CATCo grows at mid-year, sees collateral release, lines up 2019 already

The increased size of Markel CATCo Investment Management Ltd.’s assets under management, to which it added another $700 million to meet mid-year demand for its retrocessional reinsurance products, has helped the firm to underwrite a 30% larger mid-year book at the same rates as its January portfolio was secured.

That equates to roughly a 43% increase over pricing achieved at the mid-year 2017 renewals, which further sets up investors in the listed retrocessional reinsurance fund, the CATCo Reinsurance Opportunities Fund, who are not exposed to the 2017 losses for a strong year.

Also noteworthy is the fact that Markel CATCo has already negotiated a collateral release on some of its contracts that were affected by the 2017 hurricanes and catastrophe losses, which is positive for investors exposed to those losses as it means these contracts will no longer be subject to any further loss deterioration.

Impressively, having benefitted from better pricing for its underwriting for the 2018 year Markel CATCo expects that to continue into 2019 as well, with the firm expecting to have as much as $1 billion of its 2019 book written and secured at price levels equivalent to Jan 2018 by September of this year.

Markel CATCo has published its latest half-year report for the London and Bermuda listed CATCo Reinsurance Opportunities Fund, in which it updates on performance of various share classes, the renewals and the ongoing recovery from the major losses of 2017.

Having raised a fresh $700 million from investors in order to meet the demand for its products at the mid-year renewal, as we reported a month ago here, Markel CATCo put that money to work in creating a larger portfolio as it found heightened demand for its retro products.

Chairman of the CATCo Reinsurance Opportunities Fund, James Keyes, explained, “The demand for the innovative and unique products offered by Markel CATCo Investment Management Ltd. is at its highest point since the Company’s inception.  Following a notable show of support for the products amongst reinsurance buyers, the mid-year portfolio has increased c. 30% from the 2017 mid-year portfolio, at pricing that has remained at the same rates achieved at January 2018.  This is an approximate 43% increase over 2017 prices.”

Securing the same pricing at the mid-years as it did in June is perhaps surprising, as the majority of property catastrophe reinsurance renewals saw pricing begin to slip as rate momentum faded in June and July, but the unique product offering that CATCo has is increasingly relied upon and hence this demand has helped to keep pricing firmer it seems.

In addition to securing this pricing for its investors, Markel CATCo has also significantly de-risked the book, the company said.

The 2017 losses which have resulted in a roughly -40% hit to some of the CATCo share classes were modelled as roughly a 1-in-200 year event, with respect to the 2017 portfolio.

Now, following the main 2018 renewals, the much larger 2018 portfolio has much improved contract terms, meaning that the book models a similar level of loss as a roughly 1-in-700 year event, a much more remote scenario.

In addition, the higher pricing achieved is also expected to act as a buffer to volatility as well, as the fund seeks to deliver its returns.

Keyes continued, “The 2018 portfolio pricing and risk profile is the strongest since the Company’s inception, one of the distinct benefits following a significant loss year.  As a result, the C Shareholders, who are not exposed to losses of 2017, have enjoyed a strong portfolio performance during the first half of 2018.”

In explaining the funds performance, Keyes highlights that despite the significant losses of 2017 even the listed funds Ordinary shares offer their investors a positive internal rate of return, delivering 3.6% annualised since inception thanks to dividends and return of value distributions, which are expected to continue.

For investors in the latest issuance of C Shares, which were distributed after the major losses in late 2017, the net asset value return for the first six months of 2018 has been 6.31%, not including any distributions or dividends, while the Ordinary shares register a -17.12% negative return, given the 2017 loss reserve strengthening the manager made in April.

The investment manager notes that the industry, both traditional reinsurance and ILS funds, have continued to be impacted by loss creep from the 2017 hurricanes through the first-half of 2018, and Keyes says that “significant uncertainty” is likely to persist through the rest of this year.

However, importantly Markel CATCo is following its typical practice of trying to achieve collateral release as early as possible, in order to realise its losses more fully, side pocket the affected investments and therefore protect those specific contracts from any further deterioration in the loss amounts.

Typically contracts cannot have collateral released and be placed into side pockets until the contract expires and with ceding companies able to extend their expiration while losses develop this can delay recovery and the full realisation of losses, as well as expose them to further loss creep perhaps.

Hence Markel CATCo tends to try to negotiate earlier releases or even commuting them early, as has been seen with previous losses as far back as the New Zealand earthquakes and again the manager has been actively seeking to do this again in 2018.

Keyes explained, “The Investment Manager was recently successful in negotiating a collateral release across a number of January 2017 and 2017 mid-year contracts amounting to 30% of Ordinary Share NAV. As a result, the 2017 SPI (side pocket investments) will increase by an additional 9% of Ordinary Share NAV in August 2018.

“Once all 2017 SPIs have been established in August, the estimated 2017 SPI will represent c.56% of Ordinary Share NAV. While the net effect is an increase to the 2017 SPI, the substantial releases achieved on these 2017 contracts should be viewed as overall positive news for Ordinary Shareholders.”

2018 so far has not seen any major loss events for Markel CATCo, likely with most impacts dealt with under its policy of putting aside an attritional loss reserve each month. But with the hurricane season left to run there can be no guarantees of course, but the improved contract terms and resulting lower return-period risk in the 2018 portfolio will also insulate investors against all but the larger catastrophe events, which of course is exactly what the fund is there to pay for and why investors are compensated well when loss years are benign.

“he 2018 portfolio maximum no loss net return on capital remains on target at 23%. This is a c. 43% increase over the 2017 net no loss return on capital (c. 16%), with the portfolio renewed in 2018 at appreciably lower risk levels,” Keyes said.

In fact, the 30% enlarged at the mid-year portfolio with lower risk, now promises a mean return to investors of roughly 12% net, which is almost a 70% increase over the 2017 portfolios mean return of 7% net.

Investors will be delighted to hear that Markel CATCo expects flat or very similar pricing levels and terms at the January 2019 renewals as well, having already secured written and verbal orders from buyers worth $750 million for January 2019, all of which are at the same higher pricing levels as 2018, Keyes said.

In fact, Markel CATCo expects to have roughly $1 billion of orders for the January 2019 renewals underwritten before the start of September at flat pricing, which suggests a portfolio for next year that will have roughly the same performance levels as the current one.