ILS Capital’s reinsurer Prospero Re rated as it adjusts model to add leverage

Bermuda headquartered ILS fund and investment manager ILS Capital Management Ltd. is adjusting the operating model of its reinsurance vehicle Prospero Re Ltd. to add an element of leverage, while retaining the benefits of collateralized coverage.

A number of insurance-linked securities (ILS) fund managers have shifted their reinsurance vehicles models to a rated approach that enables them to incorporate leverage, while still fully collateralizing the majority of the underwritten reinsurance limits.

ILS Capital Management is the latest we’ve heard of to be moving in this direction, with the main reason being to address issues related to the trapping of collateral.

The ILS fund manager has now received an insurance financial strength rating (IFSR) of ‘A’ from Kroll Bond Rating Agency (KBRA) for its main underwriting structure, the Bermuda domiciled Class 3A reinsurance vehicle Prospero Re Ltd.

ILS Capital Management first registered Prospero Re Ltd. in 2013, incorporating the reinsurance company as a Class 3A.

That may have been prescient, as most ILS managers have registered special purpose insurers (SPI’s), which may require more work to transition to a 3A, where as starting with the right Class of Bermuda insurer may have made this change in the operating model a swifter affair.

Now with a stable rating outlook from KBRA, Prospero Re can continue its business of fully collateralized reinsurance underwriting for ILS Capital’s flagship ILS investment fund, The 1609 Fund Ltd.

Prospero Re underwrites both catastrophe and non-catastrophe reinsurance for ILS Capital Management’s fund, mainly focused on risks in the United States, Europe, United Kingdom, Canada, Japan, and Australia.

Property, marine, and offshore energy, as well as aviation and other lines are the main focus.

KBRA explained in rating Prospero Re that the shift in operating strategy for the reinsurance vehicle is as a result of learnings from the last few years.

“In order to address concerns about the opportunity cost of collateral trapped by the catastrophe events of 2017 and 2018, the company is planning to restructure its operating model so that it retains the benefits of the collateralized reinsurance model while adding an element of leverage that is more reflective of traditional reinsurers,” the rating agency explained.

Continuing to explain that rather than a one dollar of limit for one dollar of collateral strategy, “Under Prospero Re’s revised operating model, reinsurance contracts are to be collateralized by investors to a 1 in 500-year event. The remaining investor funds will be used to assume additional business, creating moderate underwriting leverage, and to support the tail risk of the collateralized reinsurance contracts to slightly more than a 1 in 1000-year event.”

A clear benefit will be the ability of Prospero Re to underwrite even more types of risk, giving additional diversification to the portfolio, KBRA said.

Prospero Re’s business model still has to be approved by the Bermuda Monetary Authority (BMA), KBRA said, and its current insurance license prohibits it from implementing the new operating model until approval is granted.

KBRA’s stable outlook for Prospero Re’s ‘A’ rating reflects the fact it expects approval to be given.

The new operating model will provide ILS Capital Management with additional flexibility when facing counterparties and there’s a good chance the strategy will allow it to still fully collateralize risks for those cedents that require it.

But the added leverage, the rating and the ability to write more and different business, with a growing range of cedents (as not all want collateralized and some demand a rated entity) all bodes well for the ILS fund managers investors.

Finally, securing a rating for Prospero Re also provides ILS Capital Management with added independence and reduces any reliance it had on fronting reinsurers. That can help to make its overall business model more efficient and effective, while ultimately the new operating model can help to optimise its cost-of-capital.