Casualty sidecar valuation requires assessing macro sensitivities alongside models: Kroll

As the sidecar market continues to expand, the traditional view of these vehicles as pure, non-correlated diversifiers is shifting. The growing adoption of casualty and multi-line exposures introduces long-tail dynamics that are inherently tied to broader macroeconomic factors like social and economic inflation. However, according to Kroll, for investors, this transition transforms the valuation process into a critical exercise in translating complex, macro-sensitive actuarial assumptions into clear market pricing.

During a recent interview with Artemis, Aaron Read, Managing Director, and Michael Sternbach, Vice President, of Kroll, a global financial and risk advisory firm, discussed why they believe valuations are so critical for sidecars, and what current trends they are seeing within the market.

Kroll is known across the industry for supporting sponsors, investors and intermediaries throughout the sidecar lifecycle by providing independent analysis that is designed to hold up in transaction environments, reporting, and stakeholder review.

Given the firm’s background in sidecars, we asked the executives what key considerations Kroll considers when valuing casualty sidecar arrangements.

“With casualty risk, it is the tail that drives nearly everything. Unlike property catastrophe exposure, where much of the answer is known within a season, casualty losses develop over years – and that long development period is the first consideration we take into account. Therefore, our valuation places significant weight on how reserves are likely to develop, and on how sensitive the structure is to that development arriving faster, slower, or larger than the actuarial central estimate assumes,” Sternbach explained to Artemis.

“As we do across the risk spectrum, we partner with actuarial firms whose expertise is in projecting that development, while our focus remains where a transaction would price if it were re-underwritten as of the valuation date,” he continued.

The executive also flagged the collateral and the assets behind it; noting that due to casualty capital being held for longer, the composition, liquidity, and credit quality of the supporting assets matter more than it would within a short-tailed structure, which often have extremely straightforward asset holdings.

With that said, as with the other long-lived assets that Kroll works through, Sternbach stated that the company is mindful of not being model-blind.

“As with the rest of the job, what we are seeking to answer is where the market would transact, and in long-lived investments models carry more pronounced exposures to factors like duration. However, that does not mean investors should expect radical mark-ups and mark-downs as a result; instead, through constant conversation with the investment community, we remain measured in assessing how value will change – really focused on where the market would clear today,” Sternbach noted.

The sidecar market continues to grow and gain momentum as more companies are turning towards these collateralized vehicles to expand their capital and risk transfer arrangements.

As the market continues to grow, more trends are being adopted across the space. One of which being the private equity/insurance tie-up, which Read states is the most pronounced trend that Kroll is currently observing in the space.

“The tie-ups, for many reasons, make sense. Insurance and private capital are natural buyers of each other’s excesses – insurers hold more risk than they wish to retain, and private capital has more capital than it can readily deploy. Both sides have their own forms of flow, and flow, while often welcome, must be managed and can be onerous. The amount of private dry powder on the sidelines means investment teams are seeking opportunities that support a large check size, and the sidecar is well suited to that,” Read told Artemis.

He continued: “For the cedant, the benefit is more straightforward: a buyer of reinsurance or retrocession gains an additional source of risk-bearing capital, and that incremental capacity is what does the work – it improves pricing directly, or creates leverage in an existing negotiation, and at the market level a deeper pool of capital chasing the risk dampens the pricing volatility these transfer markets experience. The benefits to private capital do not stop at the allocation itself; sidecars are also a source of investment-management income and carry the illiquidity premium that private markets offer.”

Adding: “Correlation is the other reason these structures fit together, and it is worth being precise about who benefits and how. For the investor, a sidecar has historically offered low correlation to the rest of the portfolio – a genuine diversifier set against equity, credit, and rate exposure. For the cedant, the same risk is by definition correlated to the book it already carries; the sidecar is not diversifying its exposure but sharing it. That asymmetry is the point – the investor is buying diversification, the cedant is buying capacity – and this is why in our view the structure has become so popular. I would add one caveat, which becomes more relevant as sidecars move beyond property: that diversification benefit is most pronounced on the property-catastrophe side, where the underlying perils are largely independent of financial markets.

“As casualty and multi-line exposure enters these structures, reserve development, economic inflation, and social inflation introduce sensitivities that are more correlated to the broader macro environment, and the diversification an investor is underwriting needs to be further assessed.”

Moreover, Sternbach elaborated to Artemis that Kroll is carefully monitoring the extent to which variable annuity risk will be incorporated into sidecars.

“While there are market specialists in this type of risk, the past few years of M&A and block activity show that not all participants are comfortable underwriting it. So, while we do see the occasional mix of fixed or indexed annuity with variable annuity, we are watching whether that becomes more prevalent as investor appetite for sidecar participation remains strong,” he said.

Given Kroll’s expertise in reinsurance sidecars, we asked the executives to explain why valuations are so critical for these vehicles.

“The insurance sector, as you and your readers know, has no shortage of models. However, as in ILS, actuarial and modelling outputs do not equate to fair value. Fair value is a phrase that people may hear frequently. It actually has a definition. Colloquially, is it the sale price at which an investment would change hands in an orderly transaction between market participants as of a given date. Therefore, using the sidecar as an example, a change in actuarial or investment assumptions is only one side of the equation,” Read explained.

The MD stressed that fair value measurement requires a consistently focused awareness of changes (or lack thereof) in investor return expectations for assets with commensurate risk.

When you bring all the components of a sidecar together, Read emphasises that for investors, these vehicles can feel like black boxes. However, he noted, that valuations can help translate changes in nuanced actuarial and investment assumptions into a price and a yield.

“Without that translation, an investor has no objective basis on which to enter, hold, or exit a position, or to report it to their own stakeholders – which is what makes valuation critical rather than merely useful. One of the ways a firm like Kroll is helpful is that Kroll sees a diverse array of transactions, so Kroll is able to provide its clients with market colour, anonymised of course, giving better guidance as to where market participants are trading. In other words, a big draw is Kroll’s closeness to the capital markets, so Kroll’s yield discussions often prove quite valuable to all involved,” Read stated.

Whilst the valuation process changes with multi-line and casualty sidecars, in comparison to pure-property structures, Read noted that this doesn’t necessarily mean that the process becomes more challenging.

“The valuation process does change as the sidecar exposure changes, but it does not necessarily become more difficult. In sidecar valuations, we routinely partner with actuarial firms with deep expertise across the risk exposure spectrum. Our expertise is in the capital markets, focused on transaction pricing and structures. While we do of course sense-check the actuarial projections, we recognize their expertise in this part of the valuation exercise.”

Read concluded: “With that said, it is an important reminder that valuation is not just a model output; instead, it relies on a deep understanding of where a transaction would price if it were re-underwritten as of a certain date, so while actuarial assumptions are critical, they are not sufficient for proper sidecar investor valuation.”

Read all of our interviews with ILS market and reinsurance sector professionals here.