Insurance Linked Securities (ILS) is one of the few alternative strategies that continues to receive close investor attention from its potential as an uncorrelated, “risk-off” asset. Conceptually, the frequency and severity of natural disasters are independent of broader capital market events and therefore returns on investment products designed to support the reinsurance market should demonstrate low or zero correlation with equity market returns.
Long-term reinsurance index data are generally supportive of investor expectations though depressed premium levels and a high severity of claims have led to near zero actual investor returns over the last five years. Looking forward, the major considerations for reinsurance investors are the following: (1) the third-party market for reinsurance capital remains very small and is not growing, (2) reinsurance premiums have risen but not to a level that is compelling, (3) claim levels are not normally distributed and historical index returns are not an unbiased representation of future experience, (4) Indices are not investable so implementation relies upon active management where fees are high, wide return dispersion exists across managers, and there is no evidence that index outperformance is the norm.
Without a "wind at your back", successful reinsurance outcomes will require extensive due diligence at the manager level and once invested, either luck that severe left-tail events are avoided, or the perseverance to remain invested long enough to normalize their impact.