Q&A: Navigating insurance-linked securities
Stephan Ruoff discusses the key attributes of insurance-linked securities, and the potential opportunities in this asset class at a time of wider market uncertainty.
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Insurance-linked securities represent a unique portfolio allocation option.
Providing exposure to weather-related, so-called catastrophe risk, the asset class is completely uncorrelated to broader capital markets – and so unaffected by market, economic or geopolitical volatility. As a result, it is seeing increased interest from investors seeking diversification, and an alternative source of income and returns.
Against this backdrop, Stephan Ruoff, Co-Head of Private Debt and Credit Alternatives at Schroders Capital, sat down with Tom Darnowski, CEO, Americas at Schroders, to discuss the key attributes of insurance-linked securities and the potential opportunities for investors in the current environment.
Key topics covered include:
- How the asset class has evolved over the past several years, in which yields and returns have risen on the back of widening spreads following Hurricane Ian in 2022
- How the decorrelated nature of the asset class has insulated it from volatility related to major market crises, including the Global Financial Crisis and the Covid pandemic
- Why forecasts for hurricane season activity do not necessarily correlate to impacts on portfolios, as we saw with lower-than-expected insurance losses in 2024
- How we think about portfolio construction – and Schroders Capital’s unique edge and deep expertise in originating, structuring and modelling that underpins our approach
Watch the full video above to find out more. You can also read our previous papers covering the case for insurance-linked securities in a more uncertain market environment, and looking ahead to the 2025 Atlantic hurricane season.
Transcript
Tom Darnowski
Welcome, everyone. It's really good to have Stephan here with me today. I want to talk a little bit about an often misunderstood and underappreciated asset class, which is the insurance-linked securities market. Stephan, as a specialist in that market, what do you really see as the market opportunity today?
Stephan Ruoff
Thanks for having me, Tom. Our market is a niche market, as you mentioned. Misunderstood? I hope not. We do just invest in natural catastrophes, not into financial markets directly; hence, it's an uncorrelated asset class.
The last three years have been fascinating because since September 2022, when Hurricane Ian hit Florida, this asset class has gone through a boost. It's provided interesting diversification and return opportunities for investors, double-digit in some of the portfolios.
We think about this asset class as something we want to promote further. The market has grown, as I said. Today's market is around $50 billion in public catastrophe bonds traded, plus another $60 billion in privately traded transactions, which makes the market of $110 billion. Admittedly small compared to other fixed income markets, however, substantial, and it's become institutionalised by a number of investors coming in.
Tom
That's great. If I pick up on a couple of words, I would say, catastrophe risk sounds awfully daunting, hence why it might be slightly misunderstood. But then you use words like uncorrelated to the other asset classes. That sounds like it's a core of portfolios. We have seen a pickup in demand, especially in the recent volatility. How do you see that playing out in clients' portfolios? How do they use it?
Stephan
The recent volatility and other market volatilities that we've seen in the past, be it the Financial Crisis in 2008 or the Covid volatility that we've seen in the early 2020, they have had no effect whatsoever on the asset class because eventually, natural catastrophes don't care about interest rates going up or down or stock markets being up or down. In that regard, indeed, it's a decorrelated asset class.
Tom
I guess if I switch gears a little bit, just a little bit to the market outlook, what do you see as you see hurricane season coming up here in the Atlantic? You're here with us in New York, so we can talk through that. What do you see in the current market outlook as you think about going through the next season?
Stephan
We do tend to think long term. Still, we focus on natural catastrophes. It's the business, actually, and decorrelation comes from the fact that we invest into the occurrence, or non-occurrence, hopefully, of natural catastrophes. Hence, a hurricane season, also, is important.
When we look back very quickly to 2024, the outlook was a hurricane season from hell. This market has performed largely in line or above expectation. Hence, we had a very active hurricane season, but that does not necessarily mean that you end up with investment losses because ILS portfolios are often positioned in a way that they are, what we call, resilient in terms of large catastrophes, and only very large catastrophes have to hit a portfolio to see major drawdowns.
Stephan
The 2025 hurricane season is supposed to be another active hurricane season, probably not comparatively high as 2024 season, but it's going to be an active hurricane season with sea waters being still warm, and ACE, that's the Atlantic Ocean Energy, a measure, still high. We expect portfolios to be probably tested, but our portfolios are built in a way that, A) they're not only focused on hurricane; they're also focused on typhoon or earthquakes, and B) built in a way that they're resilient and well diversified within the natural catastrophe space.
Tom
If you take that one step, if you think about portfolios in the current market environment, how are we positioned? We'll walk through a little bit of a positioning statement as you think about some of the core portfolios.
Stephan
The way we think about portfolio construction, i.e., portfolio positioning, is we select certain risks. That can be hurricanes; that can be earthquakes; that can be typhoons. But we always select risk that we can model with robust and tested models for which we also have a future view in which we can build in climate change, for example, as a factor with warming sea surface temperatures.
We do not over-diversify ILS portfolios per se, but focus them on certain peak risks that we think we can, as I said, model well. ILS as a diversifier in itself does not need too much diversification in itself.
Tom
If I take a slightly different task and ask a little bit about... You talked a lot about the risks that's inherent in the portfolio, which therefore, you and team need to review and understand. Walk through a little bit of what's the edge from a Schroders Capital perspective for ILS?
Stephan
I think we boil it down probably to three or four, let's say, cornerstones that we would like to bring across to our investors, the first one being a deep knowledge about the insurance and reinsurance industry and its risk transfer mechanisms, actually. The structuring of these transactions is very important, and understanding these well is something we think we're pretty good at.
Secondly, we need to quantify the exposures that we take into the portfolios. Quantifying, in this case, means we need to model natural catastrophes. We need sophisticated scientists that work in our team.
The third element for us is certainly the institutional setting, and institutional settings to do with an independent valuation of our portfolios and risk management that is independent from the view of risk that we take for our investors, actually, to benchmark it. These are probably the three most important ingredients we see when we talk about our edge.
Tom
Clearly, long tenure, deep expertise, understanding all those nuances. If you take a general view of if you're an allocator looking across ILS or looking for a catastrophe bond fund, what would you generalise there as to the factors that you need to look at for a team?
Stephan
Always depending on your risk appetite. I would add liquidity management is certainly one element. I would add in a selection criteria. But other than that, I think the team, its tenure, its capability, natural catastrophe modelling, its structuring, and its origination capabilities, because as important as the other criteria I mentioned, originating enough business to have selectivity for your portfolios in the positioning is important. We believe we have certainly one of the longest-standing teams in the market that has great origination capabilities.
Tom
That's great. That's a great way to wrap up. I appreciate, Stephan, the conversation. Really, hopefully, this brought some insight into this asset class, which, again, is starting to become a core of people's portfolios because of the uncorrelated nature. But breaking down those risks and the specialities is really important to understand. Thank you so much.
Stephan
Thanks, Tom.
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