In an interview with Artemis, Jim Robinson of MultiStrat Advisors Inc. recently discussed the novel casualty insurance-linked securities (ILS) transaction the firm arranged for HSCM Bermuda, the ILS, reinsurance and transportation finance investment firm established by ex-Goldman Sachs structured finance head Michael Millette.
Jim Robinson is the Chief Executive Officer (CEO) of MultiStrat Advisors Inc. USA, which is a sister to the MultiStrat Re total-return focused reinsurance underwriter and servicing company, owned by Multi-Strat Holdings of Bermuda.
We explored the fundamentals and benefits of such an ILS transaction, the challenges that occurred, and what the future might hold. To start, Robinson provided some information about making casualty risk or a casualty portfolio accessible to institutional investors.
“We didn’t try to reinvent the wheel. Casualty Linked Securities (CLS) are similar to CAT Bonds in some ways, but different in others. For institutional investors, non-correlation, segregated vehicles, domiciles, share structures, and acceptable collateral are all very similar to the path paved by CAT-bonds. CLS are materially different in the nature of risks, the structure of collateral, the contribution of asset management, and the motivations of investors. CLS total returns reflect more stable insurance outcomes enhanced by investment returns.”
Robinson continued to note some CLS attributes that institutional investors consider valuable:
Total Returns – “CLS can generate returns from underwriting profits as well as investment income making them more predictable.”
Risk Returns – “CLS focuses on higher frequency, low severity insurance exposures and accordingly, less volatile returns than CAT bonds.”
Non- Correlated Leverage – “Not only are the sources of returns uncorrelated to the securities markets, the float contributes meaningfully to the return on investment as a source of non-correlated investment leverage.”
Low Volatility – “Because CLS claims payouts are not binary in the way losses to CAT bonds may be, CLS offers diversification through the inherent diversity of high frequency casualty business.”
Higher Yields – “As a base case, we are expecting high single and low double digit total returns to the investor with an upside case that could add significantly to this through active management of both claims and assets. We see the sources of returns from both asset and liabilities. We see the advantage as being a source of returns from asset management combined with less volatile insurance outcomes.”
Longer Duration – “Casualty exposures are longer in duration, delivering potential tail risk offset by superior opportunities for investment. While multi-year CAT bonds are now available, CLS avoids the regular turnover and reinvestment risk associated with the shorter maturities of CAT bonds. Longer duration insurance risks also defer income recognition delivering tax-free compounding.”
Robinson then discussed with Artemis what type of casualty insurance or reinsurance exposures might be suited to the CLS approach.
“We started with high frequency legacy casualty books with substantial claims histories suitable to financial and actuarial modelling. The critical elements really are the structuring features that provide investors with higher levels of comfort, for example stakeholder risk sharing, alignment of financial incentives, and exit alternatives. Our sister company, MultiStrat Re, specializes in underwriting transactions that deliver on these elements,” said Robinson.
Unusual for the ILS space, the transaction saw a mix of the fully-collateralised investor alongside an asset manager within a single transaction, and we at Artemis were eager to understand how MultiStrat separates the returns from liabilities and assets, how this can benefit both sides, and also how it augments returns.
Robinson explained that in a CLS, “the investor can act as the asset manager or select another asset manager in seeking returns within an acceptable collateral structure. This largely depends on how active the capital provider wants to be on the asset side after the transaction is funded. We have identified a select number of asset managers with investment styles and track records that fit CLS transactions and are acceptable to collateral issuers.
“We worked closely with Payden & Regal to stress various portfolio scenarios and evaluated trade-offs between probable risks and returns, liquidity, volatility, duration matching, collateral compatibility and the ability to add alpha through active security selection. While this first investment approach will generate attractive returns, we believe investment strategies will expand and improve in a number of ways.”
Typically, a traditional 144A catastrophe bond will cover a three to five-year period, and owing to the longer tail nature of casualty risks, Artemis questioned Robinson on the length of time investors can expect to be locked into these types of structures.
“These are actively managed portfolios and each will have a target maturity range from as little as 2.5 years to more than 7 years. This is roughly the time period required to maximize the IRR by capturing the lion’s share of the underwriting profits, optimize the collateral structure and proactively manage the claims – traded-off against the relatively fixed cost of the vehicle.
“That said, because these are well known risk classes there are exit alternatives that can be explored from inception or at the necessary point in time based on investors’ expectations for “target maturities,” explained Robinson.
With any innovative, novel structure there are sure to be challenges, and Robinson told Artemis how the execution of the deal proved to be one of the difficulties.
“Execution. Execution. Execution. As Thomas Edison observed, success is 1% inspiration and 99% perspiration. CLS structuring and execution requires access to profitable structured risks, understanding of structured finance products, access to capital, knowledge of different jurisdictions, and a network of providers and advisors. Happily, the broader MultiStrat Group and our partners are able to access all of these components and integrate them successfully.
“The MultiStrat Group represents these various disciplines in our members with MultiStrat Re sourcing and structuring the risk, Annapolis Consulting Group provide diligence, claims and litigation both during the sourcing and negotiation but on an ongoing basis and MultiStrat Advisors, our capital markets focused group contributing structured finance, investor expertise and driving the product development process.
“Our resources were supplemented by our Advisors, Todd White of Puma Advisors and Kim Willey of ASW Law Limited who were instrumental in developing our initial approach for CLS at the direction of our internal teams. We also got valuable investor input from StormHarbour, who was involved with the distribution of the deal.
“The other challenge that we expect to disappear as the CLS market develops is market liquidity. While we are committed to driving acceptance and adoption of CLS as a tradable security, as an investment, CLS can be “liquidated” should it be necessary through commutation options, loss portfolio transfers, or sale of the securities to a third party investor,” said Robinson.
Underlined by the continued growth of the catastrophe bond market and broader ILS sector in recent times, is the willingness and ability of the investor base to participate in an evolving and expanding asset class.
As Robinson was keen to highlight the appeal and attractiveness of casualty risks to the investor base, and the broader market.
“We had posited that the broader markets would be interested, especially those institutional investors active in ILS. However, we were pleased to get validation from HSCM — an investment adviser that specializes in insurance investing — as our capital partner in that first transaction especially since it has its own highly experienced underwriting team.
“We were also gratified that our “broader market appeal” premise was validated when the global investment banking boutique StormHarbour had a number of very sophisticated multi-billion dollar hedge funds to initiate active diligence on the deal. This indicates that the generalists are willing to invest in this emerging class of product. All that being said, we do expect to see a lot of interest from the ILS fund managers as we increase our deal flow in the coming months since they continue to innovate beyond their core Cat bond holdings,” said Robinson.
Looking at future expansion, Robinson continued to explore the potential for this CLS structure to be used to syndicate larger portfolios of casualty risk to the ILS investor base.
“The structure lends itself to syndication, so investor interest ought not be a limiting factor. Sourcing risk transactions with the required attributes will limit future volume, until the appetite and flexibility of the CLS market expands with experience. It is also clear that individual transactions can be too small at this stage of development of CLS,” he said.
“And looking at the future of CLS, more generally, Robinson, added; “We believe the future for CLS is very bright as our underlying primary casualty markets are substantially larger than that of CAT markets. Additionally, these sources of risk continue to seek lower and lower cost of capital driven in part by the perpetual soft market driving the continuing trend towards convergence between insurance and capital markets.
“We also expect to see a full spectrum of investment strategies emerge seeking different sources of returns as investors become more comfortable with the category.”