By Ilonka Oudenampsen

Insurance linked securities offer diversification in an environment of increasing correlation across asset classes, as man-made and natural disasters are uncorrelated to financial risk factors, research by bfinance has found.

It found that the reinsurance market is cyclical and that several severe events have exhausted reinsurance capacity, with large losses putting pressure on premium levels to rise. As demand for capital outstrips supply there is a need for private reinsurance resulting in the investor base being broadened towards non-specialists, something institutional investors can take advantage of, bfinance said.

The company said that the instruments on the insurance linked securities market most suited to institutional investors are liquid catastrophe bonds, although these are mostly limited to US exposure, as well as carefully diversified portfolios of non-liquid reinsurance contracts on account of the greater diversification they offer in terms of geographies and perils.

Olivier Cassin, head of research and development at bfinance, said: “The increasing destructiveness of catastrophes and the accumulation of wealth in certain geographies easily affected by such catastrophes, especially in the US, could feed long-term demand for insurance linked investments. Recent events such as the Gulf of Mexico oil spill, earthquakes in Japan and New Zealand and flooding in Australia have created significant investment opportunities.

"In today’s environment of increased volatility and higher correlations between asset classes, insurance linked securities offer a genuine option for investors seeking to diversify their portfolios. Although insurance linked securities are a relatively new asset class for pension funds, it holds huge potential.”

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