ILS allocations can generate attractive returns despite changing climate: LGT

Even in a state of increased event activity driven by a changing climate, allocating to insurance-linked strategies (ILS) can generate attractive returns for investors, according to a whitepaper from LGT ILS Partners, the specialist dedicated ILS investment unit of the private bank and asset manager LGT Capital Partners.

LGT ILS Partners’ paper observed that, in 2023, ILS investors benefited from very attractive return momentum, driven by a much higher premium environment, coupled with a revised portfolio allocation strategy that mitigated loss impacts to a significant extent.

“ILS managers adjusted their strategies by reducing frequency covers and by focusing on risk-remote transactions, mainly concentrating on single, extreme catastrophe events,” the paper explained.

These actions reportedly reinforced the return characteristics of this asset class, however, for primary insurance companies, “2023 was far from a good year”.

Citing data from reinsurance broker Gallagher Re, LGT ILS Partners said that the industry faced a total tally of more than $130 billion in catastrophe losses in 2023, making it one of the costliest years in recent history.

“This high loss burden was not necessarily driven by individual, extreme catastrophe events – such as a massive earthquake or hurricane. Instead, the losses derived mainly from multiple series of mid-sized events,” LGT ILS Partners added.

Developments in recent years are said to have made it “increasingly apparent” that climate change is now a serious concern for the global insurance and reinsurance sector, as well as for investors in the ILS space.

Though still, as per LGT ILS Partners, allocation to the insurance-linked securities (ILS) asset class can contribute towards generating an attractive return, even in a state of increased event activity, by actively managing frequency covers, reducing investments in low-attaching transactions and focusing on single, extreme events where the impacts from climate change appear to still be limited.

The ILS investment management team advises that, to manage the increasing impacts of a changing climate, it is important to operate with, “A solid understanding of projected climate change impacts on natural catastrophes combined with a forward-looking portfolio management approach.”

This can assist by helping to “steer the ILS industry away from unexpected losses while simultaneously capturing the increase in risk premiums driven by higher reinsurance demand,” LGT ILS Partners explained.

Which, for the ILS community and its investors, can have the effect of “transforming the challenge into an opportunity.”

The investment manager states that while climate change is expected to cause the insurance industry “a likely but not precisely quantified increase in losses due to more frequent and intense non-peak perils,” for those providing reinsurance capital there would be in return, “an equal or larger increase in reinsurance premiums due to higher risks and underlying uncertainties.”

“ILS managers can therefore seize the opportunity to achieve improved returns while, at the same time, hedging against higher risks by avoiding exposure concentrations and by performing careful deal selection,” LGT ILS Partners explained.

Adding that, “Most importantly, special attention will have to be given to other important loss drivers, such as inflation, litigation and insured exposure growth, which will very likely impact insurance property losses to a larger degree than global warming.”

LGT ILS Partners explained how it thinks about and seeks to address these risks, “As an ILS manager, we aim to reduce our allocation to cedents with concentrated local exposures, minimize support of frequency covers and specifically target layers attaching at higher levels to avoid impacts from non-peak perils and ”noncatastrophic” events.

“This approach will make it possible to retain the desirable risk from peak perils at an attractive premium, while effectively managing the potential increase in mid-sized losses from secondary perils that are predicted to occur in a warmer world.”

You can download a copy of the full whitepaper from LGT ILS Partners here.