We speak to Christian Bruns, vice-president of insurance-linked securities at Zurich-headquartered private bank Clariden Leu, about what drives investment decisions into catastrophe bonds and why investors in Asia are now more open to the product.
What exactly are insurance-linked securities?
ILS are fixed-income securities through which the insurance industry passes on pure insurance risk to the financial markets. They are issued by insurance and reinsurance companies as protection in the event of extreme insurance losses, for instance following severe natural catastrophes or a potential pandemic disease outbreak. The risk assumed by investors is related to a specific insurance loss (such as earthquake, mortality or airplane crash).
What ILS products do you offer?
We currently manage $1 billion across three ILS funds. The first fund, launched in 2001, invests only in catastrophe bonds, or cat bonds, for natural-catastrophe ILS. It has $800 million of assets under management (AUM) and yields around 6.5% per annum, with a low-risk element.
In 2005 we raised around $200 million for our second fund, a mixed-use fund. It has yielded around 10% annually during a three-year period. Around 60% of the AUM is invested in cat bonds. Another 30% is invested in insurance contracts between the fund and insurance companies, which provide the insurance company with cover. The balance 10% is allocated into funds which have specific underwriting capabilities for diversifying risks.
Our third fund offers investors an opportunity to profit from the currently prevailing, unique situation. This fund targets between 15% and 20% return. Insurers are suffering after large losses they booked in 2008 and their asset base has shrunk. They can underwrite less business, therefore the premium has gone up for the same risk profile. All our funds capitalise on the current premium increase of between 30% and 50%, which can be seen on newly issued cat bonds and insurance contracts negotiated today.
What portion of their portfolio do wealthy individuals allocate to ILS?
High-net-worth individuals (HNWIs) generally put between 5% and 10% of an overall portfolio in ILS. The risk in our space has not changed, unlike that in many other investment opportunities. That is why more investors are turning to this asset class today. The insurance-linked space is essentially about assessing and mastering risk. As an investor, I want to be properly compensated through a high enough insurance premium for taking on certain risks.
Portfolio diversification is critical to an investor's decision to invest. HNWIs want to have at least one product in their portfolio where they don't have to watch financial markets daily.
How is the product marketed?
For HNWIs, who are sophisticated investors, our private bank sells the product. We book assets in Switzerland and Singapore. We also have institutional investors who sell the product to their clients.
How do investors track the value of their holding and how do they exit?
The fund administration calculates a net asset value monthly for our funds. Investors see the performance of the products in their accounts on a monthly basis. For our first fund we make a market each day although very few investors need a daily market.
Prior to the maturity of a cat bond, two scenarios may develop: as long as no major natural catastrophes have occurred, cat bonds are redeemed at 100% on the maturity date. Alternatively, if a catastrophic event of a pre-defined peril and within a specified region does occur, the bonds may default, and part or all of the capital is immediately transferred to the insurance buyer under the bond. The insurance buyer then uses this capital to pay its claims to policyholders.
How do you source your underlying investments?
Typically, the bank structuring the deal contacts us -- firms like Goldman Sachs, the Lehman North America team now at Barclays, the Merrill Lynch team now at Bank of America, and Deutsche Bank are active brokers. Reinsurance brokers such as Willis and Marsh are also active intermediaries on the traditional reinsurance side.
What is causing the ILS market to grow?
Insurance companies are now in the situation where regulators and rating agencies are scrutinising their business and determining how much business they can underwrite in 2009. As a result of the financial market crisis, traditional reinsurance capacity has become scarce; ILS as an alternative to traditional reinsurance are therefore benefiting from the current situation. We see an increased issuance of these securities at premiums anywhere between 30% and 50% higher than last year.
What is your value proposition?
Catastrophes are not predictable but they are manageable. We work like a reinsurance company and focus on risk rather than return. Our portfolio is diversified across 60 bonds on the basis of geography, catastrophe and other characteristics. We also have different payout mechanisms.
Which asset managers do you compete with?
On the ILS side, we compete with other dedicated ILS funds. Our key difference is the high liquidity of our funds and the conservative positioning. I estimate the total worldwide market for cat bonds is around $30 billion, non-life and life combined.
Has the perception of ILS changed?
The turbulence in financial markets [last] summer resulted in investors seeking improved stability for their investment portfolio. ILS are a lowly correlated asset class and have yielded stable returns during the past few years.
Especially in Asia, investors were previously very stock- and bond-focused. Last year completely changed that. As investors have seen and experienced the downside risk in equities, we have found product acceptance is higher.
ILS products are newer to Asian investors than they are in Europe. Most Asian ILS investors in the past came from the institutional side, such as sovereign wealth funds or pension funds. Now, more and more private investors in Asia are turning to this asset class, seeking diversification and stability in their portfolio.
This article was first published in the April issue of FinanceAsia magazine.