Buffer loss provision reduces collateral available for 1/1: Blue Capital

Reinsurance and insurance-linked securities (ILS) investment manager Blue Capital Management has warned investors in two of its vehicles that a portion of the collateral assets will not be available for deployment at the January 2018 renewals, as a result of contractual buffer loss provisions.

It’s an issue facing numerous of the ILS market’s fund managers and also other collateralized reinsurance vehicles, where funds and investment vehicles are structured on a rolling basis.

ILS investment managers have to reserve for potential losses, at rates stipulated by the factoring in their buffer loss tables. These stipulate that collateral must be held at a certain amount above loss estimates, to allow for the final bill to creep and as a result the collateral can be locked up or trapped for a number of months following loss events.

After a period of such heightened losses through the third-quarter of 2017, ILS fund managers face going into the January renewals with less capacity at their disposal, as a portion of their collateral is trapped and awaiting confirmed loss estimates, before it pays out to cedents, or can be released and put back to work.

Blue Capital Management said that it estimates that approximately 15.6% of the net asset value of its London stock exchange listed ILS fund the Blue Capital Alternative Income Fund (formerly known as the Blue Capital Global Reinsurance Fund)  could be locked up for the January renewal.

The manager also said that as much as 14% of the projected shareholders’ equity of its New York stock exchange listed Blue Capital Reinsurance Holdings Ltd. vehicle could also be trapped and unavailable for deployment at 1/1 2018.

The manager explains that the capital it puts to work in underwriting and collateralising reinsurance contracts is not available to its vehicles for any other purpose until those contracts expire, or if a covered loss occurs then until that loss position is fully resolved.

“As a result of the significant losses incurred from the catastrophe events of the third quarter, in line with the contractual requirements for buffer loss provisions in the treaties that the Company enters into, collateral that we would typically expect to be available at the key 2018 renewal dates will not be available for deployment,” the manage explained in a filing related to its NYSE Blue Capital Re vehicle.

The same issue applies to the London listed ILS fund as well, with the manager saying, “In addition to estimated losses that have already reduced NAV, estimated contractual buffer loss provisions are expected to lock up approximately 15.6 of current NAV at January 1, 2018 renewals.”

In the case of both of its ILS investment vehicles, Blue Capital Management explained that the trapped collateral is “projected to be released systematically through the course of 2018 and 2019.”

There will be ILS funds with greater percentages of their assets trapped for the January reinsurance renewal and this could result in some decline in ILS capacity deployed at 1/1 by some managers.

This is how the ILS and fully-collateralized product works and ensures that cedents can receive coverage payments for claims that can take time to develop.

However, overall with new capital flowing in and many ILS managers raising new mandates, the total volume of capital available for deployment could well increase.

Blue Capital Management has more ILS assets under management than just these two listed vehicles, with its open-ended ILS and reinsurance funds, funds of one and private sidecar offerings all adding to the total amount of third-party capital it has at its disposal for underwriting.

At the January renewals, it’s likely the manager will increase its assets in areas outside of the listed ILS funds, so its overall portfolio of risk could be maintained.

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