Is third party capital interest rate neutral?
It is a very common question that we get asked: if investors in third party capital structures are pension funds and private equity vehicles investing in reinsurance because they are getting little yield elsewhere, how do they react if interest rates rise? Will they still want to invest in reinsurance?
The quick answer is: yes, in my view, and I consider that there are two main reasons for this.
First, in a number of collateralised structures, there is the possibility for the collateralised funds to be invested in particular floating rate or other short term securities that may, to an extent, correlate to any interest rate rises, so there is some potential growth there and potential alignment with any interest rate rises, albeit this is dependent on cedant agreement.
Second, I believe that third party capital structures would remain relevant and appealing to investors even in a higher interest rate environment. For many investors, there is the low correlation aspect between the insurance strategies deployed by third party vehicles and the traditional financial markets—regardless of whether interest rates go up or not, the low correlation will still exist, which is something very appealing to many investors.
However, it needs to be borne in mind that when investing in collateralised reinsurance structures investors can lose their capital investment if an event occurs. This is something investors need to consider when making their investment decision.
Kinesis is a third party capital management vehicle aligned with Lancashire. We sell a lot more than just property catastrophe structures, we also deal in speciality lines including marine, energy, aviation and terrorism and that’s what makes us different. We are more diversified than many other funds.
We also work with clients who want to buy one reinsurance cover for a number of lines. Instead of buying reinsurance for aviation, for terrorism, for marine and for property—with four separate limits—we say buy one with us and it can be more cost-effective. We think there are a lot of inefficiencies within many reinsurance strategies and we try to rationalise things.