Kinesis losses reflected in Lancashire results, but opportunity ahead

by Artemis on November 2, 2017

Specialty insurance and reinsurance group Lancashire Holdings Limited reported its results this morning and as anticipated losses suffered from recent catastrophe events by its third-party reinsurance capital unit Kinesis Capital Management are reflected in the numbers.

Kinesis underwrites a unique multi-class product in the insurance-linked securities (ILS) and collateralised reinsurance or retro market, which include property catastrophe exposures and so Kinesis’ positions were expected to be impacted by hurricanes Harvye, Irma and Maria, as well perhaps as by the Mexico earthquakes.

For the third-quarter Lancashire has reported an overall net operating loss of $139.4 million, after $165 million of losses from the above named catastrophe events.

The company reported that its third-party capital management activities, including Kinesis, also suffered a loss in the quarter, with the firms 10% equity interest stake in the Kinesis collateralised reinsurance strategy driving a $13.1 million share of losses to Lancashire.

That suggests that Kinesis’ overall losses may be somewhere around $131 million, given the $13.1 million loss is based on Lancashire’s 10% equity stake, although it’s impossible to be precise as the vehicles results are not reported or broken out.

Losses of this magnitude were to be expected following the major catastrophe events and Lancashire will be actively positioning itself to take advantage of higher rates, while Kinesis’ unique product could find significant demand and so provide the opportunity to increase the amount of assets under management there.

During the third-quarter Kinesis provided underwriting fees of $2.2 million and profit commission of $500k to Lancashire, helping to reduce the overall third-party capital loss for the firm down to -$10 million after a small contribution from its Lloyd’s of London fees and profit commission as well. Some of the Kinesis profit commission is due to the timing of collateral release from losses in the 2015 underwriting cycle, something we should perhaps get used to seeing in the future after recent events as well.

Now is the time that the Kinesis offering could come into its own, as buyers of its products are all major reinsurers that appreciate the multi-class retrocessional protection Kinesis offers.

With its client base having suffered high levels of losses in recent weeks, the January renewals could see Kinesis finding pockets of increased demand for its collateralised reinsurance and retro product, hence it’s safe to assume that investors will be looking to increase allocations to the vehicle if opportunities allow.

Commenting on the quarterly results and loss, CEO of Lancashire Alex Maloney said, “Lancashire expects to pay losses, and this is reflected in our results for the third quarter and the year to date.”

Maloney said that Lancashire’s losses fell within its range of expectation, highlighting the firms disciplined approach to underwriting and risk management across the cycle.

But looking ahead Maloney sees opportunity, which will benefit Kinesis too, “After many years of soft pricing conditions we are at last seeing some evidence of an increase in pricing, particularly in catastrophe exposed lines. The first major test of the market dynamics will be the year-end insurance and reinsurance renewal round. Many product lines will be loss-affected and I would expect to see a return across the sector to more disciplined underwriting standards and pricing which reflects the true risks and exposures.

“Whilst there can be no guarantee of a market improvement, I believe that we are now entering a period where market dynamics dictate that there should be a meaningful adjustment to the pricing of the products we sell.”

In the past, Lancashire has returned excess capital to its shareholders. But after recent events the re/insurer is holding the capital as it sees opportunities to put it to work at better return.

“I am confident that the likely change in underwriting conditions affords us an opportunity to deploy the capital which we hold more advantageously, both to service the needs of our clients and their brokers and to continue creating long term value for our shareholders. Lancashire’s strategy remains to maximise risk-adjusted returns across the insurance cycle,” Maloney explained.

Elaine Whelan, CFO, also said, “While we have incurred a loss in the quarter and for the year to date, we anticipate an improvement in rates following these events. Our outlook for 2018 is more positive than it has been for some time. We therefore do not intend to declare a special dividend this year; we expect to put all of our capital to work to take advantage of improving market conditions.”

The fact Lancashire feels it can deploy excess capital more profitably in the wake of recent events suggests that Kinesis will be able to do the same.

The Kinesis multi-class product is, as we said, unique and does not conflict with the underwriting Lancashire its parent does. Hence if Lancashire sees opportunities to deploy more capital it is likely that Kinesis does too and we expect that the managers of the vehicle will be positioning to deploy more in January if they can, taking advantage of improved market conditions for their investors.

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