Markel has revealed that its ILS operations had grown “dramatically” from nothing to $92 million in 2018, in just five years and that it is “incredibly optimistic” about the future of its insurance linked securities (ILS) business despite ongoing investigations into recorded loss reserves at CATCo and its subsidiaries.
Explaining the strategy in the company’s annual letter to shareholders, the co-chief executive officers Thomas Gayner and Richard Whitt III highlighted the “multi-year and multi-acquisition process” that has built the firm’s ILS capabilities.
“Through the acquisitions of ILS managers CATCo, and Nephila, as well as State National, with its necessary regulatory servicing and licensing capabilities, we’ve assembled the largest single entity that participates in the ILS market,” they said. “We are incredibly optimistic about the future of this business and what it means for Markel as a whole.”
However, the letter added: “That said, we encountered unexpected challenges in our CATCo ILS management operations in 2018.
“As we announced in December, we received inquiries from US and Bermuda authorities into loss reserves recorded in late 2017 and early 2018 at CATCo and its subsidiaries. We are fully cooperating. We continue to investigate the issue, and we retained first rate outside advisors to conduct a fulsome inquiry into the matter.”
It said shareholders could expect more information when the investigation had concluded.
However, despite this, the letter reassured shareholders “we are confident that our efforts in ILS will prove to be a valuable and important strategic pillar of our operations at Markel. We will learn, and we will adapt as necessary, to make our ILS operations a key contributor to our results over time”.
The letter acknowledged the debate around ILS results and questions about the market’s long term viability following a series of “record-setting catastrophes in multiple markets” in 2018, which led to losses for investors after a similarly high level of catastrophes in 2017.
But the letter said: “We believe in the future of the ILS market and that the results will balance back out towards a more sustainable equilibrium.
“In hindsight, CATCo’s initial estimates for the catastrophe losses of 2017 and 2018 proved to be too low. The losses to investors on CATCo products have exceeded initial estimates.”
It said the reserve setting process at CATCo “involves a unique challenge in that products such as Industry Loss Warranty covers end up with a completely binary outcome”.
Explaining this the letter cited an “extreme and oversimplified example” where if the industry loss number in a given contract is set at $5 billion, and industry losses turn out to be $4,999,999,999, the loss for the sellers/investors in the ILS security is zero. But if the overall industry loss deteriorates by $2, that means the ILS contract would go to a total loss that might be hundreds of millions, it said.
The letter said: “Determining a point estimate for what that loss might be, and doing so for a wildfire that is burning while you are in the room and trying to come up with that number, is a tough task. Frankly, it is impossible to get it exactly right.”
However, the co-CEOs said the firm was “revisiting and reexamining the processes and elements that go into the setting of reserves, pricing decisions, and actuarial matters at CATCo”.
They added: “We remain committed to operating with complete integrity and to the very best of our ability.”
Markel, CATCo, ILS, losses, annual letter