Lancashire to avoid the competition with collateralized Kinesis offering

With its Kinesis Capital Management unit, and its Kinesis Re collateralized reinsurance vehicle, Lancashire Holdings aims to offer a niche product which has unique features within the alternative reinsurance capital, collateralized reinsurance and ILS space.

We wrote earlier today about Lancashire’s third-quarter earnings statement as it reiterated its mission to create a multiple balance sheet and capital source agnostic insurance and reinsurance platform, leveraging all forms of capital and targeting multiple markets. Its Kinesis Capital Management unit will play a key role in this mission, particularly in the management of third-party reinsurance capital.

Lancashire has revealed more details of its thinking surrounding Kinesis, third-party capital and the products it intends to offer during its third-quarter earnings call earlier and its investor day presentation held in London, which has just finished. Here we cover a mixture of comments from both events, and from the presentations made, which reveals more detail on Kinesis.

What becomes clear is Lancashire’s desire to offer a differentiated product range in the collateralized reinsurance space, thus enabling it to avoid the highly competitive property catastrophe only areas of the market where price declines have been most apparent.

CEO of Lancashire Richard Brindle said that it is the firms opinion that non-traditional capital is here to stay, that it will ebb and flow with supply and demand, but it is here to stay. He said that Lancashire will seek to deploy a meaningful amount of capital through Kinesis at the January renewals to support Lancashire’s other products.

Alex Maloney, Chief Underwriting Officer at Lancashire Holdings, hinting at the firms desire to not simply move into a crowded market commented that as well as looking to offer non-traditional reinsurance capacity through Kinesis, it will look to offer products that other collateralized reinsurance and ILS fund managers cannot offer to their clients that want them.

During the earnings call Richard Brindle commented that with pricing so attractive in the ILS and collateralized reinsurance space Lancashire may look to leverage that for its own reinsurance protection needs. Brindle said that Lancashire is likely to be a buyer of products such as industry loss warranties (ILW’s), retrocession and catastrophe bonds rather than a seller due to the attractive pricing.

Darren Redhead, Head of Kinesis Capital Management, said that Kinesis is trying to be different and is the only third-party reinsurance capital manager raising capital for a multi-class vehicle. Most capital raises in the ILS and collateralized space have been for core property catastrophe business, so with a multi-class approach Redhead said that he expected demand for Kinesis from investors will be fine.

During the earnings call as well as the investor day presentation Redhead said that he felt that the reinsurance convergence market, of collateralized reinsurance and insurance-linked securities such as catastrophe bonds, could grow to as much as $70 billion over the next 12 to 24 months. However, he noted, if there are large losses in the market followed by a hard market then you could see as much as $100 billion in collateralized form within two years.

Commenting on the way prices have been declining in property catastrophe, Redhead said that pricing could push some alternative capital providers to seek out new lines of business which may see pressure on pricing spread more widely.

Richard Brindle added that most of the new money within reinsurance does not understand business outside of property catastrophe and currently shows no sign of doing so. He said that Lancashire is not looking to rule the world with Kinesis but does expect it to become a meaningful part of its business.

Kinesis does not aim to be just another underwriter of fully-collateralized industry loss warranties (ILW’s), instead preferring to avoid the highly competitive property catastrophe only segment of the market. It wants to use its experienced team while leveraging access to Lancashire and Cathedral expertise so it can create unique and tailored, multi-class fully-collateralized reinsurance products for clients.

Kinesis intends to be disciplined, not simply deploying capital for the sake of earning fees to manage it, rather selecting the right products and opportunities to match with its capital from third-party investors.

The core Kinesis product will be a long-term typical part of reinsurance protection, but Kinesis has the flexibility to respond to market events, upscale and to expand its products dramatically should large losses impact the market.

In terms of funding, Kinesis expects to have between $300m and $500m of capital for 2014, with some of the investment coming from Lancashire itself, around 10%. The fees Kinesis will be targeting will be similar to Lancashire’s Saltire product.

In terms of its investors, Redhead said that most are investors who are already in the reinsurance space and that Lancashire knows, with a good number having invested in its Saltire product before. With a more complicated product offering Kinesis is not for every investor in the ILS and reinsurance space.

Redhead said that the capital raise has been successful and that it feels as if they’ve been cutting back on it, as pricing opportunities do not support the amount of capital raised, which suggests that demand has been high and Lancashire feels it could have raised more if opportunities existed. Lancashire continues to raise capital for Kinesis, having extended its deadline slightly.

Kinesis will aim not to conflict with Lancashire’s core business, rather seeking to be complementary or an expansion of the core Lancashire product. It will leverage Lancashire’s experience across specialty lines of business and at the same time has undertaken considerable research and development to understand exactly what the market wants to buy, in terms of collateralized protection, as well as what investors seek returns from.

The core product offered by Kinesis will be similar to Saltire and will incorporate both aggregate elemental and non-elemental covers with an expected loss of between 8% and 10%. It will also offer mid-year energy solutions using Lancashire’s distribution and pricing models.

Kinesis will also target post-loss marine and non-marine retrocessional reinsurance business, as well as potentially providing reinsurance and retrocession of Lancashire’s book itself on a multi-line basis.

Another area of opportunity that Kinesis sees is in the provision of post-loss specific single shot covers, such as to large programs like the JIA (the Japanese Insurance Abroad reinsurance program, which Lancashire’s Accordion sidecar had participated in) and Sirocco (Lancashire’s Gulf of Mexico offshore energy sidecar), on a special draw down basis.

Kinesis will offer multi-class reinsurance solutions on a fully-collateralized basis. Covers will be created to be flexible and with the ability to adapt to its client’s risk appetite, able to fit into existing reinsurance programs or even replace entire layers.

It will focus on short to medium tail lines where the event is known, including Property Direct, Reinsurance, Aviation, Marine, Terror, D&F, Satellite, Offshore Energy, Engineering, Political Violence and War.

Average deal sizes that Kinesis will participate in are expected to be $20m to $30m, with a maximum expected line of $50m to $75m and it will target a rate-on-line of 20% to 25%.

Its aim is to add value to clients, by helping to structure more efficient solutions which in the current market climate will help to reduce costs. In this way it hopes clients will see Kinesis as a complement to existing covers and a long-term partner.

Kinesis won’t be a standardised or fixed product, rather it will try to fit around existing protections, meet clients needs and add value through putting extra effort into customising its protections.

Darren Redhead laid out a number of potential solutions that Kinesis will seek to offer on a fully-collateralized basis. These include:

• Worldwide aggregate elemental covers with non-elemental coverage around specific existing protections.
• Combining higher layers into one limit, possibly with a proportion of limit available for second or third event at a lower level.
• Frequency cover at the lower end of protections, such as four covers at 25% ROL, buy three losses excess one loss, or clash of retentions.
• Retaining a share of a whole programme and protecting it with an aggregate cover to limit exposure to the balance sheet.

These product innovations are typical of Lancashire and Darren Redhead stressed that Kinesis should be seen as an extension of the firms DNA utilising third-party capital instead of its equity backed balance sheet.

In terms of the expected contribution to the Lancashire bottom line, Elaine Whelan, CFO at Lancashire, said that Kinesis activities are expected to add 1% to RoE from fees and Lancashire’s share in the business. But that this could grow to 2% to 3%, as profit commissions from the business underwritten begins to flow through in future years. Whelan also said that the contribution could go even higher if Kinesis grew signficantly larger.

It’s interesting to note the different approach to collateralized protections that Lancashire is taking with Kinesis. Especially as having a differentiator could prove very important as the third-party capital and ILS space becomes ever more filled with reinsurers seeking to leverage external capital in new capital market focused units.

It will be interesting to see how well received the product is. Judging by the success of the Saltire product, which did very well with protection buyers, there should be demand for the multi-class approach. If Kinesis can make its products comparable in price to, or even cheaper than, products offered by traditional reinsurance players then it should be well received by those seeking coverage.

For capital markets investors, the Kinesis product will prove very attractive to certain types of capital, but perhaps not all. It may not suit large global pension funds who are looking for a lower rate of return and a lower volatility investment. But for many investors already in the ILS space, or looking to enter, an investment in Kinesis will be a very attractive proposition and could even be looked on as a diversifier within the sector.

As Lancashire moves forwards, in its mission to build a multi-balance sheet, capital source agnostic, insurance and reinsurance platform, it clearly see’s opportunities to leverage alternative capital on both sides of its book of business. It will be interesting to see whether Lancashire does begin to take on more reinsurance from alternative capital sources, potentially even looking to the catastrophe bond market if rates remain attractive.

It will also be interesting to watch the development of Kinesis and its products acceptance by the market, as well as how the Cathedral acquisition fits into the mix and what opportunities that offers to both clients and investors in accessing the returns of the insurance and reinsurance market.

Read our other article on Lancashire from earlier today: Lancashire focuses on building out multi-balance sheet platform.