forward on a north-western track and to then turn right towards Florida. Although the ultimate path of hurricane Irma was still highly uncertain at that point in time, the ILS team identified three main scenarios for Irma’s future path to assess the potential damage to the ILS funds and mandates.
Hurricane Irma ultimately made landfall on the Florida peninsula at Marco Island in southwest Florida as a category 3 hurricane, 57 miles (90km) south of the port of Fort Myers. The affected regions suffered from severe precipitation of up to 15inches (38cm) brought by the storm system as well as storm surge, triggering significant flooding in the coastal regions of Southern Florida. Peak wind gusts were measured at 140mph (225km/h) in the area around Naples and Marco Island causing widespread destruction. A week after landfall, the industry loss estimate for Irma still exhibited a wide range with figures between USD 20bn and USD 50bn with a market consensus of USD 30bn to USD 40bn. Based on the actual track of Irma, market loss estimates, simulations with updated storm track data and their underwriting expertise, the ILS team provided an updated assessment of the impact of the storm on the ILS funds and mandates.
The hurricane season 2017 counts among the most active seasons since records have started more than 150 years ago. The significant insured losses caused by storms like Irma had a negative impact on the performance of insurance-linked strategies. However, financial losses from natural catastrophes drive insurance companies’ need to buy reinsurance protection. As a result, major insurance events are the key driver of higher premiums and open up new investment opportunities for the asset class.