HOOPP Beefs Up Its ILS Investments in 2022
Large Canadian institutional retirement fund, the Healthcare of Ontario Pension Plan (HOOPP), grew its allocation to insurance-linked securities (ILS) investments in 2022, with the asset class nearing 1% of its overall portfolio by the end of the year.
HOOPP reported in its latest annual report, that its investment allocation into insurance-linked securities (ILS) and ILS funds grew by 35% during the last year.
That was at a faster rate than the previous year, when it added 31% to the ILS portfolio.
By the end of 2022, HOOPP’s ILS asset allocation had reached C$973 million (approx. US $718.7m), up from C$721 million (approx. US $575m) at the end of 2021.
The Healthcare of Ontario Pension Plan (HOOPP) started allocating to insurance-linked securities (ILS), largely via insurance-linked funds, as well as some direct investments into other reinsurance-related securities, in late 2019.
HOOPP was seen to be shifting away from an equities focus, targeting a range of alternative asset classes including insurance-linked securities (ILS), as a way to help soften the blow of the market volatility seen as a result of the Covid-19 coronavirus.
At the end of 2019, HOOPP’s ILS allocation had reached roughly C$260 million in size, before 2020 saw HOOPP building on the ILS investment program, more than doubling it to reach C$549 million at the end of that year (which was roughly US $440m at the time).
In 2021, HOOPP continued to steadily grow the ILS strategy, building it up to C$721 million (US 575m) by the end of that year, representing growth of just over 31% in Canadian dollars.
2022 saw further growth in the ILS allocation at a time when HOOPP’s overall net assets shrank somewhat.
HOOPP had reported total net assets of C$114.4 billion at the end of 2021, but by the end of 2022 that had fallen to C$103.7 billion.
With the ILS allocation growing 35% to reach C$973 million in 2022, it means HOOPP ended the last year with ILS investments nearing a 1% share of its total portfolio size.
Alright, I haven't covered much from HOOPP in a long time so here is an opportunity.
First, read my comment covering HOOPP's 2022 results where the plan remains fully funded despite losing 8.6% last year.
Why did HOOPP lose 8.6% last year? It's all about its asset mix. HOOPP is still heavily weighted in Public Equities and Fixed Income and both asset classes got hit in 2022:
|Performance by asset class||2022 % Return|
Even though HOOPP doesn't provide a mid-year update, I am willing to bet that just like OTPP, they're taking advantage of US long bond yields north of 4% to scoop them up.
Most of you don't remember but HOOPP was the only pension plan to eke out a positive return back in 2008 during the GFC as their massive fixed income portfolio came through for them.
The strategy has shifted since Michael Wissell was named its new CIO and you can read more about it here.
Basically, HOOPP has an excellent Real Estate and Private Equity portfolio but they're actively ramping up their Infrastructure portfolio through fund investments and co-investments and also ramping up private credit.
As far as their exposure to insurance-linked securities, go back to read an older comment where I covered HOOPP's LDI 2.0 portfolio:
So if not bonds, then what? Well, Jeff said they're slowly ramping up a few things:
- Infrastructure: HOOPP has been late to embrace infrastructure because they thought the asset class was overvalued for many years. Jeff told me only 25% of their assets are in private markets, "much lower than our peers" (they are closer to 50%). But with bond yields continuing to go lower, they decided to start investing in infrastructure. "We set up a team, we committed $1 billion in two infrastructure funds and will co-invest alongside them in bigger deals but it's still early, so we haven't deployed a lot of that billion dollars yet."
- Insurance-linked securities: In addition to infrastructure, it launched an insurance-linked securities (ILS) program. I'm not an expert on this but read a great comment on it from Marsh here. Basically, "ILS is another form of reinsurance available to insurance entities. However, instead of facing a rated balance sheet, the insurance entity faces a fully secure, collateralized form of funding dedicated to a precise risk requiring coverage. Usually the collateral takes the form of highly-rated, highly-liquid investments, such as government gilt funds or pure money market funds. Premium flows are determined by the type of risk and investor appetite."
- Allocating more to external absolute return managers: HOOPP has prided itself over the years for delivering great risk-adjusted returns in a very cost effective way. They do a lot of absolute return strategies internally but as the size of the Fund approaches $100 billion (they're at $99 billion now), they need to find scalable alpha strategies they can't replicate internally to help them continue delivering great risk-adjusted returns. Jeff confirmed to me they are using Innocap's managed account platform (the same one OTPP and CPP Investments use for their external hedge fund managers) to onboard new hedge fund managers but they are proceeding very selectively and cautiously. I told him I used to allocate to external hedge funds and warned him: "When things go well, it runs like a car in cruise control, but when things start to falter, get ready to hear all sorts of lame excuses as to why they're not performing. Proceed with great caution." He agreed and told me they have smart people internally working on finding good managers offering unique alpha they cannot replicate internally.
- Taking more concentrated positions in higher yielding equities and bonds: This was an interesting topic, Jeff told me back in March/ April, they moved quickly to buy more Canadian banks at low prices because they were "yielding 7%" and they also gorged on provincial bonds when "spreads widened". He said they're looking to be more opportunistic and more concentrated in public equities. "Traditionally, we invested synthetically in the S&P 500 and the S&P/TSX but we will be adding to our holdings of high yielding securities when opportunities arise. That's what we did with Canadian banks and provincial bonds."
Now, HOOPP isn't the only large pension looking at insurance-linked securities (ILS).
PSP also dipped into this market three years ago and there are others.
Bernard Van der Stichele is the senior portfolio manager in charge of HOOPP's ILS portfolio and he has a lot of experience.
A full discussion on insurance-linked securities is available on FINRA's website here.
I note the following on catastrophe bonds ("cat bonds"):
One common type of insurance-linked securities, which will illustrate many of their characteristics, are "catastrophe bonds"—"cat bonds" for short. If a "sponsor," such as an insurance company or reinsurance company (a company that insures insurance companies), wants to transfer some or all of the risk it assumes in insuring a catastrophe, it can set up a separate legal structure—commonly known as a special purpose vehicle (SPV). Foreign governments and private companies also have sponsored cat bonds as a hedge against natural disasters.
The SPV issues cat bonds and typically invests the proceeds from the bond issuance in low-risk securities (the collateral). The earnings on these low-risk securities, as well as insurance premiums paid to the sponsor, are used to make periodic, variable rate interest payments to investors.
As long as the natural disaster covered by the bond—whether a windstorm in Europe or an earthquake in California—does not occur during the time investors own the bond, investors will receive their interest payments and, when the bond matures, their principal back from the collateral. Most cat bonds generally mature in three years, although terms range from one to five years, depending on the bond.
If the event does occur, however, the sponsor's right to the collateral is "triggered." This means the sponsor receives the collateral, instead of investors receiving it when the bond matures, causing investors to lose most—or all—of their principal and unpaid interest payments. When this happens, the SPV might also have the right to extend the maturity of the bonds to verify that the trigger did occur or to process and audit insurance claims. Depending on the bond, the extension can last anywhere from three months to two years or more. In some cases, cat bonds cover multiple events to reduce the chances that investors will lose all their principal.
Because cat bond holders face potentially huge losses, cat bonds are typically rated "non-investment grade" by credit rating agencies such as Fitch, Moody's and S&P. Non-investment grade bonds are also known as "high yield" or "junk" bonds. These ratings agencies, as well as sponsors and underwriters of cat bonds, rely heavily on a handful of firms that specialize in modeling natural disasters. These catastrophe risk modeling firms employ meteorologists, seismologists, statisticians, and other experts who use large databases of historical or simulated data to estimate the probabilities and potential financial damage of natural disasters.
Now, I do not know the details about HOOPP's ILS portfolio but I assume it is well diversified and not loaded up with cat bonds.
According to the report published by Virtue Market Research , in 2022, the Global Reinsurance Market was valued at $503.73 Billion, and is projected to reach a market size of $1.14 Trillion by 2030. Over the forecast period of 2023-2030, that market is projected to grow at a CAGR of 10.8%.
However, despite a modest decline in the global reinsurance industry's weighted
average cost of capital to 6.92% in 2022, some reinsurers continue to face challenges in meeting their cost of capital, testing investors'
risk appetites, according to a new AM Best report:
The Best’s Market Segment Report, "Meeting Cost of Capital a Challenge for Some Reinsurers," is part of AM Best’s look at the global reinsurance industry ahead of the Rendez-Vous de Septembre in Monte Carlo. Other reports, including AM Best’s annual ranking of the Top 50 global reinsurance groups and in-depth looks at the insurance-linked securities, Lloyd’s, life/annuity, health and regional reinsurance markets, will be available during August and September.
According to this report, reinsurers have seen a significant increase in the cost of debt, driven by rising interest rates, as well as the cost of equity due to stock market volatility. Catastrophe losses also have become more severe in recent years, with traditional catastrophic events and growing secondary perils plaguing the industry.
"Reinsurers did not meet the cost of capital in any of the past three years," said Helen Andersen, industry analyst, industry research and analytics, AM Best. "Reinsurers have been unable to meet their cost of equity since 2019 as well. Achieving hurdle rates will be difficult amid economic and social inflation, as well as escalating weather losses, despite significant price increases."
The reinsurance industry's weighted average cost of capital experienced a decline to 6.38% in 2019 from 9.44% in 2010, before spiking to 9.16% in 2021. Although it decreased in 2022, reinsurers are still struggling to generate returns above the cost of capital.
"Reinsurers that can effectively balance long-term strategies with tactical decisions and sound risk management still have the potential to meet, or even exceed, return expectations. This requires a comprehensive approach to navigating economic uncertainty and rising climate risk," said Sridhar Manyem, director, industry research and analytics, AM Best.
As the reinsurance industry continues to grapple with these challenges, investors are closely monitoring the ability of reinsurers to generate returns above the cost of capital. The hardening market points to more-sustainable pricing momentum, which could help reinsurers meet their cost of capital over the medium term. However, economic and social inflation and the growing frequency and severity of weather events will increase uncertainty. Even as capital comes back cautiously in this environment, AM Best is not seeing substantial erosion of pricing conditions.
This is a tough environment for the reinsurance industry and it takes skill and experience to properly invest in the ILS market.
Below, a 2020 panel discussion from Artemis' ILS Asia conference featuring Bernard van der Stichele, Senior Portfolio Manager (ILS), Fixed Income & Derivatives Healthcare of Ontario Pension Plan (HOOPP), Craig Dandurand, Head of Debt at the Future Fund of Australia, and Eveline Takken-Somers, Senior Director, Lead Portfolio Manager – Insurance Portfolio, PGGM who noted: “We spent quite some time educating our clients so the losses itself did not raise many questions.”
If the insurance-linked market interests you, take the time to watch this discussion.