The $30 trillion global pension fund industry is starting to muscle in on traditional reinsurers, financing protection against earthquakes and tornadoes as interest rates near record lows spur the search for yield.
A record $10 billion of institutional money flowed into insurance-linked investments in the 18 months through June, and for the first time is directly influencing pricing of some catastrophe risk coverage, according to Guy Carpenter, the reinsurance brokerage of Marsh & McLennan Cos. Catastrophe bonds can yield as much as 15 percent, LGT Capital Partners AG says.
Coverage provided by alternative capital, as pension and hedge-fund money is known in the insurance industry, reached $45 billion at the end of 2012, about 14 percent of the total global property catastrophe limit purchased, Guy Carpenter says. While welcomed by nations seeking to spread disaster burdens, pension investment is pushing down prices, even as reinsurers press for higher rates to compensate for more frequent extreme weather.
“This is the biggest change to the reinsurance sector’s capital structure in the last 20 years,” said David Flandro, global head of business intelligence at Guy Carpenter in New York. “Catastrophe reinsurance is relatively high-risk, high-return. Pension funds are looking for direct access. Most of the capital is here to stay.”
In a catastrophe bond, insurers pay buyers some of the premiums collected for protection against damage from natural disasters. In exchange for above-market yields, investors assume the risk of a disaster during the life of their bonds, with their principal used to cover damage caused if the catastrophe is severe enough. The first catastrophe bonds were issued after Hurricane Andrew in 1992.
‘Coming of Age’
New Zealand’s Superannuation Fund said in May it planned to more than double its holdings in catastrophe bonds and other insurance-linked assets, while firms such as PGGM NV in the Netherlands and Royal Bank of Scotland Group Plc’s employee-retirement fund have stepped up their reinsurance investments. Pension assets have reached $30 trillion globally this year, according to estimates from J.P. Morgan Asset Management.
“This is a coming-of-age moment,” said Michael Millette, global head of structured finance at Goldman Sachs Group Inc., which managed a catastrophe bond offering for the New York Metropolitan Transportation Authority after Superstorm Sandy in 2012. “Some of the largest asset-management complexes in the world are becoming more engaged in the space.”
Catastrophe bonds can become even more attractive in the wake of a disaster as capital is depleted and insurance prices rise, said Eveline Takken, head of insurance-linked securities, or ILS, at PGGM, which oversees about 140 billion euros ($193 billion) in retirement savings for Dutch pension funds.
PGGM is continuing to set up new investments in catastrophe insurance, eight years after its first forays following Hurricane Katrina, she said by phone from Zeist, Netherlands.
The Swiss Re Cat Bond Total Return Index, which tracks dollar debt sold by insurers and reinsurers, shows catastrophe bonds have returned about 10 percent this year. U.S. 10-year Treasuries currently yield 2.5 percent. Takken and other fund managers interviewed declined to disclose their returns.
Pension funds like reinsurance because of its low correlation to equity and bond markets. They can invest directly in the securities or allocate funds to specialist asset managers, such as Secquaero Advisors Ltd. and Nephila Capital Ltd., firms that sold stakes to Schroders Plc (SDR) and KKR (KKR:US) & Co. respectively this year as interest in the asset class increased.
More than 80 percent of catastrophe coverage is still provided by the Lloyd’s of London market and traditional reinsurers, of which Munich Re is the world’s largest. Munich Re said on Oct. 21 that rates in Germany need to rise following this year’s weather events, which included a “centennial” flood coming just 10 years after the last one.
Standard & Poor’s said in a presentation in London last month that the new capital threatened the industry’s earnings and is depressing pricing for property-catastrophe coverage.
“Pension fund money is what everyone is talking about,” said Maciej Wasilewicz, a London-based analyst at Morgan Stanley. “The funds involved have all done the due diligence, hired the right people and trained themselves up. They have the infrastructure to invest in this in the future.”
Wasilewicz said the inflows had begun to drive pricing most noticeably in U.S. hurricane and tornado coverage, which makes up more than 50 percent of total ILS issuance.
Canadian regulators last month urged the nation’s insurance companies to issue their first catastrophe bonds in the wake of flooding that inundated downtown Calgary, the nation’s most costly natural disaster.
According to Goldman Sachs, which estimates sales of catastrophe bonds to reach a record $8 billion this year, Canadian insurers had relied exclusively on reinsurance to help bear risks.
Guy Carpenter’s Flandro said the new money dominated discussions at the industry’s annual meeting in Monte Carlo last month, where reinsurers gathered with brokers and their clients to negotiate next year’s policies.
John Nelson, chairman of Lloyd’s, the world’s oldest insurance market, called on regulators in London last month to be “extremely watchful” of alternative capital, saying the new entrants could pose a threat by pricing risk too cheaply.
“Pension funds and other long-term investors are probably here to stay, so long as we can provide them with a decent return over the long term,” said Stephen Catlin, who founded Catlin Group Ltd. (CGL), a Lloyd’s insurer, almost 30 years ago.
Pension funds’ impact on the reinsurance market has been felt even though most are allocating just 1 percent to 2 percent of their portfolio to the asset class, according to fund managers and analysts. Schroders, Europe’s largest independent money manager, started its first ILS fund this month after buying a 30 percent stake in Secquaero.
“It’s not a mainstream financial asset class,” said Daniel Ineichen, a former Secquaero partner who is lead manager of Schroders’s new ILS fund, which has raised $56 million. “It’s like a hybrid” between reinsurance and a traditional bond, he said.
KKR, the buyout firm run by Henry Kravis and George Roberts, agreed to buy 25 percent of Nephila in January. Greg Hagood, Nephila’s co-founder, said 75 percent of its $9 billion in assets comes from pension funds.
LGT Capital, a Swiss-based manager of about $121.5 billion in assets, bought Clariden Leu Ltd.’s ILS unit and its team of 10 specialists in 2012. Michael Stahel, a partner at LGT, which has about $2.5 billion in insurance-linked investments, said that almost all the capital raised this year was pension money.
LGT says returns for a given catastrophe bond can vary from 2 percent to 15 percent, while some customized contracts between two parties can yield as much as 40 percent.
The New Zealand Superannuation Fund, which manages about $22.5 billion for the government, said in May that it plans to invest up to $275 million in reinsurance, its second mandate in the asset class since 2010. RBS (RBS)’s pension fund for employees boosted its holdings by more than 34 percent in the past year to 521 million pounds ($842 million), according to the Edinburgh-based bank’s 2013 annual report.
The Ontario Teachers’ Pension Plan, which manages C$129.5 billion ($124 billion), has been investing in catastrophe bonds since 2005, said Philippe Trahan, director of the firm’s ILS group, who declined to disclose its specific allocation.
As long as investors look for higher yield in a record low interest-rate environment, more opportunistic investors, including pension funds, will allocate to ILS, said PGGM’s Takken.
“In the end it’s all about convergence of price, and if it’s not attractive people will move away,” she said.
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