No gloomy outlook at Lancashire despite softening reinsurance market

Global provider of specialty insurance and reinsurance products Lancashire Holdings is not feeling gloomy, despite the softening reinsurance market and impact of alternative capital, finding much to be positive about in its latest results announced this morning.

Lancashire saw a drop in profits in 2013, due to losses and developments in its energy portfolio, the impact of European flooding and hail events and further adverse development of the Costa Concordia marine loss. However it also pulled back on some underwriting to avoid areas of the market where it felt pricing was not commensurate with risks which also impacts profits.

Despite these impacts and the navigation of a difficult market environment Lancashire as a group saw a return on equity for the full year of 2013 of 18.9%, up on the 16.7% seen a year earlier. The firm announced another special dividend to its shareholders of $0.20 per share, showing it can still return capital even in the current market conditions.

2013 was a big year for Lancashire, with the addition of a Lloyd’s platform through the acquisition of Cathedral and a complete overhaul of its third-party capital management activities under the new brand Kinesis Capital Management.

CEO of Lancashire Richard Brindle explained; “For Lancashire, 2013 has seen the most dramatic changes in our history. We have broadened our platforms, our core portfolio lines and our reinsurance purchasing capabilities, but without compromising our business model or our focus on underwriting.”

Brindle sees no fear in a soft market, saying that it shows the difference between good and bad underwriting and that Lancashire is happy to navigate market conditions carefully, remaining profitable and waiting out the next hard market.

He continued; “There is a lot of gloom about the state of the market. But there is some truth in the old view that good underwriters prefer a soft market. In a hard market the benefits of superior risk selection and a focus on risk-adjusted return are cancelled out by the broad spread of strong pricing. In a soft market the strong underwriting franchises differentiate themselves. We can select the right clients and attachment points in a programme. We have a solid core portfolio but have the discipline to let go of under-priced, opportunistic business. And through the judicious use of reinsurance we can improve the risk-adjusted portfolio returns even when pricing is under pressure.”

The impact of alternative capital on reinsurance has perhaps been overstated, to some degree, according to Brindle, who feels that ample opportunities to write profitable business remain for Lancashire.

Brindle said; “There are also signs that the panic that affected some commentators who foresaw decimation of the traditional markets was overdone. Many of our clients understand the value of the superior policy features offered by traditional markets like reinstatements and multi-year capacity. They know that relationships are based on an understanding that claims are often a process of negotiation based on detailed policy understanding, which goes beyond the ability to model an output.”

In U.S. catastrophe reinsurance, where alternative capital has made its biggest impact on rates and competition, Brindle said that the Cathedral platform has a niche which has allowed it to continue writing profitable business with no sign of the impact being seen elsewhere in this market.

In fact, Brindle said that the impact of alternative capital on Cathedral’s U.S. mutual portfolio has been close to zero, showing that the impact of alternative capital has not been ‘one way traffic’.

Brindle said that Kinesis Capital Management has already begun to show its potential. He explained; “Kinesis, has made a good start deploying over $252 million of limit at 1 January 2014. Darren Redhead’s team has developed a bespoke product combining risk and catastrophe exposures, that offers real benefits to clients on tail risk mitigation.”

Brindle said that Lancashire does not share the gloomy outlook, which is true of many of the larger reinsurers who have a diverse platform for business. Lancashire, with the addition of Cathedral, its focus on specialty business and the revamp of its third-party capital activities under Kinesis, has a particularly diverse business, perhaps more so than similarly sized players which can help it to maintain profitability in the current market environment.

Brindle commented; “With our three platforms comprising our permanent reinsurance asset management business in Kinesis, our top-performing Lloyd’s business in Cathedral and our leading specialist insurance and reinsurance businesses in Lancashire, together with our sound business model and outstanding team, we believe that we can navigate a course through this market, and indeed the next hard market when that comes.”

Aside from one-off impacts, largely due to costs associated with the acquisition and on boarding of the Cathedral at Lloyd’s business, the fourth quarter saw Lancashire’s performance in line with expectations and with no notable loss events occurring. It will be interesting to see how Cathedral contributes to Lancashire’s coming quarters when it will be fully accounted for.

The reduction in 2013 premiums written has a lot to do with Lancashire’s pulling back from property retrocessional reinsurance business, which it felt was losing profitability during the year. It also ceased writing direct and facultative property business in the middle of 2012, so those premiums did not come through in the 2013 underwriting year.

Lancashire was also selective in the property catastrophe reinsurance business it wrote in 2013, choosing not to renew some opportunistic deals but finding other opportunities to replace them and expand in, resulting in property catastrophe premiums being largely flat year on year.

On its Accordion sidecar, which acts as a collateralized quote share reinsurance sidecar for Lancashire, the firm actually ceded less business in 2013, $47.9m in 2013 versus $64.8m in 2012. This will be partly to do with the pull back on property retro and property direct and facultative, but Lancashire may also find it can access other sources of retrocessional capacity going forwards, which are as efficient as Accordion and will further diversify its sources of risk capital.

Lancashire Capital Management, the firms third-party capital activities prior to being rebranded as Kinesis Capital Management, brought in a share of profit of associates of $0.5m for the fourth quarter of 2013 and $9.2m for 2013 reflecting its 20% equity interest in the Accordion vehicles and 16.9% interest in the Saltire vehicle.

Kinesis has now underwritten its first book of multi-class reinsurance, on behalf of Kinesis Reinsurance I Limited, incepting on or around 1 January 2014. All of these contracts are fully collateralised with combined aggregate limits of approximately $252m, 90% of which was raised from third-parties while Lancashire contributed 10% of the capital. More on the Kinesis portfolio deployment can be found here.

Lancashire continues its mission to build a multi-balance sheet, capital source agnostic, insurance and reinsurance platform, with access to multiple markets and access to both traditional and non-traditional capital. It’s going to be an interesting firm to watch as the Kinesis platform begins to contribute to its profits and the Cathedral operations at Lloyd’s bring in results as well.

Both of these new platforms provide Lancashire with diversity in an insurance and reinsurance market where that will be an important factor, the more focused players are the ones facing the biggest threats it is generally thought. As the year moves forwards, both platforms will begin to contribute meaningfully to Lancashire’s profits and earnings and, if successful, they will provide a good example of how difficult markets can be navigated effectively and the contribution that a third-party capital strategy can make.

More details can be found in the firms results statement here.