Universal cuts quota-share with Nephila’s help, explores cat bonds

Florida based primary insurer Universal Insurance Holdings has disclosed in its earnings that its reinsurance programme quota share has been reduced to zero with the help of an agreement it has in place with ILS manager Nephila Capital.

Nephila Capital, the largest investment manager focused on natural catastrophe reinsurance, weather risks and insurance-linked securities (ILS), has increasingly found new ways to access and secure participation in major property catastrophe reinsurance programmes while creating strong relationships with cedents, with the Universal case being an interesting example.

Universal has been actively restructuring its reinsurance programme for a while now, considering new options such as catastrophe bonds and tapping fully-collateralized sources of reinsurance capacity through provides such as ILS manager Nephila Capital.

The insurers relationship with Nephila has deepened, with CEO Sean P. Downes calling the ILS manager “a significant partner of ours.”

Back in December 2014, Nephila Capital entered into an agreement with Universal, which saw the Florida primary sell 1 million shares in its common stock at a price of $19.00 per share, in a privately negotiated transaction with Ananke Catastrophe Investments Ltd., an affiliate of Nephila Capital Ltd.

Universal said at the time that the transaction would benefit it threefold, boosting its book value per share, reducing its reinsurance costs specifically the use of quota-share reinsurance, and assisting the insurers goal of expanding geographically outside Florida.

“This investment by Nephila, the premier investment manager within the global property reinsurance space, underscores the strength of our longstanding partnership and their confidence in Universal,” said Sean P. Downes, the Company’s Chairman, President and Chief Executive Officer at the time.

In the insurers results which were released late yesterday Universal revealed that the goal of eliminating its quota share reinsurance had been achieved.

Downes explained;

“Our decision in 2014 to reduce our quota share reinsurance allowed us to retain a greater portion of our business and increase profitability. We enter 2015 with a clear opportunity to build on this operational momentum. The proceeds from our recent transaction with Nephila Capital coupled with our healthy balance sheet position us to lower our quota share percentage to zero. This change will enable us to retain 100% of our business, an estimated additional $230 million of our own organically grown premium, and further drive profitability and shareholder value.”

The transaction is listed in Universal’s 10k filing as ‘Contingently Redeemable Common Stock.’ The original agreement stated that Ananke, Nephila Capital’s investment vehicle that was used for the transaction, would have to hold the 1 million shares for a minimum of six months, after which restrictions on the shares sales were in place.

The original transaction, entered into on the 2nd December, also featured an interesting redemption feature based on the triggering of a catastrophe swap, or industry loss warranty (ILW) type arrangement between Universal and Nephila. The filing states:

UIH purchases insurance coverage through a covered loss index swap transaction which protects its own assets against diminution in value due to certain catastrophe events impacting UPCIC.  In the event any covered loss index swap in place is triggered for payment, UIH shall, at the option of Ananke, repurchase all or any part of the common stock then owned by Ananke at a price of $19.00 per share.  The proceeds from the covered loss index swap would be used to fund the repurchase.  Circumstances under which the covered loss index swap would be triggered are considered by the Company to be remote.  The Company must exhaust a specific layer within UPCIC’s Florida catastrophe reinsurance coverage before triggering payment on the covered loss index swap. The specific layer that triggers payment has a remote probability of occurrence according to the leading insurance industry catastrophe models licensed by the Company that simulate expected loss outcomes on UPCIC’s portfolio of risks.  Subsequent adjustments to the carrying amount will not be made since the contingently redeemable common stock is not currently redeemable and it is not probable it will become redeemable in the future.  The capital resulting from this transaction is not restricted.

However, the redemption feature described was eliminated in its entirety from the agreement on the 19th February 2015, because “both parties agreed that, given the remote possibility of the redemption to occur, the value of the redemption feature was de-minimis.” As a result of which the classification of the shares were changed to permanent equity.

As part of the original agreement signed on the 2nd December, when the shares were sold, Universal revealed that it entered into an agreement with Ananke calling for a “minimum annual spend of $5 million towards covered loss index swaps during the period from June 1, 2016 through May 31, 2025.”

It’s not clear whether that agreement remains in place or not, after the redemption feature was eliminated.

Jon Springer, COO of Universal Insurance Holdings, explained a little more about the arrangement with Nephila Capital during the firms earnings call yesterday.

The capital generated from this transaction, along with strong retained earnings from 2014, puts the company in its strongest capital position in its history.

From a quota share reinsurance perspective this enhanced capital position will afford us the opportunity, as Sean mentioned previously, to retain 100% of our own business effective Jan 1st 2015 to further drive profitability.

One minor point of clarification related to the Nephila transaction. The originally signed agreement, in early December, contained a provision whereby Universal would repurchase the original shares from Nephila, at Nephila’s option at $19 per share, if any catastrophic event occurred that triggered a recovery by Universal Insurance Holdings from its $80m covered loss index swap.

This provision was subsequently removed from the agreement. However, from an accounting perspective this provision was technically in place as of December 31st 2014. So therefore the equity was required to be temporarily classified as mezzanine equity. The equity is now permanent equity and as of February 19th increases our shareholders equity by a full $19m.

So Universal benefits from this $80m industry loss index swap (ILW?) arrangement with Nephila still, it would seem, but it just isn’t part of the redemption arrangement anymore.

Nephila Capital plays an important role in Universal’s future now, as a major provider of reinsurance capital to the firm. Universal names Nephila as among the largest private participants in its reinsurance programme, alongside Odyssey Re, Everest Re, Renaissance Re, ACE Tempest Re and Lloyd’s of London syndicates.

The arrangement for Nephila Capital is a way to build strong relationships with cedents and partners, deepening the use of its risk capital for expansive primary property insurers is a smart way to secure future business and to become more ‘relevant’ to them.

Relevance is not just important to traditional reinsurers, it is important to ILS players too, and Nephila through transactions like this and its work with State National shows that it is keen to become an increasingly important provider of reinsurance and risk capital to cedents it feels it can grow alongside.

Universal is clearly attracted to fully-collateralized reinsurance capacity as well, liking the use of catastrophe index swaps or ILW’s as well it would seem. The insurer has an ambition to leverage alternative capital and ILS where it makes sense and continues to explore a potential catastrophe bond as a component of its future renewal.

COO Springer explained; “With respect to our plans for the upcoming reinsurance renewals we continue to explore ways to maximise our efficiency in the catastrophe coverage space, through both enhancements to traditional products and the possibility of alternative mechanisms like a catastrophe bond.”

Universal previously said that it was looking at catastrophe bond options, or other alternative capital mechanisms, for its June 2015 reinsurance renewal, so if its investigations prove fruitful and pricing is attractive the insurer could come to market at some point during Q2 of this year.

As ILS and alternative capital plays a growing role in reinsurance and the appetite to participate in the reinsurance programmes of insurers like Universal increases as well, these large catastrophe exposed primary property insurers are likely to place increasing business with the capital markets.

Universal clearly sees an opportunity to use the innovative approach of the ILS market to leverage risk capital across its business, as evidenced by the way it is working alongside Nephila. We’d expect insurers like Universal to grow their use of ILS and alternative capital in the future, as the efficiency and lower-cost of capital makes increasing sense in a lower-priced Florida (and elsewhere) catastrophe market.

Springer concluded; “The number of additional parties providing capital to the reinsurance arena has created an extremely efficient buying environment for companies with a proven track record like ours. We plan to continue reinsuring both of the insurance subsidiaries to similar conservative levels as past years.”

Also read:

– Nephila Capital vehicle buys Universal Insurance Holdings shares.

– Reinsurance capital, ILS & Nephila Capital help State National grow.

– Universal Insurance Holdings explores cat bonds for 2015 renewal.

– Nephila taps catastrophe risk returns in deal with State National Companies.

– Nephila Capital helps Universal to extraordinary reinsurance cost reductions.

– Nephila Capital investing in Florida takeout insurer Heritage’s IPO.