ILS is still rebuilding investor trust, stopping new asset classes: Lohmann

The insurance-linked securities (ILS) market has been bullish in recent years, breaking numerous records in terms of new issuance. Yet the risk transfer industry is still rebuilding trust with ILS investors, something that may stymie the growth of some new asset classes such as cyber.

That is the view of Dirk Lohmann, vice chair of the ILS Business Unit of Schroders Capital. He told Monte Carlo Today that, despite historic highs in the issuance of cat bonds, the most traditional form of ILS, he remains wary of promoting to investors the idea of investing in new risk classes when there are lingering challenges around trust in the sector.

“The industry is still in the process of rebuilding trust.” 

He cites three reasons the industry needs to regain credibility: the poor performance of some investment managers in recent years (“not Schroders”, he stresses), specific challenges around some life ILS deals and 2023’s Vesttoo scandal, although he notes the fallout from this has been relatively self-contained, such was the specific nature of the fraud.

“The industry is still in the process of rebuilding trust with investors. There were some investment managers who disappointed investors quite severely in terms of performance. There is still a broad issue with credibility. We need to show investors we know what we are doing and get a fair price for the risk,” Lohmann said.

This makes him cautious on recommending emerging asset classes such as cyber. “It’s such a rapidly evolving risk, it’s hard to say what a fair price is. We need to engage with investors on their willingness to be exposed to cyber. 

“Getting an investor to invest in ILS is a long-term process. Even in traditional risks, one of their principal concerns is fully understanding the exposures, model risk, the question of the impact of climate change, and whether they are being adequately compensated.

“When you take an area such as cyber, which is a rapidly emerging risk, it is very hard to fully understand the nature and magnitude of the exposure. We have colleagues monitoring this asset class, but it’s not at a point where we can say we’re comfortable.

“We will need to educate investors on the nature of the risk and the reliability of modelling. Up to now there have been a few headline events, but there is still a significant miss factor with regard to insurance penetration. 

“That may change as insureds seek more and broader coverage following events such as CrowdStrike. Simply saying it represents diversification from cat and offers a good coupon is not good enough. The industry is in a trust-rebuilding phase, so it is not worth risking damaging your franchise if you get it wrong.”

Commenting on life ILS, Lohmann said there has been a serious erosion of confidence among some investors. He cites poorly structured transactions where an inaccurate assessment of the structure and/or counterparty was made. There were instances where investors found themselves exposed to credit risk as opposed to pure life risk (mortality and lapse).

“If it’s done properly life ILS offers excellent risk-adjusted returns.”

“Some of those mistakes were pretty horrific and scorched the reputation of life as an asset class. We dodged those things. We had a bit of a loss in extreme mortality here due to the COVID-19 pandemic, but that was a 1 in 100-year event,” he said. 

“But trying to sell life to investors currently is very difficult. It’s unfortunate because if it’s done properly life ILS offers excellent risk-adjusted returns and a true diversification from cat risk.”

Sector trends

Cat bonds were the main driver of the ILS market’s recent record years. The ILS market reached $43 billion of issuance in 2023, a 20 percent increase on 2022. Looking at figures to June 2024, there was growth of 18 percent year on year, and returns have been bullish.

Lohmann describes this trend as being good for the whole sector, but notes there have been some spikes in pricing, caused by excess demand from protection buyers sponsoring new issuance, not a shortage of capacity to absorb that issuance. That was further exacerbated by restrictions some investor managers have on the percentage of an issuance they can take. 

“In May, for example, there was a ton of issuance and limited liquidity in the market. That caused spikes in pricing, as there was a mismatch in timing between issuance and maturity. But things settled down again in June,” Lohmann said. 

He expects continued growth driven by cat bonds, but states that the real challenge is to develop new structures that would enhance the overall capital structure of sponsors—for example by whole book securitisations. He said the hindrance to growth of this sector has been the need to rely on internal models. 

“There are some out there but you need a lot of internal actuarial capability to analyse those types of structures,” he explained. 

Lohmann notes new developments to casualty ILS deals. The challenge remains the desire of investors to crystallise the result in a relatively short period of time, allowing them to recycle the capital. “I’ve always been a bit reserved because I am unsure about the exit, but there’s potential there,” he concluded.

For more news from the Rendez-Vous de Septembre (RVS) click here.

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