Lower profits at Lancashire but third-party capital contributes positively

Specialty insurance and reinsurance company Lancashire Holdings Limited reported lower first-quarter profits this morning, but premiums written were up significantly and the firm also reported a positive contribution from its third-party capital management activities.

Lancashire has been undergoing some fundamental structural changes in the last year, with the purchase of Lloyd’s business Cathedral, the launch of its new third-party reinsurance capital unit Kinesis Capital Management and the recent retirement of founding CEO Richard Brindle.

On top of all this organisational change the firm has had to grapple with the increasingly challenging reinsurance marketplace, which has caused it to pull back from some property catastrophe business and to expand in its core specialty areas.

For the first quarter Lancashire reported a net profit of $57.4m, down from $78.9m a year earlier. At the same time the firm reports gross premiums written of $316.7m, significantly up on the $214.9m written in Q1 of 2013. The growth in premiums should stand the firm in good stead as earnings are realised from this business over coming months as long as losses remain low. The increase in premiums is largely the result of the embedding of the Cathedral business within Lancashire’s results and it will be interesting to watch how this contributes in quarters to come.

Despite the lower than perhaps forecast profit Lancashire Holdings expects to return additional significant capital to its shareholders over the course of this year.

New CEO of Lancashire, Alex Maloney, commented on the results; “The first quarter has been a busy one on many fronts.  There has been the successful launch of the initial Kinesis product, the development and Lloyd’s approval of the business plan for the expansion of Cathedral’s Syndicate 3010 and the realignment of the Lancashire Companies’ catastrophe exposures into the property catastrophe excess of loss line. Thanks to our strong value-added proposition with our brokers and clients as a leader for much of our business, we have been able to protect the core business lines at Lancashire Companies and Cathedral from the weakening rate environment. We have maintained our position and in spite of the pressure on signings, we continue to see strong submission levels for both new and renewal business. For our finance and actuarial teams it has also been busy as the Lancashire Companies and Cathedral work together to harmonise reporting and align practice across the Group.  Operations and IT have also been working hard during the transition, particularly with preparations for the move to a new building, which will bring all the London operations of the Group under one roof later in the year.

This is my first opportunity to report to you as the CEO of the business after over eight years in underwriting roles for Lancashire.  It is a tribute to Richard that my transition into this role has been so smooth.  The DNA of Lancashire – the commitment to underwriting as the core of our profitability and the commitment to capital management as the core of our discipline – is deeply embedded across the whole group and will not change.  We are thankful to Richard for all that he has done to build a strong management team across the Group.  I am therefore confident that we are well placed for the next chapters in the Lancashire story, and that we can continue to serve our clients, brokers and shareholders as we have since our inception.”

Group CFO Elaine Whelan discussed the firms financial performance in Q1; “While we experienced some adverse development on the 2013 accident year due to a late reported energy claim, there were no major losses in the first quarter and the Group produced a RoE of 3.9% with a combined ratio of 66.4%. RoE for the Lancashire Companies was 3.5%, with Cathedral adding 0.5% and acquisition adjustments now only detracting by 0.1%.”

If market conditions remain as they are currently, Lancashire expects to returns more capital to shareholders as it continues its strategy of turning down business which does not meet its risk appetite and risk management controls.

Whelan explained; “Our January and April renewals went well and were in line with expectations. We will continue to monitor market developments over the rest of the year but, with no indication of any change in trading conditions, it is likely that we will return a substantial portion of our earnings later in the year. Should conditions change we will clearly put any excess capital to work. While we do not currently anticipate any need to raise additional capital we are ready to do so if the circumstances merit.”

Lancashire’s pull-back from the retrocessional reinsurance business, which it feels to be largely underpriced, led to a decrease in its property catastrophe premiums of around 11%. The firm continued to expand its catastrophe excess of loss book, but this was not sufficient to offset the decline in retro underwritten.

Lancashire’s results statement explained; “With reinsurance pricing in general under pressure, as property retrocession rates, terms and conditions continued to worsen rapidly, we redeployed capital to property catastrophe excess of loss, adding some new business and restructuring some existing programmes for core clients, including writing some business on a multi-year basis. Other property classes saw relatively consistent premium volumes compared to the same period of 2013.”

Lancashire took advantage of retrocessional reinsurance rates to purchase some new non-marine retrocession aggregate cover and also to restructure its marine, energy and terror programmes with increased limits ceded. The Cathedral unit also purchased some additional reinsurance protection at reduced cost.

During the first quarter Lancashire’s third-party capital activities made a positive contribution.

Profit commission of $6.7m was received following Lancashire’s commutation of its quota share agreement with the Accordion retro vehicle which is no longer in operation and is now in run-off. Lancashire’s Saltire facility, which is similar to the new Kinesis product offering but in a more typical sidecar format, ran loss free in 2013 and Lancashire received $3m of profit commission in the first quarter of 2014. Saltire is in its final year of operation and will also be run-down, leaving Kinesis as Lancashire’s core third-party reinsurance capital offering.

For the new Kinesis Capital Management unit, an underwriting fee of $0.6m was earned by Kinesis Capital Management for providing its underwriting services to the Kinesis special purpose reinsurance vehicle. A $1.6m share of profit of associates earned for Q1 2014 is due to Lancashire’s 10% equity interest in Kinesis and its remaining 20% equity interest in the Accordion vehicle, following the commutation. This is down slightly on the share of profit of associates in Q1 2013, which was $2.9m for the first quarter of 2013 and related to the Accordion and Saltire vehicles, however Lancashire’s share of its third-party activities is now lower than in previous years with more of a share given over to its third-party investors.

The contribution made to Lancashire’s bottom-line by Kinesis will be expected to increase over the rest of the year and it could be a particularly attractive contribution if Kinesis remains largely loss free.

Lancashire’s results reflect a business which has been through a number of significant changes. The profit level remains attractive and the business looks to have the potential to whether the evolving reinsurance market due to its focus on specialty business and ability to adapt to market conditions.