ILS returning to health. 2023 returns beat sum of previous 9 years: J.P. Morgan

Analysts at J.P. Morgan say that the insurance-linked securities (ILS) market is returning to health and also point out an interesting fact, that the average return of ILS funds tracked by the Eurekahedge ILS Advisers Insurance Linked Securities Fund Index in 2023 actually beat the sum of returns over the previous 9 years.

A fact that drives home once again just how good a year 2023 was for the ILS fund community, as record performance has been delivered to end-investors by many ILS strategies and third-party capitalised reinsurance structures.

We already knew that ILS funds were tracking as the best performing hedge fund category of 2023 in December.

Then, once November’s ILS fund returns were reported, the Eurekahedge ILS Advisers Index had already set a new record high annual return for 2023, as the average return of the insurance-linked securities (ILS) funds tracked rose to 13.33%.

The previous high annual return of the Eurekahedge ILS Advisers Index, which tracks a basket of ILS fund strategies, was set way back in 2007 when it hit 13.22%.

With 75% of ILS funds now having reported their December 2023 returns to Eurekahedge and ILS Advisers, the annual return of the ILS fund Index now sits at 14.12% for 2023.

The sum of the previous 9 years (2014 to 2022 inclusive) of returns for this ILS fund Index adds up to 8.56%, the J.P. Morgan analyst team highlight. It’s only once you add in 2013’s ILS fund returns that you get to a figure above the single-year return of 2023.

While this won’t have been true for all ILS funds by far, as this Index is balanced across pure catastrophe bond funds and also a mix of funds with private ILS, reinsurance and retrocession investments, it does suggest there could be some end-investors out there that will have done better out of the ILS asset class in 2023 alone, than they had for almost an entire decade prior to that.

The J.P Morgan analyst team comment, “After several difficult years for the asset class, ILS produced a record return in 2023 with a ~14% return for the year. Returns reflected some repricing but also a relatively light year for big ticket catastrophe losses during the year. The return was far higher than recent years with the 2023 return more than the sum of the previous 9 years with some of these suffering from material levels of catastrophe loss. The previous high return for the asset class was in 2007 when it was far smaller than it is today with ~13% return.

“Despite excellent returns in what is clearly a far stronger operating environment, the track record of the asset class as a whole is still mixed. The rolling 10-year average return is 2.3% but clearly has momentum to improve materially due to a greater focus on severity risks and improvements in pricing and terms.”

They add, “We believe that this mixed longer term track record is a reason why we have not seen significant capital inflows into the market despite what are undeniably better conditions in reinsurance.”

However, the analysts do have a more positive outlook, saying that 2023’s record ILS market returns are evidence of health returning to the sector.

“So far, capital has only tentatively been coming back to the market and we expect that whilst some product such as catastrophe bonds are likely to see continued interest, other areas such as collateralised reinsurance are unlikely to see material flows in the near term,” the J.P. Morgan analyst team state.

Of course, there are very diverse results and performance across the ILS fund community, with such differing strategies available to investors and we have seen collateralized reinsurance focused funds with decent returns in many of the last 9 years as well.

ILS funds with structures in place to assist with fronting and that can help to negate the challenge of trapped capital have actually performed quite well through this period, in some cases.

It is far from a level playing field across the private ILS and collateralized reinsurance (or retro) investment fund space.

While investor flows have been harder to win, some of the collateralized reinsurance strategies are receiving much more interest now and we do expect positive flows in 2024 to many of them, as long as catastrophe loss activity falls within expectations.

It’s also important to look at the full-range of benchmarks available and it’s clear the catastrophe bond market has been the better performer.

The record near 20% returns of 2023, as recorded by Swiss Re’s Index, is only better than the sum of the previous 6 years, for example, not 9 like the broader ILS fund Index.

Meanwhile, the UCITS catastrophe bond fund Index calculated by Plenum Investments, faired similarly, although with a lower return of 16% for 2023.

The analysts from J.P. Morgan say that the impressive ILS fund performance of 2023 also bodes well for reinsurance results.

When you compare the two, reinsurers appear to have done better over many of the recent years where ILS fund returns were depressed or negative.

But, in some of those catastrophe loss hit soft market years, ILS was the protection that buoyed those reinsurers returns to a degree and the alignment between protection capital provider (ILS) and the cedent (re/insurer) was less well-defined, aligned or structured than it is today, thanks to the greatly improved terms and conditions now prevalent in the market.

Which does make it feel like ILS took a perhaps overly large share of losses, due to where the attachments and terms sat back then after the soft market pressure.

Something that is unlikely to be repeated right now, with the current market terms and structures, were similar loss years to repeat themselves.