Insurance-linked securities (ILS) is the “best asset class from a diversification perspective,” according to private bank and asset manager VP Bank AG, with the current level of compensation for taking on catastrophe risk still seen as more than adequate even as hurricane season begins.
VP Bank has been recommending catastrophe bonds and ILS investments since 2022, when it saw the post-hurricane Ian market environment as an opportunity.
The asset class has served the private bank and its clients well since that stage and with returns before losses of close to 11% still possible, according to cat bond market yields, it remains attractive both for its returns and the relative lack of correlation to other asset classes.
In its latest thinking on the ILS asset class, VP Bank calls it the “best” from a diversification perspective.
However, the company is also acutely aware that hurricane season has begun, which being the main catastrophic peril the cat bond market is exposed to means a time to remain watchful, although the private bank says it is not concerned given the compensation still being received.
While the hurricane season is ramping up towards its peak at this time, VP Bank says, “In our view, this is no cause for concern.”
It continues, “The compensation for this risk is generous. In addition to the return on the collateral of 4.3% on the bond market, there is a 6.7% return for the risk of damage. The expected losses are almost three times lower at 2.3 %.
“The great uncertainty of ILS concerns the timing and amount of losses. To exaggerate, an expected loss of 2.3% can mean that there are no losses for nine years and 23% in the tenth year.
“History shows that a negative performance at the current level of compensation is extremely unlikely.”
The track-record of the catastrophe bond market shows that even in year’s of major hurricane losses, ILS returns have remained positive in most cases.
Of course, investors seeking higher return-potential can venture into private ILS, such as lower collateralized reinsurance and retrocession arrangements, where the risk of a negative annual performance is higher, but so too is the compensation.
With the benefits of diversification and track-record for more positive years of returns than negative, cat bonds in particular present a very attractive option for many investors at this time, something VP Bank is telling its clients. However, as the name suggests, cat bonds and ILS as an asset class are typically an investment category that allocators should be looking at as a long-term commitment, so the positive year’s more than outweigh any with worse performance.
