Karson launches KT-Notes, an alternative reinsurance & ILS collateral

by Artemis on November 17, 2017

Karson, a global provider of liquidity, capital and collateral solutions to the insurance industry, is anticipating strong demand for its newly launched KT-Notes, which are designed to address the collateral needs and obligations of reinsurers and insurance-linked securities (ILS) investors.

Karson is led by a veteran of the insurance-linked security (ILS) and alternative risk financing space, Derrell Hendrix, banker of the 1994 Kover Limited transaction, Hannover Re’s first dip into the capital markets.

Artemis wrote at the start of 2016 that Karson, alongside BNY Mellon, had successfully completed its first K-Note reinsurance collateral financing transaction in Canada and, since December 2009 the firm has completed 17 transactions amounting to $8.34 billion.

Karson has now announced that it will launch its new KT-Notes, designed to help both reinsurers and investors meet ongoing collateral obligations, while overcoming some of the issues with traditional collateral and investment alternatives, such as collateralized reinsurance arrangements, letters of credit (LOC), and reinsurance trusts.

One of the ways KT-Notes differ from Karson’s original product, K-Notes, is that they are backed only by short-term U.S. Government issues, whereas K-Notes were backed by a broader asset portfolio. The reason for the change is to meet demand for an investment security of very high quality, and one that is more liquid than the original K-Notes, for use as collateral.

“We believe that KT-Notes offer one of the most effective, secure and efficient solutions to insurers’ collateral needs in an environment where reinsurers may need to post significant amounts of collateral on short notice when traditional providers are increasingly capital-or liquidity-constrained. Regulators are also placing tighter restrictions on the quality of collateral they are prepared to accept in the interest of protecting policyholders, taxpayers and markets (e.g., Lloyd’s of London).

“Karson believes that KT-Notes, which are redeemable securities backed by a short-term managed portfolio of US government or US government-backed obligations, offer the market a unique high-quality, liquid asset that was designed to satisfy regulators and cedants, while paying an attractive return to buyers,” said Hendrix.

The supply and demand for collateral is creating challenges in the current insurance and reinsurance landscape, and Karson hopes to mitigate or even eliminate these issues with the launch of and subsequent adoption of its KT-Notes.

Karson explained that first and foremost, the new KT-notes are a “high-quality liquid investment where fund managers and reinsurers can invest cash in a US dollar security that is both redeemable and transferable,” which also offers the potential to earn a greater yield than generally available.

“Karson’s approach allows market participants to either purchase KT-Notes for cash or, alternatively, to post a wide range of “non-eligible” assets with Karson in exchange for delivery of a KT-Note. This allows our clients to maintain a more flexible and dynamic investment strategy while posting eligible or qualifying collateral in the form of KT-Notes.

“This should be a real performance driver for parties needing to put up collateral, both from an investment and cost perspective, and especially for global reinsurance companies who are feeling the pinch of losses and competition,” continued Hendrix.

Karson’s new and innovative KT-Notes are backed by securities issued or guaranteed by either the U.S. Government of U.S. Government agencies, which Karson says makes them a suitable security for ILS funds and collateralized reinsurance investors.

The KT-Notes are issued to investors via a Karson special purpose company, with the proceeds managed by a portfolio advisor. The portfolio management security arrangements will enable the KT-Notes to pay a periodic net pass-through variable coupon and their full-face amount of principal at maturity, while avoiding counterparty risk in relation to Karson, BNY Mellon and the portfolio advisor.

“Also, as admitted assets, they can also be delivered directly to cedants as eligible funds-withheld assets under standard reinsurance treaty terms and conditions to avoid the costs associated with reinsurance trusts, making them an ideal alternative for collateralized LOCs,” explained Karson.

Karson stated that KT-Notes are expected to be listed on the Irish Stock Exchange in Dublin, and rated by a nationally recognized statistical rating organization, e.g., Moody’s or DBRS, in line with its rating for US government issued or guaranteed securities

According to Karson, advantages of KT-Notes over other alternative collateral products include lower fees, higher returns on invested funds, the ability to select a fund manager from a panel, increased transparency, the elimination of bank risks, no investment manager risk, simple to redeem, they’re portable, and they are accepted for reserve credit purposes and as admitted assets in the U.S.

Martin Davies, of London-based intermediary, AHJ Capital Markets, also commented; “We are actively promoting Karson’s KT-Note structure to clients as a solution to a range of liquidity and collateral issues. They can help insurers avoid liquidating assets and are an innovative alternative to other forms of collateral.”

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