Conyers Dill and Pearman Bermuda insurance practice head Chris Garrod on the future of convergence

Chris Garrod

In a depressed global economy, one of the most consistent challenges businesses in many sectors have faced is how to eke out a decent return on investment when interest rates remain stubbornly low.

As major institutional investors have sought higher yield, one of the asset classes they have been increasingly attracted to is insurance-linked securities (ILS) such as catastrophe bonds, and industry loss warranties (ILWs). Providing capital to insure against catastrophic natural events such as hurricanes and earthquakes was once the preserve of traditional reinsurance companies and extremely sophisticated investors.

Now, it is seen as a much more mainstream asset class that is increasingly finding its way into the diversified portfolios of heavyweight investors such as pension funds and hedge funds.  

Over the past few years, we have seen an increasing number of fund managers move into the ILS space as a means to enhance the overall performance of their investment portfolio.

With returns that have been consistently higher than average stock market yields in recent years, it is not hard to see why an avalanche of alternative capital has been pouring into the reinsurance markets in the past few years.

The Swiss Re global cat bond performance total return index has delivered an average annual return of 8.45% since its inception in 2002. The index tracks a basket of natural catastrophe bonds, which results in a reasonable approximation for the return of the outstanding cat bond market. The total return for the index so far has just over 8.8% for the first three quarters of this year.

The Eurekahedge ILS investors index, which is an equally weighted index of 30 constituent ILS funds, has returned 5.55% for the year to date, and 2.1% in the third quarter of this year.

The Mercury investible catastrophe risk index (MiCRIX), which tracks the performance of a diversified portfolio of peak peril ILWs, had returned 11.99% in 2013 to date, and 8+% in the third quarter alone.

With returns as high as these, it comes as no surprise that total cat bond issuance is predicted to reach record levels this year. In October, Munich Re reported that the first three quarters of 2013 had been the busiest on record for ILS, with an aggregate issuance of $5.48bn. The world’s largest reinsurer predicted that total non-life issuance of ILS should reach $7bn, breaking the record of $6.8bn of issuance in a single year that was set in 2007.

Munich Re found that there will be $2.7bn of maturities through to March 2014 and that it expected many of the sponsors to renew their maturing cat bond cover. In terms of total outstanding volume, Munich Re expects to see cat bonds providing $19bn of risk capacity to the insurance sector by the end of this year.

ILS and other property cat-based instruments performed relatively well during the during the sub-prime crisis, especially compared with the credit and equity markets, which lost significant value. This really has reinforced the view that catastrophe risk as an asset class really does have a low correlation with the broader credit and equity markets.

The ever-growing range of players in the ILS space is one reason why this year’s Convergence 2013 ILS event in Bermuda on 13 and 14 November is so eagerly awaited. The low interest rate environment has clearly been a factor which has led to the growth of the ILS industry, and as the issuance figures illustrate, global interest in the sector has never been higher.

Chris Garrod is head of the Bermuda insurance practice at Conyers Dill & Pearman.