In December last year, a panel discussion on ESG and Insurance-Linked Securities (CAT Bonds) took place on the industry platform ARTEMIS. Markus Hill spoke for FUNDBOUTIQUES.COM with Nico Rischmann, Plenum Investments AG, about the challenges in this market segment, investor education, and the need for cooperation in the industry (sponsors & asset management). In terms of content, topics such as regulation, entrepreneurship, the importance of tail risks, and product management were addressed. Besides, topics such as ratings, risk management, natural disasters, and optimal entry points in the CAT Bonds segment for investors in 2021 were discussed.
Hill: ESG is currently attracting a lot of interest as a topic. You and your colleague Dirk Schmelzer had initiated a panel discussion on sustainability and insurance-linked securities (ILS) on the industry platform ARTEMIS back in December. The big players in the industry were also involved. How did this idea come about?
Rischmann: We invited to the discussion because we had gained the impression that the ILS industry had not made any progress in the last three years on the topic of “transparency of insurance books”. As a first step, we are trying to demonstrate to violators and insurance brokers that non-ESG compliant behavior will lead to a significant decrease in CAT bond demand because about 45% of ILS/CAT bond demand comes from Europe. We would like to explicitly alert our industry to the risk of potentially losing investors in the future. Our roundtable was the beginning of a series of issues that we still need to work through to establish a generally accepted best practice standard in an asset class that does not conform to traditional ESG analysis methodology. At this point, I would like to appeal to members of the CAT Bond value chain as well as our peers to work together to set this standard.
Hill: What did you see as the main findings of the discussion at that time?
Rischmann: It was gratifying to see that our industry is taking the issue seriously. That’s not so easy, since we ensure a majority of U.S. risks or cover U.S. violators that are not listed on the stock exchange. We were also very pleased to see that Swiss Re is actively trying to implement sustainability in the risk transfer market. Insurance brokers also seem to be moving. We are in the “butter on the fish” phase.
Hill: To what extent is there a concrete need for action for the various providers of ILS (CAT bonds, etc.) and for fund managers who use these products?
Rischmann: There is a great need for concrete action. Not only because the relevant laws are now being implemented, but much more because it is a question of interpretation or how to meet the requirements of the legislator. We also see the possibility of a clash between “Forms over Substance” and “Explain or Comply” in the market. What’s my point? We see investors analyzing CAT Bonds by putting the issuer or sponsor at the center of the ESG analysis – as if one were invested in an insurer’s stock or bond here. Since ESG analysis agencies have little information about the insurance book, they focus on analyzing the asset side of the insurance balance sheet. Formally, this approach is consistent with the traditional ESG view. Applied to the holding of pure reinsurance contracts, it seems to us that the use of this method is not appropriate. One would urgently need a generally accepted best practice standard for CAT Bonds. This is currently the big construction site, as the Disclosure Regulation with its categorization in Article 8 or 9 will fuel this discussion. Either the so-called “general amnesty” for CAT bonds will come or the application of the RTS will have to be accepted in a figurative sense to do justice to the special character of CAT bonds. After all, no one denies the high social contribution of this asset class, which can be achieved by an investment to hedge against natural catastrophe events. I don’t anticipate that the legislature will develop its RTS specifically for the ILS industry.
As you know, three years ago we began to cast the issue of sustainability and CAT Bonds into a mold with the seriousness it deserves. We decided at that time to go the FNG seal route. It was a very important process for us to learn what language the sustainability industry was speaking. We kept hearing the arguments from our industry that CAT Bonds are sustainable per se. In principle, that statement is correct. But it doesn’t help our industry, because investors need answers to their questions as part of their “check-the-box” due diligence.
CAT bonds are still not mainstream. To move in that direction, more education needs to take place. This is because we believe that a thorough understanding of capital market-based insurance risk transfer will generate the understanding necessary to recognize that CAT Bonds are sustainable investments. This includes the discussion about the impact of CAT Bonds. Swiss Re has taken a first and important step with its discussion on the iSDG (Integrated Sustainable Development Goals). Furthermore, we are convinced that it is now time for the ILS-/CAT Bond industry to organize itself worldwide in the sense of an association. After all, the ILS/CAT bond market has meanwhile developed into a major pillar of the reinsurance industry in the field of natural catastrophe risks.
Hill: When and how did you personally become interested in CAT bonds?
Rischmann: At the beginning of 2000, Plenum Investments AG was the fund management arm of the then Plenum Group that was outsourced to alternative investments. Our core business at that time was the fund of hedge funds business and we were also invested in so-called “event-linked” strategies. During the financial crisis, we were surprised that this asset class was hardly affected. After that, it was clear to me that asset management had to be more than just dealing with volatility. We were made aware that the systemic risks were enormous. Speaking of systemic risks, they have not become any less today. When it comes to debt, the stakes have been raised yet again. To cut a long story short, anyone in the asset management industry who fails to grasp tail risks, or grasps them inadequately, will have a hard time maintaining their credibility vis-à-vis their clients. After the crisis is before the crisis. And whether the wealth management client has already forgotten the last financial crisis may be doubted. So I was faced with the question of who can competently handle tail risks: The reinsurance industry. It quickly became clear to me that insurers have something the capital market can only dream of. Stably low correlations between the positions in the portfolio make it possible to significantly reduce portfolio risk without sacrificing returns. Because that is the basic problem of the capital market: When it is stressed, the majority of correlations point in the wrong direction. This is called fair-weather diversification. Customers are less and less willing to spend money on such a service. Shortly after the financial crisis, we decided to realign Plenum Investments AG by specializing in insurance-linked securities/CAT bonds. We had to change the whole team and find new experts. The big question was, with which risk management concept do we enter the CAT bond market?
Ten years ago, we launched the Plenum CAT Bond Fund with the vision of providing investors with a conservative investment alternative to fixed-income investments. Then, as now, hurricane risk-focused CAT bond funds with higher yield targets and the corresponding high tail risks dominated the offering. The investment approach of the Plenum CAT Bond fund is characterized by balanced diversification and conservative tail risk management of reinsurance risks. What seems self-evident today was a major challenge ten years ago. This is because the main problem was finding the expertise in CAT Bond fund management. These skills were hard to find in the market at that time. Dirk Schmelzer, who was one of only three known CAT bond fund managers at the time, joined us together with David Strasser, who also came from one of the other two teams in the Swiss market. To this day, both are working on the success of our CAT Bond investment line.
In 2020, we added proven experts to our expertise to specifically expand our offering. Daniel Grieger, the founding partner of one of our competitors, joined us together with Rötger Franz. Rötger is a highly experienced Insurance Credit Analyst who worked for SocGen London for over ten years. He joined us to further develop our tail-to-tier risk management approach in the CAT bond business.
Hill: What do you see as the biggest challenges for institutional investors at the moment?
Rischmann: Internationally, ILS/CAT bonds are still underrepresented among institutional investors, although the trend toward higher allocations has been ongoing for some time. Institutional investors such as pension funds and insurance companies in Switzerland, Denmark, and the Netherlands are already further ahead. In Germany, a certain group of institutional investors seems to be “trapped” or restricted by regulation. I am referring to the acquisition of ILS/CAT bond funds for Solvency II and investors regulated under the Investment Ordinance. This is because the administrative practice of BaFin and EIOPA is far from clear. In short, this group of investors must have a certain self-confidence when it comes to investing in ILS/CAT bonds. A clarification by BaFin would be appropriate.
Hill: Hurricane season is upon us. How should CAT bond investors position themselves?
Rischmann: The CAT bond market is characterized by a high proportion of U.S. hurricane risk. This means that as hurricane season begins in June, insurers are purchasing their coverage for the current year. This further means that primary market issuance is naturally high through the end of May. During the hurricane season, liquidity is reduced as little new issuance comes to market. Non-seasonal risks such as earthquake risks are usually renewed towards the end of the year. Those who want to place high volumes in the market take advantage of this circumstance. Investors should be clear about how much US hurricane risk they want to “load” because these risks have a high tail risk that the transferred risk is heavily concentrated in a few metropolitan areas such as Miami. This risk pays well but raises the question of the investor’s risk-bearing capacity.
Premiums in the reinsurance business are subject to a cycle. The higher the losses, the higher the risk compensation. Since insurance losses have been very high in recent years, investors are now benefiting from very attractive premium levels. This is also the reason why a lot of money is flowing into the asset class again. Spreads are tightening again. We expect another small increase in premiums for the current renewal round for hurricane risks. The entry point before the hurricane season is almost ideal due to high premiums.
Hill: What are the current topics on the agenda for you and your company in the current year?
Rischmann: At the beginning of this year, we decided to launch two new investment funds. This was not born out of a whim, but because when we launched our Plenum Insurance Capital fund, we registered strong customer interest in the two investment strategies used in the fund. These are a more offensive risk profile in CAT Bonds paired with a strategy focused on managing European subordinated bonds issued by insurers. The latter strategy has been available on the market as a separate fund since mid-March. A fund product with a more offensive CAT Bond strategy is scheduled to launch at the end of May.
Hill: Thank you very much for the interview.
Nico Rischmann studied at the Faculty of Social and Economic Sciences at the University of Innsbruck, majoring in capital market research. Immediately after graduating, Nico Rischmann founded Plenum Finanz AG, which specializes in alternative investments, in 1993. As a member of the Executive Board, he built up the Plenum Group and assumed various executive functions in the subsidiaries. From 2005 to 2011, he was CEO of the Group’s own life insurance company and was instrumental in the realignment of Plenum Investments AG into a specialized ILS provider in 2010. He has been a member of the Executive Board of Plenum Investments AG since 2009 and is responsible for Business Development/Institutional Investors Services. Besides, he holds various board mandates.
PLENUM INVESTMENTS AG: www.plenum.ch
Information on “ESG in the ILS & Catastrophe Bond Market” (ARTEMIS): https://www.artemis.bm/news/esg-in-the-ils-catastrophe-bond-market-roundtable/