Swiss Re Insurance-Linked Fund Management

Original Risk: A Society for Change Agents

KKR & Co. L.P. and Nephila Capital, the benefits flow both ways


When KKR & Co. L.P. (Kohlberg Kravis Roberts) acquired a 25% stake in the largest asset manager in the insurance-linked securities (ILS) and reinsurance sector, Nephila Capital, it was clear this was good for Nephila and it’s also proving very good for KKR.

It’s almost a year since KKR invested in Nephila Capital, taking 24.9% of the firm through a deal which saw it buy shares from Nephila Capital’s management team and its other key investor Man Group plc.

This was a big story in the ILS and reinsurance-linked investments space in 2013. It provided a signal early on in the year that, as an asset class, ILS and catastrophe risk had reached a new high. The asset class had attained a profile sufficiently high enough to attract the attention of these large institutional investment houses, something that continued throughout the year as capital increasingly flowed into the space.

For Nephila Capital, having the backing of one of the largest private equity and buyout firms in the world gave it access to a new and much broader range of potential capital sources and certainly elevated its position in the broader hedge fund and alternative investments world.

At the time of the deal Nephila’s management committee said; “Having access to KKR’s global network of relationships, infrastructure and management expertise will open up new doors for Nephila and our investors.” Over the course of 2013 Nephila Capital’s position in the reinsurance world has certainly risen and it is now considered one of the most innovative and forward thinking firms in the reinsurance space (not just in ILS and third-party capital).

KKR co-chairmen and co-CEO’s, Henry Kravis and George Roberts, said that they felt that the Nephila Capital team was the best in the industry at the time of the deal and it’s clear from recent comments that KKR has been feeling the benefits of the relationship and that it plans to help Nephila Capital grow even more.

At a recent Goldman Sachs conference, George Roberts was asked about the Nephila Capital deal and what plans KKR had to help the firm in the future.

Roberts cited the lower cost-of-capital associated with third-party reinsurance capital as one of the key differentiators that makes ILS as an asset class and asset managers like Nephila Capital so attractive.

Roberts commented; “If you want to find what the secret sauce is, their cost of capital is cheaper than the insurance company and so it’s a pretty neat product.”

The lower cost-of-capital associated with ILS managers and third-party reinsurance capital, from institutional investors such as pension funds, has been a key realisation for the reinsurance industry in 2013. Prior to this year ‘cost-of-capital’ was not a hot topic, despite the existence of ILS capital for many years (Nephila Capital itself is 15 or so years old).

In 2013 it has become one of the key conversation points as the way ILS pricing has declined demonstrated the lower cost-of-capital and the traditional market realised that it may not be the most efficient source of reinsurance capital for every layer of the reinsurance tower anymore.

Roberts said that KKR will benefit by helping Nephila Capital to grow. He noted that one issue with this is finding the capacity opportunities to deploy new capital, something that Nephila has become more vocal about this year. Co-founder and principal Frank Majors cited the need to find new opportunities by expanding the market as important to enabling further growth of ILS in his speech to the Lloyd’s market earlier this year.

Nephila Capital has become a prominent voice calling for the reinsurance market to seek new opportunities by looking to areas and risks where there is insufficient capacity, or where ILS capital can be more efficient than the incumbent traditional capacity, or even to the development of entirely new reinsurance markets where catastrophe risks are greatly underinsured.

Having a partner like KKR will assist with these goals. It has already no doubt helped Nephila Capital raise its profile and gain a voice in conversations that it perhaps would have been seen as too small, or niche, to be involved in previously. This is not just good for Nephila, it is good for the entire reinsurance market, both traditional and alternative.

Roberts said that KKR can take what Nephila Capital has achieved and, if the capital deployment opportunities can be found, introduce Nephila to some key investors that KKR has. He said that at the time of buying into Nephila, KKR found that there was very little overlap between its investor base and Nephila’s investors.

This will allow KKR to help Nephila Capital to grow, which in turn will benefit KKR financially and Roberts said that the relationship is already generating meaningful earnings for KKR. This is really an ideal relationship for both parties at this stage, as Nephila can leverage KKR’s scale, networks and investor base to help it grow and access new business, while KKR stands to benefit financially through this growth. This is typical of the way KKR often invests.

Roberts explained that every acquisition KKR makes has to add some ‘synergistic value’ to the firm. A core principle of the KKR investment strategy is that its acquisitions and deals add something to the firm that it doesn’t already have and there is a two-way flow of benefits. “That’s really the litmus test that we have learned,” said Roberts.

The importance of the Nephila deal for KKR has not gone unnoticed. Even ratings agency Standard & Poor’s mentioned the acquisition when it raised KKR & Co. L.P.’s issuer credit rating to ‘A’ recently. S&P said that in recent years KKR has significantly expanded, developing a broader and more durable business model.

One of the acquisitions which contributes to this broader and more durable business model was the acquisition by KKR of; “A 25% stake in a catastrophic risk and weather derivatives-focused asset manager,” according to S&P.

Nephila Capital, as the largest asset manager in ILS and reinsurance, stands to feature strongly in the January reinsurance renewals, likely participating in many of the world’s largest programs as it deploys its $9 billion or so of capital. As we move into 2014 it will be interesting to watch Nephila to see whether it can find the opportunities to allow it to fully embrace the growth that its relationship with KKR could potentially bring to it.

If the opportunities to deploy capital can be found, and KKR exerted its fullest influence to help Nephila grow, the benefits that both firms gain from the relationship stand to become significantly larger.

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