On Tuesday 11th June, executives from Bermuda based reinsurance company RenaissanceRe presented at the Morgan Stanley Financials Conference. As you would expect, given the recent focus on third-party reinsurance capital and its impact on catastrophe reinsurance rates, the RenRe executives spoke at some length about the firms use of alternative sources of capital.
The talk shied away from discussing the rates and pricing environment too much, with the RenRe executives preferring to focus on what they believe makes their firms model of managing both shareholder and third-party capital an effective strategy going forwards. Seeking Alpha has a full transcript of the presentation here and we’ve only covered the key points on third-party capital below, so do head over to Seeking Alpha for the full transcript.
Jeffrey Kelly, CFO at RenaissanceRe started by explaining RenaissanceRe’s thinking behind how best to manage its capital, both owned and third-party. He said that to be the best underwriter you have to match the most desirable risk with the most efficient forms of capital.
This means you need to be able to source the most attractive risks, choose the best risk and structure to meet the clients needs and then match that with sources of capital whose owners find the risk and reward trade-off appealing. Only by doing this can you construct a superior portfolio of risk, and only in this way does RenRe think you can generate superior returns over time, Kelly added.
Kelly notes the growing alternative reinsurance capital market, both in terms of size and importance and said that RenRe has always recognised the need to leverage alternative sources of capital where they meet clients needs.
RenRe has been managing third-party capital since 1999, Kelly said, and this is why it does not see the recent developments in the market as revolutionary, instead seeing the current third-party capital growth as evolutionary.
He agrees to some extent with analysts who see third-party capital’s presence in the reinsurance market as a threat to RenRe’s business. However RenRe uses third-party capital vehicles as trading partners, and if they can source capital more efficiently then RenRe will use the alternative capacity to lay off risk at attractive levels to improve its book return to shareholders.
Some of Kelly’s comments are then focused on where he sees RenRe’s competitive advantage. To create a performing portfolio of risk you need to have a broad view of the market enabling you to see all of the risk on offer so you can select the most attractive risks to deploy capital into. Some third-party capital focused businesses may not have this view of the whole universe of risk that is on offer, Kelly said, insinuating that they may not have a wide enough range of risk to select from to create a performing portfolio.
In tandem with this, Kelly said that risk selection capabilities are vital to allow attractive risks to be distinguished from unattractive. Customer relationships are also key as well as having superior capital management skills. Kelly believes that RenRe’s competitive advantage gives it a book of risk with the expected returns noticeably exceeding the rest of the market.
Kelly highlighted the importance of knowing when to use shareholders capital and when to leverage third-party capital, for deployment into risk, and how to balance the two types of capital within one business. RenRe concludes that the optimal is to be right in the middle and to know when to leverage which type of capital for the right risks.
Kelly then noted the need to match risk and capital as well as client and investor needs and the importance of keeping true to its clients needs for traditional reinsurance structures, with reinstatement and low basis risk, while offering investors the best return possible.
Aditya Dutt, who manages RenRe’s Ventures division where all of the sidecar and ILS fund work is undertaken, was the other speaker and he started by saying that in 2 years the volume of alternative capital in the market has grown by more than 100%. For comparison, the traditional reinsurance capital in the marketplace has only grown by 14%, although that is a larger sum than the alternative capital doubling.
The traditional capital has not increased due to new capital inflows in the main, rather it is largely retained capital. The alternative capital is down to new inflows from institutional investors and the like.
Dutt said that RenRe believes that there is a point where rated capital from the balance sheet is most efficient to where fully collateralized balance sheet capital becomes best for the job of underwriting.
RenRe wants to have a hybrid capital structure leveraging the best of both types of capital, with balance sheet capital deployed when the business is diversified and when business is more concentrated leveraging the collateralized capacity.
Dutt breaks down the business as Renaissance Reinsurance Limited which is owned and rated balance sheet, Da Vinci Re which is $1.04 billion of third-party institutional capital from pension plans and endowments etc, then he lists the sidecars which he terms as joint-ventures including Timicuan III and Upsilon Re.
These three sides to the business all use different types of capital with different risk and reward motivations and RenRe’s job is to match the capital with the right types of risk at the right time for its clients.
Dutt also explains that Top Layer Re, a joint venture with State Farm, is available to clients looking for AA rated capacity for the top of their reinsurance programs. Top Layer Re has $4 billion of capacity largely deployed with non-U.S. clients.
Dutt also said that occasionally RenRe will establish a vehicle with a limited lifespan to take advantage of specific opportunities in the marketplace and the right place for this is on the collateralized balance sheet.
The upshot of this is that RenRe looks like a $4 billion company but is actually working with around $9 billion of capital. It’s how RenRe flexes its use of capital sources, between shareholder and third-party capital, that will be vital as it goes forwards. As the transcript says the matching of the right type of capital to the right risks, clients and returns is the key for a business like RenaissanceRe which wants to play across the whole spectrum of available reinsurance capital.
We’d agree with the comments that the current third-party reinsurance capital trend is an evolution of the reinsurance market rather than a revolution. However, it’s worth noting, that evolutionary change can often be just as disruptive as revolutionary change, so disruption is to be expected for some reinsurers and it is going to take a nimble and innovative approach to adapt to this ‘new normal‘.