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Diversified ILS portfolios are the future

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Interest in insurance-linked securities (ILS) is moving beyond catastrophe instruments, although this is the most mature sector. There is growing appetite for climate related impact products and specialty insurance lines focused on issues like aviation, terror and cyber.

Interest in insurance-linked securities (ILS) is moving beyond catastrophe instruments, although this is the most mature sector. There is growing appetite for climate related impact products and specialty insurance lines focused on issues like aviation, terror and cyber.

“We expect increasing demand for ESG ILS strategies and for other lines of insurance that complement core catastrophe holdings,” observes Greg Hagood, co-founder and co-CEO, Nephila. “Interestingly, while each of the catastrophe, ESG and specialty ILS strategies have a low correlation to financial markets, the individual strategies also have a low correlation with one another, thereby making a multi-strategy ILS approach of growing interest to some investors.” 

Nephila currently manages two strategies outside of the cat (re)insurance space; one is tied to ESG/Impact and essentially provides risk transfer products to sectors such as renewables and agriculture. For example, the renewables contracts are tied to lack of wind, rain or sun for the underlying project and the strategy thus has low correlation to financial markets. The second strategy is centred on specialty insurance lines such as aviation, terror, and cyber. 

“In a world where correlations across assets continue to increase, we expect growing demand for truly non-correlated strategies; ILS offers that. We expect more focus on climate change and how that changes the risk assessment and pricing for catastrophe ILS exposures,” Hagood explains.

Discussing the opportunities in the climate space, he notes: “Global trends from this past year toward increasing sustainability and decreasing uncertainty serve as tailwinds to our business. Our core strength is analysing climate risk and offering solutions to limit organisations’ exposures.

“There is unprecedented momentum to decarbonise society and to recognise climate risks. Renewable energy projects are proliferating, electric vehicle adoptions are accelerating, and sustainable agriculture practices are sprouting. Coupled with these climate-forward projects are efforts to quantify climate risks. Governments, shareholders, and consumers are demanding that organisations disclose how climate change will impact revenue on income statements and assets on balance sheets. After publishing this information, groups want organisations to limit their exposure to climate-related risks by selling or insuring their assets.” 

With increasing focus on climate change and quantifying corporate disclosures around it, Hagood expects a growing need for risk transfer products in the ESG sector as well as increasing investor interest to support these initiatives. 

He says: “The past year has shaken awake many organisations which have neglected these mounting climate risks. This has increased the appetite for Nephila’s risk transfer solutions. Just as businesses with remote work strategies were better prepared for the pandemic, organisations with climate risk strategies will be better placed for climate change. “Theoretical” risks (e.g., a global pandemic or a warming planet) are becoming real, and organisations previously unprepared for global disruption do not want to be caught on the backfoot. As a result, they are reaching out to Nephila to limit their climate exposure.”

Specialty insurance risk products

On the non-cat side, Nephila is preparing to launch a specialty insurance risk strategy next year. “There is demand to broaden ILS exposure into other types of risk. We have built a diversified portfolio of specialty risks including classes like cyber risk, terrorism, aviation and energy, which will complement our existing catastrophe and climate strategies,” outlines Hagood.

The main challenges with this type of strategies are access to risk and creating the right structure to allow investors to enter and exit the exposures with reasonable liquidity. Hagood elaborates on how Nephila has tackled this: “We have been investing in a platform at Lloyd’s of London since 2013 for our catastrophe risk products. This investment in Lloyd’s provided an ideal home for a new specialty risk product. Much of the target risk trades in the London market and Lloyd’s provides a structural solution that can work for our investors. Nephila’s team in London will underwrite this portfolio and manage the product.”

By and large, the specialty market has benefited from a broad upturn in the pricing cycle and many target lines of business are seeing stronger pricing and attractive underwriting opportunities. 

Different sources of return within the ILS market allow investors to spread risk within their portfolios. The catastrophe ILS arena is by far the most mature sector with investors globally allocating to it, typically on a standalone basis. However, given these growing areas are also uncorrelated to one another, they enable investors to build a diversified portfolio with low correlation to financial markets which can earn them a positive return over time. 

Looking ahead, Hagood comments: “There will likely be more competitors in ILS to service this increasing demand, but the winners will likely be those who have experience in origination, risk assessment and pricing, plus a platform that can stay on top of a rapidly changing landscape.”

Nephila Capital started in 1997 and the current bulk of its USD9.5 billion in assets under management focuses on building portfolios of catastrophe risk. 

Hagood details the growth of the ILS asset class: “From 1997-2005, investors were generally unfamiliar with the sector and most of our time was spent educating them on what it was and why it would benefit their portfolios. In 2005, post Hurricane Katrina, the market grew materially because very wide spreads attracted new capital. In 2009, the market took another big step forward as investment consultants saw the non-correlation of the asset class hold during the Global Financial Crisis and began advocating for it as a strategic allocation for investors. From 2006-2016, there were very few material catastrophes and investors had a great run. More recently, there have been a number of catastrophe events that have caused losses in the market, but spreads have widened for four straight years and pricing is back to levels not seen since 2013.“ 

Greg Hagood, Co-Founder and Co-CEO, Nephila Advisors
Greg co-founded Nephila Capital. Today, he is co-CEO of Nephila Holdings and a Director of Nephila Capital. Greg focuses on investor relations, risk management and the firm’s strategy. He started at Bear Stearns in New York, where he managed the mortgage servicing desk. In 1997 he joined Willis Group in London to help start up what is now Nephila Capital. He has been a licensed broker at Lloyd’s of London and has a BSc in Finance from the University of Tennessee.

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