The lack of attractive investment deals has led large, established reinsurance managers such as Nephila, which manages about $10 billion for institutional investors, to close its mostly customized investment strategies to new money.
Younger, smaller reinsurance managers such as Elementum Advisors LLC, Chicago, which manages about $2.8 billion, are walking a tightrope when it comes to holding asset owners' interest.
“We are seeing rising interest in reinsurance strategies from institutional investors, but it's challenging because we are very capacity aware,” said John DeCaro, an Elementum founding principal and portfolio manager, noting that present market conditions are not conducive to investment.
Until the investment climate improves, Mr. DeCaro and his colleagues will continue to develop investor relationships, especially with U.S. investors who lag behind their European, Australian, New Zealand and Canadian counterparts in adding reinsurance and ILS allocations to their portfolios.
Tight market conditions for reinsurance managers require “a fine balance from managers when it comes to capacity,” said Todor Todorov, senior investment consultant and an ILS specialist based in the New York office of Willis Towers Watson PLC.
“To compete for the best deals, you must have capital to invest, but you have to be able to invest that capital if you raise it. It's not an easy situation for many managers,” he added.
The lack of investment opportunities and stagnant insurance premium rates also has lowered returns for ILS and reinsurance strategies. “I think when investors compare long-term returns to current returns, it's obvious that insurance premiums have drifted down over the last couple of years because there haven't been major disasters,” said Robert Howie, a principal and Mercer Investments' lead ILS researcher, based in the firm's London office.
“Regardless of where you are on the risk spectrum, returns have progressively come down in the past several years in a somewhat consistent fashion,” said Norman Kilarjian, head of macro and quantitative strategies at hedge fund consultant Aksia LLC, New York, in an e-mail.
Mr. Kilarjian estimated that overall annual returns for reinsurance are about 50% of what they were five or six years ago, with the riskiest strategies, for example, returning about 10% now compared with 20% six years ago. Similarly, a lower-risk catastrophe bond portfolio that previously returned 7% to 8% now would be expected to return 3% to 5%, Mr. Kilarjian said.
Sources generally agree with Mr. Kilarjian's annual return ranges, with the consensus as: cat bond portfolio (passively managed), 3% to 4%; combination reinsurance-cat bond portfolio (actively managed), 5% to 6%; and pure reinsurance portfolio (actively managed), 7% to 8%.
Capacity and lower returns notwithstanding, reinsurance managers reported a recent uptick of interest in reinsurance, ILS and a combination strategy, especially from U.S. asset owners.
Nephila Advisors, for example, opened its closed reinsurance strategies for a total of $750 million earlier this year, and quickly found willing investors, said Mr. Hagood.
Pensions & Investments' reports show some funds have invested in reinsurance this year, including:
c Indiana Public Retirement System, with $29.7 billion in assets, in June invested $40 million in a catastrophe risk strategy managed by Aeolus Capital Management Ltd.;
c Arkansas Teacher Retirement System, with $14.4 billion under management, in April invested $50 million with Nephila and added $37 million to Aeolus, bringing the Aeolus total to $147 million; and
c The $45.5 billion Maryland State Retirement and Pension System invested $100 million in a Nephila strategy in October.
One reason for the rise in interest stems from a search for positive returns not correlated to the market beta produced by traditional equities and bonds, and reinsurance strategies provide that, consultants said.
“We find reinsurance and ILS strategies to be an important portfolio diversifier because the returns are completely uncorrelated to other asset classes and the portfolio risks are fundamentally different,' said Willis Towers Watson's Mr. Todorov, adding that there's been a “significant uptick” in investment by the firm's consulting clients.
“Reinsurance adds a huge amount of portfolio diversification because the returns are genuinely uncorrelated” because they are the result of natural and human-caused devastation rather than market processes, Mr. Todorov added.