Reserving impacts Lancashire’s profit commission from Kinesis

Prudent reserving for potential losses that have not yet fully crystalised has reduced the amount of profit commission that insurance and reinsurance firm Lancashire Group Holdings received from its third-party capital and reinsurance-linked asset management division Kinesis in the first-quarter.

Kinesis, which manages third-party investor capital for deployment into a mix of reinsurance business lines much of which is on a multi-class basis, reserved for potential impacts from loss events during the fourth-quarter of 2015.

At the time, CFO of Lancashire Elaine Whelan explained that Kinesis had potential exposure to and had set aside some reserves for “mid-sized claims in the property risk and worldwide energy books from the January 2015 underwriting cycle.”

Now, in Lancashire’s first-quarter 2016 results which were announced today, the company explained that a reduction in the profit commission earned from Kinesis was “due to the timing of confirmation of loss quantum and the resulting release of collateral held.”

It’s important to note that as yet it is unknown whether Kinesis will actually suffer a loss, but it shows the management team being prudent in ensuring adequate reserves are held until that becomes clear.

It’s possible that one of the events Kinesis holds collateral for, in case of a potential loss, is the Tianjin, China port explosions, a loss event which has not yet been fully settled and estimates have continued to rise as information emerged.

Loss events such as this require prudent reserving practices and Kinesis appears to have reserved for a potential loss, even though that has not yet been confirmed. The ILS management unit will be waiting for confirmation from counterparties as to whether it has any exposure to the events and holding collateral for the contracts it has reserved for.

Kinesis returned approximately 15% to its investors for the 2014 underwriting cycle and hopes to do the same for 2015, even allowing for the reserving it set in Q4 of 2015.

By holding collateral, in case a loss does crystalise, Kinesis can ensure primarily that it has the capital to pay claims, but also that the loss is segregated, typically in a side-pocket and so does not affect performance of the rest of the portfolio. But of course, this affects profit commission until any loss is fully understood.

Once notice of final loss estimates is received from counterparties Kinesis will be able to pay any claims due and also release any collateral above any claims back into the vehicle, which would then allow any profit commission due to be paid.

So, for Q1 of 2016 Lancashire earned underwriting fees of $0.5m and profit commission of $1.8m from Kinesis. This compares to $0.7m and $5.1m a year earlier. As stated above, at least some of the decline in profit commission is almost certain to be recouped in months to come once any losses are fully realised.

Kinesis also earned Lancashire a share of profits of associates of $1.3m due to the company’s 10% share in the vehicle, up from $0.7m a year earlier. Giving Lancashire a total revenue contribution from its third-party reinsurance capital activities at Kinesis of $3.6m for the quarter.

The slight decline in underwriting fees is likely due to Kinesis Re, the reinsurance vehicle that underwrites the Kinesis products, having fewer premiums under management at the end of Q1 2016, at $50.6m compared to $62.2m a year earlier.

This is likely a reflection of two things, the state of the reinsurance market and also the effect of any collateral locked up for the loss reserves set in the fourth-quarter of 2015, which can reduce the capital available for underwriting for the next cycle.

It will be interesting to track Kinesis’ results through the year and see when the profit commission from any reserves that can be released flows back into the vehicle, with Lancashire taking its share.

The actions of the Kinesis team, to reserve and hold collateral for any potential loss events is another good demonstration of managers of third-party reinsurance capital prudently ensuring they can both pay their claims, when due, and protect their investors capital.

Also read:

– Kinesis to return 15% to third-party investors for 2014 and 2015.

– Kinesis third-party profit commission & fees add to Lancashire RoE.

– Predictions for 2015: Darren Redhead, Kinesis Capital Management.