Insurance-linked strategies
Insurance-linked strategies (ILS) are an innovative niche asset class that allow investors to gain exposure to reinsurance catastrophe risks and earn returns largely uncorrelated to traditional and alternative asset classes.
Investment strategies
ILS strategies access insurance risks, providing cover for prespecified catastrophe events, including natural catastrophes, man-made catastrophes, and specialty lines of business (e.g. agriculture, engineering, marine, and aviation), and receive premiums in return.
Consequently, the performance of ILS is contingent on the occurrence or nonoccurrence of specific insurance events and is uncorrelated to other investments.
ILS strategies typically invest in one or more insurance-linked instruments, including but not limited to securities (e.g. cat bonds), private reinsurance transactions with insurance and reinsurance companies (ILS private transactions) or portfolios of reinsurance contracts (e.g. quota shares).
Risks
Potential risks
- Risk of loss – due to for example the occurrence of unforeseen insurance catastrophe events and/or other insurance events that might be covered by the ILS instrument. An unusual clustering of independent insurance events can severely exacerbate the risk of loss
- Failure to achieve investment objectives – for example due to lack of availability of suitable investment opportunities in a highly competitive market with a high degree of uncertainty
- Portfolio concentration risk and lack of diversification – for example due to the relatively limited number of independent insurance perils that are covered by the ILS market
- Illiquidity and valuation risks – for example due to ongoing insurance events and / or due to changes in market expectations of the final losses related to insurance events that have occurred
- Model risk and risk assumptions – for example due to highly uncertain assumptions that could be based on subjective judgment to a certain degree and / or due to the difficulty in predicting type, frequency and severity of catastrophic events
- Uncertainty of loss estimates and their development over time – for example causing impairments in valuations of ILS instruments several weeks, months or years after the occurrence of an insurance event driven by issues related to claims development and / or claim coverage
- Limited ability to hedge – due to for example the limited availability of negatively correlated securities to reduce outstanding exposure to certain insurance perils
- Reliance on certain loss-related information – for example due a potential lack of accuracy in loss estimates facilitated by third party index providers and / or insurance regulators and the inability to verify or challenge this information
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