15 October 2013

An impressive partnership

With a host of reinsurers piling into the convergence space in recent months, XL has taken a rather more measured approach to the formation of its own third party venture. As Charles Cooper, president and chief underwriting officer at XL’s Bermuda Reinsurance Operations explained, the company has spent considerable time exploring its strategic options, rather than diving headfi rst into the convergence waters. XL has closely considered the approaches taken by others, said Cooper, which have varied from wholly-owned ILS subsidiaries to minority investments in established ILS platforms. However, as he outlined “there were concerns with both approaches”, with XL determining that a joint venture is the best means to enter the convergence space.

Such an approach will draw upon the best of both XL and its capital markets partner in the new venture, private equity fi rm Stone Point Capital. Cooper said that investors would be able to “leverage XL’s 20-plus-year track record of underwriting property catastrophe business profi tably, signifi cant investment in portfolio management and risk analytics, and well-established relationships with brokers and cedants” through the new venture. In Stone Point, investors would benefit from an “optimal partner with a deep understanding of the reinsurance business, who can provide invaluable third party validation of our strategy”, as well as significant fund management expertise.

XL and Stone Point have shared history, with the private equity firm having been one of the initial investors in Mid Ocean Re. The two firms have since worked closely together and Cooper is confi dent that in their new joint venture Stone Point will bring to bear its “exemplary track record in the property and casualty space and its world-class stewardship of capital.”

Leveraging oversight

Cooper explained that with both XL and Stone Point prepared to deploy considerable capital, investors may be confi dent that risks underwritten will be aligned with their interests. Leveraging oversight and expertise from the two joint venture companies should prove attractive to capital market investors. “For every dollar of XL-underwritten risk to be provided to investors, there will be multiples of XL capital at risk. Investors need to understand and be comfortable that the steward of their capital has as much at risk—if not more—than they do when they invest.”

Cooper said that the new company will provide oversight and due diligence on any XL-underwritten business to help ensure it meets the standards expected by investors. As he outlined, “The compensation of management is intended to be aligned with those of investors and to reflect returns achieved by the fund, with the company providing its own portfolio management and oversight of XL-sourced business.”

A diverse offering

When operations are fully commenced, investors will be able to access the full range of convergence products through the new venture, said Cooper, with allocations reflecting their particular appetites. The key will be the ability to offer them the full range of choices, he explained.

"Some buyers appreciate collateralised solutions, while others are interested in capital sources that can be more efficient at certain risks levels than a traditional rated balance sheet."

The company intends to offer XL-sourced and underwritten business through a special purpose insurer, which will comprise collateralised, single-shot reinsurance and retrocessional protection to insurance clients; ILS and ILW products will be managed by the portfolio manager of the new joint venture. “The weighting of the funds will very much depend on investor appetite,” said Cooper, but what is apparent is that XL is geared up to fulfil varied investor appetite in the space.

The initial focus will very much be upon the property catastrophe space, but Cooper did not preclude other lines of business being considered. “Capital flows towards opportunity. If opportunities emerge, capital market investors will figure out ways to structure products that enable them to access them.”

Meeting client demand

Cooper said that rather than being cannibalistic to its traditional rated balance sheet, the new venture would provide additional capacity and alternative products to its existing, long established customer base. As he explained, “More and more clients are looking to round out their reinsurance buying with a collateralised component. It could be a certain tranche, it could be reinstatement premium protection or a ‘top-anddrop’ which sits at the top of the programme, but we want to be able to extend a diverse offering to buyers—from a rated balance sheet to collateralised solutions.”

Cooper said that some buyers appreciate collateralised solutions, while others are interested in capital sources that can be more efficient at certain risk levels than a traditional rated balance sheet. He explained that with some tranches of risk being highly correlated with a reinsurer’s balance sheet, there are peak peril risks—such as US wind—that may well prove more attractively priced in the capital markets.

He added that more and more insurers are evaluating the different capital structures on offer, with alternative forms of reinsurance representing a tool for reinsurers to be more competitive when it comes to cost of capital. Cooper said that catastrophe bonds and collateralised reinsurance form part of this opportunity—one that XL is evidently keen to seize. Addressing XL’s move into the convergence space, Cooper said that offering a broad range of products “is clearly a capability any large global re/insurance firm needs to have”.

Nevertheless, Cooper made clear that traditional reinsurance will remain the mainstay of XL’s future offering. “Most buyers are attracted to the more permanent structure and predictability of a rated balance sheet,” but as he explained, XL is determined that it will also satisfy clients’ appetite for collateralised structures and ILS through the new joint venture. These are dynamic times. XL has made its move with care and consideration, with the new venture due to start writing business from Bermuda in January.

The principles of convergence

Addressing what is needed for other lines to enter the convergence space, Cooper said that in order to be considered, lines would need to address four factors, namely:

• Confidence in measuring and modelling such risk to a degree that will satisfy investors;

• Low correlation with wider capital market portfolios;

• A duration that marries with investor liquidity requirements and their investment horizon. As such, long-tail lines might not necessarily make sense until a structure can be found that will offer liquidity;

• Investors need to be confident that there is an alignment of interest with whoever is sourcing the risk.

Questions do however remain regarding the stickiness of investor appetite, both in the catastrophe space and for potential emerging risks. Cooper said that investors will likely “stick around” following a single major loss, but that multiple losses across a number of years might prove sufficient to encourage some to exit. He also highlighted losses that call into question modelled assumptions as another potential factor that might spook investors, but he was clear that “most investors are now committed to the asset class”. He said that while the current interest rate environment made alternative reinsurance particularly attractive, its low-correlation nature would likely help to sustain interest even in a higher interest rate environment. Reinsurers must necessarily adapt to a new norm.