Blue Capital Global Reinsurance Fund beats target return

The London Stock Exchange listed, Montpelier Re operated, Blue Capital Global Reinsurance Fund beat its target return to investors in its first year of operations, but its chairman notes that reinsurance market conditions are more challenging.

Blue Capital Management, the third-party capital and reinsurance-linked investment management arm of Bermuda based reinsurer Montpelier Re, has published the final results for the period from 6 December 2012 to 31 December 2013 for its Blue Capital Global Reinsurance Fund today.

The fund beat its stated target of a net return to its shareholders of LIBOR plus 10% per annum, inclusive of dividends and achieved an 11.8% increase in the net asset value of its shares during the period, net of fees and expenses, and inclusive of dividends.

This impressive first year for the fund may not be quite as easy to repeat, with pricing in the property catastrophe reinsurance and insurance-linked securities (ILS) market markedly reduced compared to a year ago. Chairman of the Blue Capital Global Reinsurance Fund John Weale commented on the market environment in the funds report.

Weale noted that the use of third-party capital in reinsurance underwriting, such as the capital provided by the fund, is of benefit to reinsurance buyers; “The continuing convergence of traditional reinsurance and capacity from capital markets provides carriers with additional flexibility in their risk transfer solutions and establishes capital market solutions as a sustainable complement to traditional reinsurance.”

But the lower-cost of this capital, which has enabled it to accept ever lower premium rates for assuming risk, can present a challenge in itself, Weale commented; “This will also result in challenges for our Managers. The January 2014 underwriting period was a competitive one, characterized by pressure to reduce prices and offer more generous contractual terms and conditions.”

In terms of pricing, Blue Capital’s fund has a focus on underwriting regional property catastrophe reinsurance for small to mid-size reinsurers, which should help it to avoid the heaviest of the price declines.

Weale commented; “From a pricing standpoint, the Company benefitted from its continued focus on regionally-exposed traditional reinsurance business. While prices in the retrocessional and Cat Bond markets decreased in excess of 20 per cent., observed risk-adjusted price changes on the Company’s contract renewals were 12 per cent. lower compared to the January 2013 renewals. Additionally, contractual terms and conditions on regionally-exposed traditional business remained consistent with market best practice.”

Weale also explained that the fund took a quota share of a reinsurance program to help to increase its access to preferred business; “The January 2014 portfolio also incorporates the addition of a quota-share participation of a traditional property catastrophe book of business, which further increases the Company’s access to its preferred client base.”

Blue Capital’s fund provides traditional reinsurance products backed by the fund capital to collateralize it, which it feels is a better approach to creating a long-term and sustainable pipeline of underwriting business.

The investment manager explained; “The Company focuses on traditional reinsurance, which provides customized reinsurance protection to insurance clients in bespoke indemnity programmes. Traditional reinsurance, which is most commonly provided in the rated (as opposed to collateralised) reinsurance market, represents the bulk of the more than $300 billion of limits purchased annually. The advantage of establishing relationships with longer-term reinsurance buyers is that the business is more of a relationship market than a trading market, where the consistency of counterparties is an important consideration for the reinsurance buyer.”

Avoiding the worst of the price decline is important to a fund with targets to meet. Blue Capital Global Reinsurance Fund feels much less exposed to the declining yields than investment funds focused on instruments such as cat bonds.

The report states; “Typically, those segments which are easiest for securitized product investors to penetrate, for example Cat Bonds, have seen new issue spreads compress more than 30.0% on a risk adjusted basis. Similarly, the ILW market and the high yield retrocession market have seen rates suffer with estimated rate softening of more than 20 per cent. on a risk adjusted basis. The traditional reinsurance markets, which for structural reasons can be much harder for capital markets investors to penetrate, have seen rates reduce by between 15 per cent. to 20 per cent., although there have been some areas of rate hardening, such as tornado exposed reinsurance programs in the United States.”

As a result the fund believes that rate softening is less relevant to it than many other capital markets reinsurance strategies.

The fund has also taken advantage of market conditions to buy some protection for its portfolio from the industry loss warranty (ILW) market, something we’ve seen a number of funds do in recent months.

The manager said; “In response to rate softening in the ILW markets, the Company has opportunistically purchased collateralized protection to optimize its portfolio while managing downside risk. The Company will continue to monitor these opportunities and to purchase ILW protections for risk management and/or arbitrage purposes.”

After a strong first year the management of the Blue Capital Global Reinsurance Fund remain confident in its ability to meet its stated targets, of LIBOR plus 6% per annum on the original issue price of its shares and a net return to its shareholders of LIBOR plus 10% per annum, net of fees.

The fund is perhaps less exposed than others to the declining pricing in reinsurance and ILS, given its underwriting focus, but challenges will still remain as the reinsurance market softens making risk selection and underwriting skill ever more important as well perhaps as the link to parent reinsurer Montpelier Re.