Reinsurance and retrocessional reinsurance investment manager CATCo Investment Management has successfully allocated capital to a 2014 portfolio which could generate returns significantly above target, but with lower risk and better protection.
CATCo Investment Managers has published its annual portfolio update for its flagship London-listed reinsurance investment fund, the CATCo Reinsurance Opportunities Fund Ltd. In the update the manager explains the portfolio construction and how an environment of high competition and competitive rates has affected it.
In short, CATCo has felt the rate decline, caused by the excess capital in the reinsurance sector and lower-cost capital entering the sector from the capital markets. However the impact from reinsurance rate declines is measured as just 2% and in fact CATCo has successfully secured a portfolio which puts it on course for above target returns once again in 2014, but this time with more of its own retrocessional protection in place.
In 2013 CATCo had a very impressive year, helped by the very low levels of insured losses around the globe. Net asset value for the CATCo Reinsurance Opportunities Fund grew by 21.9%, while share price total returns hit 24.34% and share price growth 19.04%. The share price premium to NAV at the end of 2013 was 0.64%.
Again demonstrating its prudent and conservative nature to reserving for any potential exposures, during 2013 CATCo saw a cash drag of approximately 3.4% from historic side pockets in 2013. It also established a new retrocessional reinsurance loss reserve equal to 100% of exposures to a series of U.S. and Canada tornado events that occurred in 2013. This took a further 1% off the NAV.
At the same time CATCo settled side pockets it had established for exposures to the 2011 New Zealand earthquake and the Tohoku Japan earthquake only yesterday announcing a return of capital from the Japan exposed contracts to its investors.
CATCo said that the market disruption caused by the oversupply of investment capital in the retrocessional reinsurance market has resulted in a challenging renewal season for the manager. However the firm has maintained discipline in deploying capital and constructed a de-risked portfolio which still promises returns above the stated targets of LIBOR plus 12% to 15% per annum.
Continued convergence of traditional and capital markets capacity continues, said CATCo, but the increased demand from capital markets investors has resulted in an over-capitalised market and created pricing pressure.
This trend is expected to continue, said CATCo, however, the effects have not been as originally expected. Rather than providing a source of risk capital, which would give carriers greater flexibility to offload, diversify risk and establish capital markets solutions as a complement to traditional reinsurance, it has instead gone into direct competition with traditional capacity and those funds selling traditional products.
Despite the competitive landscape, CATCo has secured a portfolio with above target potential returns. The investment manager has agreed terms on new 2014 reinsurance transactions with multiple reinsurance counterparties and has utilised around 85% of the available capital.
The portfolio contains a significantly diverse set of global risk pillars, CATCo’s preferred method of diversifying its risks, with 42 pillars detailed in the portfolio update. Indicative net returns for the 2014 portfolio, including retrocessional protections that CATCo has bought, provide for a maximum no-loss return of 18%, still 3% to 6% above the funds stated targets.
The diversified portfolio, including reinsurance protections, means that the most severe possible scenario loss could not result in a net return to investors worse than negative 4%.
At the renewals, comparing the 2013 with the 2014 portfolio, CATCo noticed declines in pricing of 7.5% for comparable risk levels reflecting the current market conditions. However, CATCo deployed about one-third of the 2014 capital into reinsurance contracts with around 40% lower expected loss rates, so subsequently with lower pricing than in 2013.
That reduced the indicative returns of the portfolio to 21%. CATCo then brought efficient retrocessional reinsurance protections for itself, which cost around 3% of the target return.
So CATCo equates the reductions in indicative returns as; 2% from premium rate reductions, 4% from writing lower risk contracts and 3% from retrocessional protection purchases. Hence the lower loss-free target of 18%, compared to the 27% in 2013.
Overall, CATCo’s 2014 portfolio has an aggregate risk level 20% lower than the 2013 portfolio.
The Chairman of the CATCo Reinsurance Opportunities Fund commented; “The Manager’s investment performance for 2013 has been excellent. Perhaps more impressive was the fact that the Company has been able to generate such positive results for all investors over the past three years, despite the first two years having been the costliest ever recorded for the insurance industry. Furthermore, faced with a well documented, difficult 2014 renewal environment, the Managers were able to deploy their capacity with indicative 2014 net returns in excess of the Company’s stated objectives and with a lower risk profile.”
To maintain a portfolio with above target returns, but with 20% lower aggregate risk and protections in place, in the current market environment is impressive. Retrocessional reinsurance is currently a very attractive area for reinsurers and the capital market players to expand into, given the attractive potential returns, so we can expect to see CATCo facing increased competition in years to come.
CATCo, however, has positioned itself as a leading player in the retro market, with a unique product that protection buyers like and an asset management approach to capital. This puts CATCo in a good position of operating with a source of very efficient capital and having established relationships with counterparties. If the firm keeps delivering on these attractive returns, as it has since its inception, we can expect to see it raising more capital over the course of 2014 and beyond.