Insurance-Linked Securities (ILS) represent an important and growing alternative asset class with diversifying and income-oriented returns. Its low correlation to traditional equities and fixed income embeds resiliency in portfolios during periods of financial market stress. In this Q&A, Rick Pagnani and Vijay Manghnani, the founders of specialty ILS manager King Ridge Capital Advisors, provide further background on how ILS can add an important source of returns to most investors with multi-asset portfolios.

Insurance-Linked Securities (ILS) represent an important and growing alternative asset class with diversifying and income-oriented returns. Its low correlation to traditional equities and fixed income embeds resiliency in portfolios during periods of financial market stress. In this Q&A, Rick Pagnani and Vijay Manghnani, the founders of specialty ILS manager King Ridge Capital Advisors, provide further background on how ILS can add an important source of returns to most investors with multi-asset portfolios.

Q: What exactly are ILS, and why do they exist? 

Pagnani: The concept of ILS gained traction in the 1990s following several significant natural disasters, such as Hurricane Andrew (1992). These events highlighted the need for additional capital to support the insurance industry, especially for covering large, infrequent, and severe losses.  Simply put, ILS are financial assets that transfer insurance risks to the capital markets. The most common type of ILS is a catastrophe bond, which transfers risk of events, such as hurricanes, earthquakes, or wildfires, to capital market investors. This helps insurers manage their exposure to large-scale losses and maintain financial stability. As in any bond, investors receive regular interest coupons. These payments are typically higher than those of comparable high-yield bonds. If the specified catastrophic event happens (e.g., a major hurricane hits), the bond is "triggered." This means the insurance company can use some or all the money in the secure account to pay for the damages and claims. If the catastrophic event doesn't occur during the bond's term (usually 3-5 years), investors get their principal back at the end of the term, along with the interest payments they received along the way. Cat Bonds are floating rate instruments like collateralized loan obligations, which makes them somewhat insulated from interest rate volatility. 

ILS offers a compelling value proposition for both insurers (access to capital markets) and investors (attractive and uncorrelated returns)

Q: Why are investors embracing ILS? 

Pagnani: ILS provides an important source of returns that are largely not related to factors driving the financial markets. Investors value a truly diversifying asset. Performance is driven by occurrent of natural events – such as hurricanes, earthquake and floods – not by the financial markets. In other words, unlike many other financial assets, in ILS, the risk trigger (a catastrophe event) is decoupled from the underlying source of yield.

The diversification properties of ILS have been demonstrated across various financial market events. 

For instance, during the global financial crisis in 2008-2009 – when global equities were down 54% - ILS returned 5.1%, based on the Swiss Re Cat Bond Index.

On a standalone basis ILS have generated attractive return delivering positive annualized returns of ~8% between 2002 and 2024, with a volatility less than 4% (for the Swiss Re Cat Bond Index).

Finally, as a floating rate fixed income instrument, ILS demonstrates low duration and limited interest rate sensitivity.

Q: How have ILS performed historically? 

Manghnani: As discussed above, the 23-year annualized average returns of the Swiss Re Cat Bond Index is ~8%. The time series of annual returns for the index are presented below. Notably, over the past decade, there has been only one year of negative returns—a decline of 2.15% in 2022. This performance is particularly impressive given the increasing property and casualty (P&C) underwriting risks in the face of changing weather patterns. 

It is crucial to consider not only the return profile of ILS but also its correlation with other primary asset classes. As illustrated in the correlation matrix below, ILS returns are largely uncorrelated with those of other asset classes. Consequently, incorporating an ILS component into most portfolios can enhance returns and reduce volatility, effectively pushing the portfolio's performance upward and outward on the efficient frontier.

- Correlation based on monthly returns from Jan 2002 through Dec 2023

- CAT Bonds represented by the Swiss Re Global Cat Bond Total Return Index

- US Stocks represented by the S&P 500 Index

- Commodities represented by Bloomberg Commodity Index

- US Agg IG Bonds represented by the Bloomberg US Aggregate Index

- US HY Corp Bonds represented by ICE Bank of America US High Yield Constrained Total Return Index

Q: What is the current market size of the ILS market and what are the growth projections? 

Pagnani: The outstanding supply of Insurance-Linked Securities (ILS) is approaching $120 billion. The figure below includes Cat Bonds, Industry Loss Warrants (ILWs), and dedicated Sidecars. The outstanding supply is expected to exceed $150 billion by the end of the decade. 

Annual issuance of Cat Bonds approached $18 billion in 2024, representing a year-over-year increase of approximately 7.5%, and may exceed $20 billion in 2025. This growth has been driven by attractive spreads relative to instruments of comparable risk and strong investor demand from a growing investor base.

Q:  What are the ILWs and Sidecars shown in the figure above?

Manghnani: An Industry Loss Warranty (ILW) is a type of reinsurance contract or Catastrophe (Cat) Bond that provides coverage based on the total industry insured losses experienced by the entire reinsurance industry from a specific event, such as an earthquake. Payouts are triggered when industry-wide losses exceed a predetermined threshold at various attachment points. 

A Sidecar is a financial structure that allows investors to share the profits and risks of an insurance company's reinsurance business. Essentially, it lets investors participate in the underwriting of insurance policies without directly owning the insurance company. This helps the insurer spread its risk while providing investors with a way to earn returns from insurance premiums.

Q: How are ILS returns positive even though it appears that the frequency of catastrophes is increasing? 

Pagnani; Think of an ILS or Cat Bond structure like a collateralized loan obligation (CLO) or residential mortgage-backed security (RMBS). These structures have various attachment points, with losses accumulating from the equity tranche upward to more remote layers. The more remote the attachment point, the lower the risk, but also the lower the "coupon" or interest payment. Therefore, most of the events don’t rise to the excess CAT bond tranches. 

A well-diversified ILS portfolio is further insulated from any single large shock event, since exposure to different perils and exposures is closely monitored and managed in real time by expert portfolio managers. 

ILS also generally reprice annually to account for changes in underlying exposures and the market/underwriting environment. 

Finally, Cat Bonds are floating rate instruments like CLOs, which makes them somewhat insulated from interest rate volatility. 

Q: What is KCRA’s competitive edge? 

Pagnani: As highlighted in our bios, our extensive experience in the insurance and reinsurance industries provides us with a deep understanding of the critical factors in building and managing ILS portfolios. Our years of underwriting risks in the insurance and reinsurance space enable us to evaluate the unique perils embedded in individual Cat Bonds and assess the value associated with return expectations.

A unique differentiating factor is Vijay's doctorate in meteorology and his leadership in assessing the impact of climate change on underwriting risks. In a world of increased climate volatility and loss severity, in-house climate expertise is essential. Our collective experience has driven the development of proprietary models that are crucial for evaluating the risks embedded in every Cat Bond. Without a clear understanding of these risks, it is impossible to determine whether investors are being appropriately rewarded for participating in the underwriting of those risks.

Our long tenure in the industry has also fostered strong relationships across private and syndicated markets, which are essential for maintaining high levels of information flow. Collectively, these factors have led to the development of a rigorous, repeatable, and highly structured investment process that ensures ongoing success.

Q: What products and services do KRC offer?        

Manghnani: Our mission at King Ridge Capital Inc. (KRC) is to deliver innovative, data-driven ILS investment solutions in the insurance industry and create exceptional value for investors. 

We offer both beta strategies (via the industry’s first ILS ETF) and alpha strategies through our funds and separately managed accounts. 

Our track record enables us to provide strategies beyond traditional property catastrophe exposures and will include long-tail, lower-volatility casualty exposures.

Our strategies are designed to appeal to a wide range of investors seeking ILS exposure—from retail investors to high-net-worth individuals and family offices, as well as institutional investors such as pension plans, sovereign wealth funds, and multi-strategy platforms. 

We look forward to engaging with potential investors to discuss opportunities with KRC.

Executive Bios

Rick Pagnani is the co-founder, lead portfolio manager, and CEO of KRC. Prior to KRC, Mr. Pagnani was Executive Vice President, Head of PIMCO's insurance-linked business, and CEO of Newport Reinsurance Ltd. Before joining PIMCO in 2018, he was the CEO of Mt. Logan Re, where he launched and grew the third-party ILS investment business for Everest Reinsurance.

Previously, he was a partner at TigerRisk Partners, focusing on production in the Life and P&C markets and new product development. He also served as chief executive officer of Ascendant Reinsurance, a class 3 Bermuda–based reinsurance company focusing on catastrophe derivatives. He was a Managing Director at Swiss Re New Markets, a division of Swiss Reinsurance Company. He has 36 years of investment experience and holds an MBA from Fordham University and a bachelor's degree from Hobart College.

Vijay Manghnani is a recognized leader in ILS, catastrophe risk management, and innovative climate-related financial products. With a distinguished career spanning global financial and insurance institutions, Vijay has been instrumental in driving advanced science, analytics, and risk management strategies.

He was a founding member of the ILS team at PIMCO, serving as SVP, Head of Risk and Analytics for the ILS Fund and was the Chief Risk Officer & Chief Actuary at Newport Re. Previously, he led the Catastrophe Risk Management and Analytics Center of Excellence at AIG. Throughout his career, Vijay has held senior leadership roles at ACE/Chubb, Weather Predict (Renaissance Re), and Aquila Inc, managing portfolios of climate, weather, and catastrophe insurance products.

Vijay holds a Ph.D. in Meteorology from North Carolina State University, is a Fellow of the Casualty Actuarial Society (FCAS), and is a member of the American Meteorological Society. He also served as Chair of the North American Actuaries Climate Change Committee, contributing to the quantification of climate risk for the insurance industry. Beyond his corporate achievements, Vijay has shared his expertise as an Adjunct Professor of Civil Engineering at Clemson University.