Sidecars mirror ILS demand
At the end of March, PartnerRe became the latest reinsurer to launch a so-called sidecar—a special purpose company the reinsurer will use to facilitate third-party investors to participate in collateralised reinsurance deals.
The deal was just the latest of this ilk to be completed by a reinsurer, further illustrating the much talked-about convergence between traditional reinsurance capacity and the capital markets. After a quiet January, the insurance-linked securities (ILS) market has a healthy pipeline with the same sets of investors often interested in both (see box).
As well as the obvious benefits of sidecars, however, some suggest they also increasingly represent a tick box for shareholders seeking innovation in senior management teams in reinsurers.
There have been a number of deals in recent months, complementing more established sidecar vehicles. Everest Re launched a sidecar called Mt Logan Re earlier this year, raising $200 million to complement $50 million provided by Everest; Lancashire Holdings launched Saltire Re I Limited with capacity of up to $250 million; Argo Group launched Harambee Re; RenaissanceRe has its established Upsilon Re II; Validus has AlphaCat 2013; and Alterra recently increased the capitalisation of New Point V.
PartnerRe’s Lorenz Re, which is domiciled on Bermuda, has been capitalised with $75 million from investors via the issuance of a number of classes of preference shares. It will provide PartnerRe with additional capacity on various catastrophe reinsurance treaties over a multi-year period, allowing the company to tap into and leverage third-party capital.
Aon Benfield Securities acted as adviser on the transaction. Prime Management Limited, a Bermuda company specialising in the administration of investment funds and special purpose insurance vehicles, will serve as the insurance manager of Lorenz Re.
The Bermudian company said the new venture will allow the reinsurer to access more capacity by linking up with investors from the capital markets. But it is becoming increasingly obvious that there are also other very good reasons for doing these types of deals.
A badge of honour
Some experts have also suggested that having this ability is now something that shareholders in reinsurers look favourably upon in the same way, perhaps, that having an involvement on the ILS side of things was seen as an advantage a few years ago. Some suggest that regardless of the tangible reality of sidecars, the very fact that they allow a reinsurer a link into the capital markets is regarded very favourably.
“There is no doubt that this is increasingly a big reason as to why more reinsurers are looking to set up these facilities,” said one industry executive close to a recent deal, who asked not to be named.
“There is a small club of reinsurers at the moment which have these facilities in place and being in that club is very attractive to reinsurers. I would not go so far as to say setting these up affects the share price directly but it certainly does the management team no harm in terms of the way they are perceived by investors. It is a box they now want ticked.
“The other thing is that these deals are not actually easy to set up. Looking at such deals from the outside, it might be easy to assume that there is a lot of cash from capital markets investors just waiting to pour into vehicles of this nature. That is not true. Investors need convincing, especially for a new formation. It is for the reinsurers to convince them that these work and that there is money to be made.”
However much convincing investors might need, however, reinsurers are certainly succeeding in their efforts. A number of funds have also been launched in recent months, illustrating the investor demand for such products. This has also gone hand in hand with the expansion of funds focused on the ILS market.
The Montpelier Re-backed Blue Capital Global Reinsurance Fund, which invests in catastrophe exposed collateralised reinsurance-linked contracts and other ILS investments, is looking to raise more funds through a series of placements of new shares. One market participant said the placement illustrated the still growing demand for ILS products among investors.
The fund, which was launched in December last year raising more than $100 million, has said it expects the share placements to begin in the second quarter of 2013. Managed by Montpelier Re’s investment management subsidiary Blue Capital Management, the fund invests in a number of products including collateralised reinsurance-linked contracts, industry loss warranties, catastrophe bonds and other ILS.
It was also recently announced that New York investment firm Stone Ridge Asset Management has successfully raised its initial target capital for its two ILS and reinsurance-linked investment funds. The manager launched two reinsurance-linked funds in the last quarter of 2012 and completed its first round of fundraising by the end of January.
Cat bond update: the pipeline grows
In 2012 there was the second highest level of catastrophe bond issuance on record, signalling strong growth in the market, according to Willis Capital Markets & Advisory (WCMA). At year end, $5.9 billion of catastrophe bonds had been issued—a 37 percent increase over 2011.
In the fourth quarter of 2012 there was new issuance volume of $1.9 billion of non-life capacity. This capacity was issued through seven transactions, which compares with the same volume ($1.9 billion) in nine deals in Q4 2011. Three transactions were sponsored by reinsurers, three by primary insurers and one by a government entity.
Now, as we move through the first quarter of 2013, the pipeline for cat bonds is starting to fill up nicely again with (at the time of going to press) a number of deals in the pipeline.
Florida state-backed insurer Citizens is looking to repeat the success of its first cat bond issued in 2012, with a second bond issuance under Everglades Re this year. Everglades Re made headlines in 2012 when it became the largest cat bond ever, growing from a $200 million tranche of notes to $750 million by the close of the deal. Significant interest in the bond helped to buoy the ILS market in 2012 and it is likely investors will be considering the latest issuance with interest.
Arthur Wightman, partner—insurance leader at PwC in Bermuda, said that given the size of last year’s transaction, and the anticipated value of this year’s deal, this latest issuance will represent an important benchmark for the ILS market.
He also expects other state insurance funds to start looking more closely at using catastrophe bonds themselves.
Meanwhile, two other new catastrophe bonds are being marketed that should take 2013 issuance to around $1 billion. Merna Re IV is a $250 million three-year deal that will provide State Farm & Casualty with US earthquake protection.
Guy Carpenter and Munich Re are reportedly working on Tar Heel Re, which would give the North Carolina wind pools—the North Carolina Joint Underwriters Association and the North Carolina Insurance Underwriters Association—three years of hurricane protection.
This is State Farm’s fourth catastrophe bond in the Merna Re series of deals. This latest Merna Re IV cat bond will replace some of the cover provided by Merna Reinsurance II which matures in April. Standard & Poor’s has rated the new bond B+.
Experts in this market say they expect both deals to be well received on the back of strong investor demand for products that offer decent returns yet are uncorrelated to the rest of the financial markets.
“Until something dramatic happens in the non-insurance markets, these deals will retain their attraction to investors,” said Clive O’Connell, partner at law firm Goldberg Segalla. “At present, there is precious little scope for investment, unless you wish to invest in the arms industry!
“ILS products represent a reasonable return for limited risk: limited, that is, if investors or their managers are sensible in diversification and don’t make the mistake of accumulating risks on any one possible event. Of course, there is a danger of multiple events in a given year, but if sensible diversification is utilised, these risks can be significantly reduced.”
Another trend of recent deals has been of reinsurers dedicating experienced personnel to running these vehicles—usually executives with experience gained on the ILS side of the business.
Lancashire Holdings has an established track record of involvement in sidecar and investor-backed underwriting vehicles through its Sirocco, Accordion and Saltire efforts. But Lancashire Capital Management, for instance, is now formally led by Simon Fascione, who takes this role in addition to being chief underwriting officer of Lancashire Insurance Company.
“We see such opportunities as a capital-efficient way of generating additional benefits for our shareholders, drawing on Lancashire’s underwriting expertise,” said Richard Brindle, chief executive of Lancashire Group. “We are actively engaged in the further development of these types of opportunities under the banner of Lancashire Capital Management. But we are careful only to develop products we believe in and to ensure that these projects don’t distract us from the ‘mother ship’.”
Meanwhile, Everest Re recruited Rick Pagnani, a seasoned executive with vast ILS and alternative capacity experience to run Mt Logan Re. He was a partner with TigerRisk and prior to that he was CEO of Bermuda reinsurance startup Ascendant Reinsurance where the firm focused on catastrophe derivatives. Before that he was with Quanta Reinsurance and, even earlier, reinsurers including Swiss Re and Zurich Re.
“We are pleased to have Rick join us as the chief executive officer of this new venture,” said Joseph Taranto, CEO of Everest Re. “Rick brings a wealth of experience and is well-known within the Bermuda reinsurance community. As he had successfully led prior reinsurance ventures, we are fortunate to have an executive of his calibre join us to launch this new operation.”
Taranto added: “For Everest, this vehicle adds yet another tool to our underwriting arsenal that allows us to meet the dynamic demands of the reinsurance marketplace and enhance the returns of our investors.”
Some companies, however, are going about the creation of sidecars in a slightly different way and are wary of any suggestion that such a vehicle could cause them to lose focus.
Bermudian re/insurer Argo Group has stressed that the recent sidecar it formed, capitalised by capital market investors, is very different from similar vehicles launched by rivals in that it complements the company’s core underwriting accounts instead of focusing on more opportunistic, possibly non-core business lines.
Harambee Re (Harambee means ‘pull together’ in Swahili) was launched by Argo at the start of this year. Sidecars provide exposure to potentially lucrative business without diluting the company’s existing shareholders, but Mark Gibson, director of Alternative Risk Markets at Argo Group, says a critical difference between this and similar ventures in the market is that its underwriting scope will reflect the core portfolios of two of Argo Group’s entities.
It will support both reinsurance and insurance portfolios providing capacity of some 5 percent of premium income for specific property portfolios within Argo Re, the group’s reinsurance operation, and Colony Specialty, Argo Group’s excess and surplus lines segment.
“A big difference is that most sidecars are established, quite reasonably, by sponsors seeking to generate a supplementary revenue stream by matching their underwriting expertise with the demands of investors for certain risks and related returns,” Gibson said.
“This might be in areas where there are reinsurance market capacity constraints such as in the retro market or in peak zones such as Florida where pricing may be relatively more attractive than in other zones.
“What we have done is very different. This will help us build our core account while maintaining the level of volatility we believe is appropriate for our balance sheet.”
Gibson also backs the view that the ability to fund and launch sidecars also represents an extra string to the bow of insurers and reinsurers—something that investors can give credit for.
“I think that it can certainly be beneficial for a company to demonstrate that it has the ability to engage with capital market investors in this way,” Gibson said.
“There is only a handful of companies that have formed these vehicles and it is good for Argo to be able to join that list.”
Kalista forms ILS unit
Kalista Global, a Bermuda-based re/insurance company specialising in the origination, structuring and execution of ILS deals, has launched several new products in recent months in a strategy that values innovation over market share in this market.
It has launched a cat bond issuance platform, a parametric cat reinsurance product, an El Niño parametric cover and a suite of crop industry loss warranties in recent months as it builds out its capabilities in the ILS space.
Spencer Conway, Kalista’s chief executive, said the recent launches had been well received by the market. “With these new products we don’t compete for market share, rather we see niches and create relevant products that offer real innovation to the market,” he said.
Conway said that there is significant interest in the ILS space, with levels of capital entering the market helping to drive innovation. Kalista is looking to extend accessible and affordable products to the market, Conway said, satisfying demand among those companies that have baulked at the cost and complexity of traditional cat bonds and ILS.
Kalista has five additional new products in development which it plans to roll out in 2013 and 2014 in order to satisfy rising demand for innovation in the ILS space.