XL upsizes alternative capital use to $3bn, to support front-end growth

XL Group, the parent to the XL Catlin insurance and reinsurance brand, has considerably increased the amount of alternative capital it uses at the renewals in order to reduce its catastrophe exposures and optimise its book, by making the most of efficient capacity.

XL now leverages a huge $3 billion of alternative reinsurance capital, from investors in its catastrophe bond issues, from collateralized players and ILS funds, as well as through its own ILS fund management venture New Ocean Capital Management.

In the fourth-quarter of 2017 and at the January 2018 renewals, XL took advantage of the appetite of ILS investors to increase its catastrophe protection, adding $500 million of coverage to its major catastrophe program, a significant chunk of which was from alternative capital.

CEO of XL Mike McGavick explained the rationale that led to this increased use of the capital markets during XL’s recent earnings call, saying, “It is clear that meaningfully reducing our volatility in the cat space, while maintaining and monetising in new ways the market position and high-quality customer base we’ve built over many years, is the right thing to do.

“We have been doing this through our ceded programs, in both traditional reinsurance and even more so with our long-standing alternative capital partners. You’ll see from our actions in the fourth quarter and at 1/1 that we’ve made good strides and we’re not done.”

McGavick suggests that the alternative capital market will see more XL risk over the course of 2018 as well then, which would not be unexpected given further cat bond issues are likely.

Explaining what makes this attractive right now, McGavick said, “To be blunt, the more efficient cost of capital has allowed us to do so on quite attractive terms.”

That is key, as XL has moved forwards with its strategy of leveraging the most efficient reinsurance capital on the back-end, to support expansion on the front-end insurance and reinsurance business.

That’s exactly the strategy that we’ve been urging traditional companies to adopt, using the capital markets to reduce exposure, optimise the book and to support overall growth of the portfolios underwritten, thus maximising profits using the most efficient capital.

McGavick highlighted this, “We have seen the reaction in reinsurance to be less favorable to the total equation for us than the reaction on the primary side. So we’re excited to drive more of our opportunity for earnings into what’s going on in the primary side and to share more of the risk on our reinsurance side, particularly in the cat affected lines that could be both insurance and reinsurance, with alternative capital.

“We see that as a furthering of the strategy we’ve been adopting for a long time and a particular set of pricing and opportunity conditions that allowed us to accelerate that strategy.”

XL has clearly found the state of the market has pushed it towards this strategy, earning more through the practice of hedging more, with efficient capital sources.

It’s perhaps a type of arbitrage, that XL finds it can hold onto more of the risk premium of the business it underwrites by using efficient capital on its ceded reinsurance side. But it’s also a reflection of the differing appetites for return that different types of capital have, which is now allowing XL to maximise the return on its own intellectual capital.

Using alternative capital on the back-end of the business enables XL to extract as much profit from the original outlay of intellectual capital, the analysis, underwriting, structuring and pricing of risk, as it can.

XL Group has been building towards this, creating a diversified global platform with access to a diverse range of capital providers, both traditional and alternative. The longterm goal has always been to figure out the most effective way to make the most of efficient capital, but market forces have allowed it to embrace this in a bigger way, much more quickly than it had anticipated.

“With the events last year, we felt that there was a lot to learn from them and we also felt that the market that would emerge would be absolutely crucial to how we would go forward, and would be able to illustrate the value of the diversified platform we’ve been building and our long-standing comfort with alternative capital developments,” McGavick said.

Continuing, “As it happened, the market that emerged was the one that we feel really matched to both that desire to accelerate, the use alternative capital, and let the results from our increased participation on insurance and specialty, on the primary insurance and specialty lines, really shine through. It seems to me that’s exactly the year that’s come into being.”

XL feels that the stars have aligned in insurance and reinsurance, allowing it to maximise on its use of alternative capital for reinsurance and retrocession, to support growth on the front-end of its business.

Finding a balance that works, to extract maximum profits out of the underwriting side of the business, while making maximum use of available efficient hedging capacity, is key and XL clearly feels the market has now reached a tipping point that has allowed it to achieve this.

It’s exactly what the company should be doing at this time, we’ve seen these strategies gathering pace in recent years. But McGavick’s comments suggest we’re going to see an acceleration of the adoption of alternative capital strategies over the course of 2018 and beyond.

That bodes well for ILS funds and investors, as well as for those traditional companies brave (or innovative) enough to make ILS and alternative capital providers a key partner within their business models.