Why the development of a secondary market will transform ILS

There are many things investors look for when deciding where they should allocate capital. First, they need to believe they will be paid a fair return for the risk involved. They value investments that offer diversification—assets that are not correlated with other things in their portfolios. And they tend to prefer investing in things that are liquid: it is easier to justify investing in something when it is also easy to sell it, should you suddenly need the money for something else.

Insurance-linked securities (ILS) have traditionally offered good returns and offer the diversification element of this in spades. The typical institutional investor will have a portfolio consisting predominantly of stocks and bonds, supplemented by other things such as real estate, commodities and hedge funds. ILS is an attractive addition to these investments, because it should, in theory, have very little correlation with these financial assets.

However, what it has not been able to offer to the same degree is liquidity. Opportunities to sell ILS are limited, meaning investors often buy ILS with a view to holding it to maturity. That is fine for some investors, but to maximise its appeal across the whole spectrum of investors, ILS needs a functioning secondary market.

Transformation

There is a growing movement within the ILS community that understands this and is attempting to rectify it. Brad Adderley, partner at Appleby in Bermuda, says it has the potential to take the industry to a new level.

“A secondary market for ILS will transform the industry. I don’t want to say it will lead to exponential growth, but it will certainly be a real game-changer,” Adderley says.

He explains: “Investors want to know they can access risk and sell their positions quickly if they need to. A liquid market for ILS will drive down the cost of doing business and increase demand.

“The more demand there is, the better the price for issuers, so the more appealing it is to them too.”