Blue Capital proposes ILS fund changes due to reinsurance market

A number of changes have been proposed by the investment manager of the London and Bermuda stock exchange listed reinsurance and insurance linked securities (ILS) investment fund, the Blue Capital Global Reinsurance Fund, due to reinsurance market conditions.

The fund’s investment manager, Blue Capital Management Ltd., a subsidiary of Bermudian insurance and reinsurance firm Endurance, has proposed changes to the investment policy, the target return and also the performance fee structure, as it expects that the available reinsurance market returns are likely to remain depressed for the foreseeable future.

The Board of Blue Capital Global Reinsurance Fund Limited, following discussions with the investment manager, said in an announcement that it believes it is “In the best interests of the Company and the Shareholders as a whole to revise the Company’s (and the Master Fund’s) investment policy in advance of the January 2016 reinsurance cycle.”

Taking into account its view of the future prospects for the global property catastrophe reinsurance market, the proposals, as well as amending the investment policy, include reducing the ILS fund’s return target and amending the performance fee paid to the investment manager by the Master Fund.

Blue Capital appears to be seeking to get on the front-foot, to enact changes that will enable the fund to continue to meet return targets and also better navigate the softened reinsurance market, while also helping parent Endurance to leverage the access to third-party capital both to source risk for the fund and as source of efficient retrocession.

The key changes proposed to the investment policy are:

• the formal adoption of investment guidelines and restrictions relating to the classes of reinsurance (e.g. indemnity reinsurance, indemnity retrocession, quota share, etc.) in which the Master Fund may invest.;
• the adjustment to certain maximum net aggregate exposure and net probable maximum loss limits, enabling the Master Fund to have more flexibility to pursue exposure to particular zones (being specific occurrences of specific perils in specific geographical regions) ; and
• the removal of the prohibition on the Master Fund from investing directly in contracts or securities with a premium of less than 5 per cent. of the limit exposed to a single event.

The revised investment policy is designed to give the investment manager more flexibility in strategy, enabling the fund as a whole to generate better returns in the softened reinsurance market. The manager will be able to target larger quota share agreements than before which it says will provide enhanced underwriting leverage and distribution.

The new policy will also enable the manager to better diversify the portfolio and its product offering, providing a way to differentiate itself from competitors.

With the new investment policy the Blue Capital Global Reinsurance Fund will be able to make better use of the relationship with its parent, Endurance. The ability to enter into larger quota shares would enable Endurance to retrocede more risk to the fund, which could enhance its access to risk.

Another change to the investment policy would allow the fund to allocate up to 10% to “non-property catastrophe risks”, so enabling it to diversify into other lines where Endurance is strong, such as weather risks, agriculture and specialty lines, if the manager saw attractive opportunities.

The maximum net aggregate exposure to a single region is being raised from 35% to 50%, which will allow greater concentration to be achieved again allowing the fund to access the best returns. At the same time the net probable maximum loss limit from a single catastrophe event is being raised slightly from 25% to 35%, again enabling greater concentration of investments in peak zones.

These changes will allow Blue Capital to better navigate the challenging reinsurance market conditions, avoid the worst priced business, access more of the better priced risks and also to better utilise the relationship with parent reinsurer Endurance.

The fund’s target return is being adjusted to “better reflect the expected long-term market conditions.” The change would see the target return reduced from LIBOR plus 10% per annum to LIBOR plus 8% per annum, over the longer term. The distribution remains unchanged however, remaining at an annualised dividend yield of LIBOR plus 6% per annum on the original issue price of Ordinary Shares.

A performance fee trigger is proposed to be lowered from LIBOR plus 10% to LIBOR plus 8%, so that annual performance would need to hit the new lower target return before any performance fee is paid. Also the performance hurdle is being raised from LIBOR plus 3% to LIBOR plus 5%, so that in order for performance fees to be paid a higher threshold would need to be reached as well.

Overall these changes signal Endurance looking to the future for this Blue Capital fund, both in terms of ensuring its attractiveness and performance for investors, as well as ensuring it can make best use of the access to third-party capital it provides.

Shareholders will be invited to vote to approve or otherwise the proposals at a meeting later on 21st December 2015.