As climate-driven disasters continue to intensify globally, insurance-linked securities (ILS) are being positioned not only as a source of uncorrelated returns but as essential social infrastructure, according to Gareth Abley and Jehan Sukhla, Co-Heads of Alternatives at MLC Asset Management.
According to re/insurance broker Aon, total economic losses from natural disasters in 2024 reached US$368 billion, 14% above the 21st century average. However, as Abley and Sukhla highlight, only US$145 billion of this was covered by insurance, leaving an insurance gap of US$223 billion.
“Insurance is expensive, and insurers can’t always stomach the megaton risks of a warming world. ILS inject additional capital into the system, helping to fund coverage and act as a supportive lever to make protection more accessible,” the pair write.
Adding: “Beyond financial returns, ILS offer tangible societal value. When triggered, payouts fund rapid recovery – rebuilding infrastructure, supporting businesses, and stabilising communities post-disaster.”
The pair also stress that climate change amplifies the relevance of ILS.
“Rising global temperatures have intensified the frequency and severity of natural catastrophes, with insured losses from weather-related events averaging US$110 billion annually since 2017.”
They also affirm that one of the risks, if not the most important risk in the asset class is model risk.
“This is the probabilistic assessment of the likely loss under myriad events that could occur – taking into account (for example) the tracking of hurricanes, windspeed, property values, severity of damage and the like.
“While this is a hugely resourced scientific effort, incorporating sophisticated independent vendor modelling, which is then often reviewed and overlaid with various adjustments by specialist ILS managers… it is ultimately something of a ‘best estimate.’”
As ILS gains greater prominence in institutional portfolios, not just for its returns, but also its impact, the authors emphasise the importance of how exposure is built.
While some investors may view the space as offering market “beta,” the pair argue that outperformance lies in careful implementation.
“There are myriad variables that can make a huge difference to performance,” the report explains, pointing to distinctions such as peak vs. non-peak peril exposure, public catastrophe bonds vs. private reinsurance instruments, and per-occurrence vs. aggregate contracts.
“Another distinctive characteristic of the asset class is that risk is driven by infrequent and unpredictable catastrophe events,” the pair continue.
Even highly skilled managers can experience setbacks if a low-probability event happens to impact their portfolio, showing how outcomes in this space can be driven as much by chance as by expertise.
“ILS present a compelling case for institutional portfolios – low correlation, attractive risk-adjusted returns, and positive societal impact. Yet, to capture these returns reliably is not simple and requires a deep understanding of the underlying nuances,” Abley and Sukhla conclude.
Also read: Multi-manager approach key to navigating ILS manager dispersion: MLC.
