XL uses New Ocean & new quota share in alternative capital expansion

As insurance and reinsurance specialist XL Group increased its use of alternative capital to $3 billion around the renewals, it did so by leveraging its ILS fund manager New Ocean Capital Management, as well as through the addition of a new property quota share deal with third-party capital partners.

That wasn’t all that XL Group, parent to the XL Catlin insurance and reinsurance brand, did in the fourth-quarter and at the renewals, to increase its use of alternative reinsurance capital.

As we wrote recently here, XL’s increased use of alternative capital has been part of a strategy to use the most efficient reinsurance capital on the back-end of its business model, to support expansion of the front-end insurance and reinsurance underwriting business.

During the re/insurers fourth-quarter earnings call, Greg Hendrick, President and Property and Casualty at the firm, explained a four pronged approach to the capital markets that XL followed in recent weeks.

First, XL was the first catastrophe bond sponsor to come to market after the major hurricanes of 2017, with its $150 million Galileo Re Ltd. (Series 2017-1) transaction.

“We were one of the first issuers after the third-quarter cat activity and we marginally reduced our total in-force limit, but expanded our coverage for U.S or Caribbean wind and convective storm,” Hendrick explained.

The second lever, which was also 100% transacted with alternative capital providers, was a restructure of some of XL’s reinsurance and retro as well as shifting it all across to third-party capital.

Hendrick said, “We purchased more worldwide enterprise catastrophe aggregate and reduced insurance and reinsurance segment specific coverages. This structure provides us with the broadest coverage and protects our portfolio, net of any catastrophe bond recoveries.”

Thirdly, XL pushed more risk to investors through its ILS fund management unit, New Ocean Capital Management, as Hendrick explained, “Via our ILS fund manager New Ocean, we increased a cession to an alternative capital provider through a specific proportional cession of individual property catastrophe treaties.”

New Ocean Capital Management has been steadily ramping up its activities in the last year, with new structures and ways to act as a manager for portfolios of risk from the XL Group to the benefit of its third-party investors.

Finally, XL added a new quota share arrangement, using purely third-party capital on the back-end.

“We’ve added a new property quota share, which covers our four core catastrophe exposed lines, property cat treaty, property treaty, large risk property insurance, and London wholesale property insurance classes,” Hendrick said.

He continued, adding, “This combined protection has been placed entirely with alternative capital providers and this initial placement at January 1st is the first of a number of cessions, that will be decided as we determine the return profile of our inward and outward risk activities.”

XL has clearly decided to maximise on its use of alternative capital in 2018, perhaps recognising that it is the most efficient way for it to grow its insurance and reinsurance books, while controlling catastrophe risks and its exposure to tail risks.

In this way XL can extract the risk premium it seeks from property business it writes, getting paid for the expenditure of expertise and intellectual capital, then pooling risks and ceding the pure catastrophe exposures to third-party capital partners.

Now XL has reached a new high point in its use of the capital markets, as Hendrick explained, “In total, we have in-force over $3 billion of catastrophe limit sourced from alternative capital.”

Hendrick went on to discuss what makes the changes important, structurally to the protection that XL benefits from.

“The impact of these changes and others is that we now have more cover on a broader basis, enhanced protection across more frequent parts of our catastrophe exposures and we’ve achieved a lower attachment point for non-peak perils,” he commented.

Continuing, “We’ve reduced our exposures across the curve but most meaningfully at lower probabilities where we are down 20% to 30%. While these are on an occurrence basis, our worldwide aggregate exposure has decreased by similar amounts.”

Impressively, XL’s new protection for 2018 means that despite the fact it has been growing its book its exposure to a repeat of 2017 has decreased, with the alternative capital arrangements having de-risked its catastrophe exposures.

Hendrick stated, “Were the same events of 2017 to occur again, our net loss would have decreased approximately 20%. We will continue to adjust this position throughout the year.”

The shift to leverage more alternative capital is part of a strategic move by XL to make the most of the efficiencies of the capital markets and ILS structures, following years of planning and relationship building with key investors.

Explaining why XL has adjusted its coverage, Hendrick said, “We’ve been mindful of the lessons learned and changing market conditions. The changes made reflect both the current pricing environment and our journey to regain a lean position in the transfer of risk to alternative capital providers.”

Tellingly Hendrick also said, “Our underwriting capital management is a dynamic process that we’ve operated all through the year, as we establish our inwards risk margins balanced against the lower cost of capital of many of our risk transfer partners.”

This gives away some of the promise of alternative capital and how it can dovetail with active portfolio management, and even technology tools such as machine learning in years to come.

If companies like XL Group can actively manage their books, to establish inwards risks, how to extract maximum returns from them without becoming over-exposed, and using alternative capital to balance that, a future model for profitable growth may be found thanks to alternative capital investor appetites.

XL is on its way there, it seems, shifting towards becoming a business that balances inwards risk, with outwards hedging opportunities, in order to extract maximum value from the risk premium it underwrites and get paid for its intellectual capital outlay.

Also read: XL upsizes alternative capital use to $3bn, to support front-end growth.