Natural disasters have dominated the news lately with Hurricane Harvey and Irma hitting back to back. While broader markets have not been impacted in the aftermath of these disasters, insurance companies have the most direct exposure to catastrophic events. To defray the risks, most insurance companies will work with even larger re-insurers. But another method of hedging out their risk has been to package these policies and sell them as insurance-linked securities (ILS).
Insurance-Linked Securities and CAT Bonds
Many kinds of financial products, particularly mortgages and credit, can be securitized and sold off to other investors. Insurance-Linked securities serve a similar purpose in that insurers are able to aggregate policies to reduce overall risk, then sell them to other investors. Catastrophe (CAT) bonds, which aggregate policies on natural disasters, are a form of insurance-linked securities. They cover all kinds of natural disasters including earthquakes, storms, volcanoes and meteorites.
For more information we recommend checking out Artemis, which seems to be the largest source of information on ILS and CAT bonds.
The Bermuda Stock Exchange, Center For ILS Investing
The Bermuda Stock Exchange (BSX) has become the main exchange for ILS investors. The market itself is worth almost $30 billion USD now, and grew by over 11% last year. While the BSX also lists regular equities including 11 domestic equities on its main board, it has 212 listed ILS according to its website.
The BSX is a frontier market that we monitor, and it has two main indices, the RG/BSX Index that tracks equities, and the Bermuda Insurance Index that tracks the ILS listed. We will put up an investment guide in the near future.
Why Bother With ILS?
If natural disasters are to become more frequent due to either climate change or fracking (in the case of earthquakes), then CAT bonds do not seem to be a very wise investment. A quick browse through the latest issuances also show that the yields are roughly equivalent to emerging and frontier market government debt, although when you factor in the expected losses the margins are roughly 2-3% on some of these deals. So returns alone probably do not justify the lack of information and liquidity on these type of deals.
The main benefit is the lack of correlation to any other market out there. Even smaller frontier markets will have a higher correlation to developed markets due to how globalized the world is. But the chances of a natural disaster occurring should (ideally) have nothing to do with future interest rates, inflation, or growth rates.
We currently do not have a position in ILS or the BSX but will be looking at whether there are opportunities in this overlooked but growing market.