One conclusion from the 2008 financial crash was that asset classes often move in lockstep in a crisis. But such behaviour doesn’t stop investors hunting for investment areas where they diversify risk in the medium term. One area getting attention for this reason, advocates say, is insurance-linked investment. 

In 2012 Dexion Capital, a specialist investment bank in the alternatives sector, launched the DCG IRIS fund, a listed, Guernsey-registered closed-end investment company that is a feeder for the CS IRIS Low Volatility Plus Fund. The latter vehicle was set up in January 2012 and has approximately $656 million in assets under management as at August 2013. DCG IRIS was established in June 2012 and is up 6.10 per cent to the end of August 2013.

DCG IRIS is achieving diversification and steady returns with a low risk profile through investment in insurance-linked strategies, but what exactly is insurance-linked investment? Dexion explained it to WealthBriefing in the following way: Insurance-linked strategies consist of either securitised publicly traded instruments (cat or “catastrophe” bonds) or private transactions and are driven by the requirement of an insurer or reinsurer to transfer a proportion of the insured risks that they are exposed to. The former market is worth about $16 billion and the latter is much larger, worth around $400 billion of market volume (both as at June 2013).

Catastrophe bonds are issued in the capital markets. The capital provided by investors is used as collateral against losses triggered by a defined event and in exchange investors will receive a stream of coupon payments. The longer the period over which an insurable event fails to occur, the more the investor can earn from the coupons. (In other words, if the hurricane season remains relatively quiet this year, for example, that is good news for investors.)

Private contracts, on the other hand, are bespoke agreements between insurers, reinsurers and counterparties that are willing to take on part of the risk exposure in return for earning a premium. This allows asset managers to clearly define the risk of events and at what magnitude they will pay out.

Insurers and reinsurers all have significant excesses, Dexion told this publication. The investor only has to pay for claims after insurers and reinsurers have suffered claims in excess of pre-defined amounts (attachment points) or other defined triggers (such as an earthquake of magnitude 7.0 on the Richter scale). In this way, investors can avoid being the subject of an adverse risk selection - receiving only bad risks. For instance, an investor in a catastrophe bond may only be liable for $200 million worth of insured claims, and only once a catastrophe like a hurricane or earthquake exceeds the insurable cost of $1 billion. For reference, Hurricane Sandy was the most costly insured event of 2012, costing the industry in the region of $22 billion. However, this did not affect the DCG IRIS portfolio because this fund only takes exposure to the mega-risk events, such as the 1906 San Francisco earthquake.

Growing interest in the ILS space.

There are now three London listed investment companies investing in the reinsurance market, all of which have launched since December 2010. The bulk of the exposure within these vehicles is in private contracts, so investors can buy into the $400 billion, relationship-driven, private, un-securitised part of the ILS market through buying shares in one of these companies on the stock market.

The reason why most exposure is in the un-securitised, private market is because cat bonds deal mainly with US wind and earthquake risk, so dealing entirely in cat bonds doesn’t give investors any good amount of diversification. Nonetheless, there are open-ended funds, some in a UCITS wrapper, which make investments into the securitised part of the insurance-linked market, Dexion said.

DCG IRIS, through investing in private contracts, has achieved a greater degree of geographical exposure compared with cat bonds. It has also marked itself apart from its listed company counterparts through more active exposure management (greater engagement with events as they are happening), while taking no performance fee and achieving consistent returns. It is these attributes that make an insurance-linked strategy an increasingly interesting investment proposition for investors seeking yield and diversification, the firm said.

Where does the interest lie?

Dexion said it is seeing interest in this insurance-related strategy from family offices, private banks and large wealth managers; it has fundraised from this audience for the fund three times in the last 12 months.

“What this demonstrates is that the return profile offered by the company (steady NAV growth, income and lack of correlation with other traditional and alternative investments) appeals to a wide range of investor types,” a spokesperson for Dexion added.

As with all investments, of course, it pays to read the fine print carefully. For those willing to put in the research, insurance-linked investments deserve attention, it seems.