Kinesis third-party profit commission & fees add to Lancashire RoE

by Artemis on February 18, 2016

The increasing contribution made from third-party reinsurance capital management activities at Kinesis Capital Management has helped to boost the full-year 2015 return on equity (RoE) at specialist re/insurer Lancashire Holdings.

It’s the first time Lancashire has disclosed the contribution to its full-year return from activities at Kinesis and while the smallest of the group’s segments the contribution is significant when you consider that it will scale over time.

“All of our platforms contributed as expected to our warrant adjusted RoE of 13.5% for the year, with Cathedral contributing 3.4%, Kinesis 0.8% and the traditional Lancashire platform 9.3%,” CFO Elaine Whelan explained in Lancashire’s results statement this morning.

For the fourth-quarter Lancashire reported benefiting from underwriting fees of $1.5m from Kinesis, with profit commission of $0.1m for the quarter as well. For the full-year 2015 the underwriting fees earned, from underwriting services provided to Kinesis and its investors, reached $5.6m, while the profit commissions reached $7.3m.

It’s the first full-year of profit commissions earned by Lancashire from its third-party capital activities in Kinesis, and this additional income helped to offset a decline in profit commissions from Lancashire’s Lloyd’s managing agency business.

The results also show up a potential loss for Kinesis in the fourth quarter of 2015, with evidence of reserving apparent, likely due to some of the major loss events that occurred in the quarter such as Tianjin or any natural catastrophes that occurred.

Lancashire reported that in Q4 2015 it shared a $0.2m loss of associates, compared to a $1.6m profit in Q4 2014. That reduced the share of profits of associates for the full year down to $4.1m, from $5.9m a year earlier.

The share of profits of associates reflects Lancashire’s 10% interest in Kinesis. We suspect that the loss in Q4 will be due to reserves put in place for losses yet to fully crystalise, which would suggest that some of this could flow back to Lancashire in quarters to come.

Overall Lancashire continued to control its underwriting appetite during the final quarter of the year, while still returning a very healthy full-year RoE to its shareholders. Lancashire’s strategy of returning capital when it cannot be profitably used for underwriting, while maintaining its position as a key market and partner ready for any opportunities, seems to be working.

CEO Alex Maloney explained the results and Lancashire’s approach; “Within the context of one of the most difficult trading environments during the last twenty years, I am pleased to be able to announce what is an excellent set of results. The return on equity is 3.5% for the fourth quarter and 13.5% for the full year, on a warrant adjusted basis. As a business, we pride ourselves on our underwriting expertise and our ability to react nimbly to the challenges of the market so as to moderate our risk appetite and adjust our capital base to provide a good risk-adjusted return to our shareholders. The last year has witnessed a dramatic fall in the oil price, which severely shocked the whole energy sector, as well as volatility in the investment markets. Neither of these aspects of the world economy seems likely to stabilise in the near future. Furthermore, the over-accumulation of capital has continued to generate downwards pressure on the pricing of insurance and reinsurance risk over an extended period. Against this background, our industry witnessed a wave of mergers and acquisitions which we view as an attempt by some of the larger and more complex businesses in our sector to rationalise back office costs and achieve capital efficiencies.

“Lancashire is not immune to the pressures faced by the market, but our strategic approach is distinctive  because, rather than seeking top line premium growth, our focus continues to be on remaining relevant to our clients and brokers. In my view, this is the key to trading through the underwriting cycle. Our underwriters have worked hard to maintain and defend our excellent core book of business. In certain lines, such as the energy book, this means sharing to a degree our clients’ pain and settling for an acceptable lower return on less risk. In other lines, such as our property catastrophe and terror books, we have continued to produce decent returns, partly due to low loss ratios – a product of yet another year of few major catastrophe losses within the most well developed insurance markets.

“We have been particularly active this year in managing our overall risk levels through the purchase of well-priced reinsurance.  Our excellent combined ratio of 72.1% for the full year is testament to the discipline and hard work carried out in this very challenging market to moderate our overall risk exposures. We do not consider top line premium growth to be a prudent objective for its own sake and we have endeavoured to avoid involvement in both broker underwriting facilities and the rapid growth in certain untried and untested lines of coverage. These are dangerous distractions. Our priority has been, and will remain to be, sticking to our stated strategy.

“Part of that strategy is keeping our headcount small and nimble. That means everyone does their bit. I would therefore like to thank all our people, whether they are working for our Cathedral Lloyd’s platform, our Lancashire London and Bermuda operations or our Kinesis third party reinsurance capital manager. This strong set of results is a tribute to their hard work and the exceptional expertise within our Group.”

This approach, while differing from many other players, does seem to be enabling Lancashire to navigate the softened market effectively, while still maintaining attractive returns for shareholders.

As third-party reinsurance capital management at Kinesis continues to ramp up, the contribution made to the RoE will likely grow, becoming an increasingly important piece of the Lancashire group’s prospects and positioning the re/insurer well for any uptick in rates or opportunities to raise and deploy more third-party capital.

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