During the firms recent earnings call, executives of global specialty insurance and reinsurance provider Lancashire Holdings discussed the firms Kinesis Capital Management third-party reinsurance capital unit and why it is different.
With its Kinesis offering Lancashire has tried to bring something different to the ILS and collateralized reinsurance market, playing to its strengths as a specialty insurance and reinsurance provider to offer something different to both investors in Kinesis and the group’s clients.
Kinesis offers capital markets investors a unique reinsurance linked investment opportunity as the only third-party capital manager which is currently solely focused on specialty lines of reinsurance business. The reinsurance contracts underwritten at Kinesis tend to be multi-class as well, further differentiating it from other opportunities to invest directly in the returns of the reinsurance market.
With its flexible structure bringing two offerings per year to investors, for the January 1st and July 1st renewals, Kinesis is also very well positioned to act quickly and be able to bring attractive opportunities to its investors during market dislocations, via special draws.
Lancashire has been clear that its intention is to build a diversified insurance and reinsurance platform, with its core specialty business, the addition of Cathedral at Lloyd’s and now its third-party capital management unit Kinesis. It sees this as a way to avoid the bleak outlook it believes smaller reinsurers will face.
CEO of Lancashire Richard Brindle explained why the firm is seeking to remain relevant by staying one step ahead of market trends; “Small, narrow, largely following carriers are now under pressure as never before. They lack the power to make brokers sit up and take notice and with non-traditional capital flowing in to the CAT space and other carriers flexing their muscles in response, the outlook for them is bleak indeed.”
Kinesis is a core piece of Lancashire’s new structure, giving it the ability to leverage lower-cost capital from third-parties within its underwriting and also on a quota-share basis, should it choose.
Darren Redhead, CEO of Kinesis Capital Management, explained the thinking behind the unit and its products; “Over the past few years, Lancashire has been involved in collateralized vehicles for various products, energy and retrocessional using various different structure. From the start we set out to create a much more flexible standalone capital management vehicle which is a special purpose insurer and reinsurer.”
With Kinesis Lancashire set out to create something which is true to the Lancashire brand, said Redhead, while being different from the other offerings in the collateralized reinsurance space. Redhead said that Kinesis differs from other offerings in three distinct ways.
“Firstly, the way investors have access to the market and the kind of investors as well. We have two fixed capital raises a year and if sums are not deployed they are returned to the investors. Not left to sit on account, almost being forced to be used. Also we have the ability to raise funds very quickly under a special draw should the need arise,” explained Redhead.
The flexibility of the special draw facility, to raise capital for opportunities that arise in the reinsurance market, was demonstrated as recently as last week when Kinesis reported it had executed its first special draw, raising capital from investors for collateralized underwriting outside of the typical renewal cycle.
This strategy of creating the investor base to support quick capital raises to take advantage of underwriting opportunities or market dislocation is likely to become more widely followed by other third-party reinsurance capital managers. It makes perfect sense, particularly under current market conditions, to be able to react quickly should new underwriting opportunities arise.
The special draw is also a reflection of the changing buying habits in the reinsurance market. Some large primary insurers now buy their core program at renewal and then go back to the market to top up, or expand, parts of their reinsurance tower around the renewal cycle. With the availability of reinsurance capital less cyclical, since the introduction of the capital markets and third-party capital, this is a trend we could see increase.
Redhead continued; “Secondly the business written rather than just follow the crowd writing property catastrophe only, we have leveraged Lancashire’s expertise in specialty lines, terrorism and energy, for example packaging them up with property cat perils to create an individual product. Also we have generated new business not just ceding away our existing business.”
This is the attractive piece of the puzzle for investors, with the underlying risks in the Kinesis portfolio quite different to the majority of the opportunities available in the insurance or reinsurance linked investment market. Of course it also means that investors are exposed to some risks which may be harder to model or less well understood, so not every investor in ILS would have the risk appetite to participate.
Kinesis does offer a very interesting diversification for investors already allocating to ILS. It can provide a return from a very different part of the reinsurance market, which would complement investments in catastrophe bonds or pure property catastrophe reinsurance funds.
On the topic of diversification, Redhead explained; “Lastly, we have endeavoured to give investors a balanced portfolio, so not to expose all their capital to one event.”
Lancashire feels that it has created something which has an appeal both for its clients and investors in Kinesis, having spent a considerable time working out the finer details.
Redhead commented; “During 2013, a lot of hard work was done in investigating the landscape from a supply/demand point of view. Something I think that is not done enough in this industry, especially in this type of market. Using these findings we developed a concept for products that both appeal to potential clients and investors.”
Lancashire targeted $300m to $500m in limits to be deployed for the Kinesis venture in 2014, but pulled back a little on that ambition for the January renewals.
“As of January 1st, we have deployed just over $252 million of limits. We look to be on target for the middle of our range, with our mid-year capital raise which will again be specialty focused. We feel we could have raised more capital at 1/1 but in the present climate held back to maintain our returns,” said Redhead. With their latest special draw, though, it is thought that Kinesis are now closer to $300 million in terms of total limits deployed.
CEO of Lancashire Richard Brindle discussed the successful way in which Kinesis has worked hard to raise capital while building what it hopes will be long-standing relationships with a panel of investors.
“What we’ve created, and I think we talked about this before, with Goldman as our advisors is a sort of investor club. And it took a bit of time and Darren did a hell of a lot of work last year, as he mentioned in his script, identifying the supply, because that’s not done often enough, and getting people really acquainted with our underwriting approach and that paid dividends at 1/1,” Brindle explained.
Kinesis Capital Management will look to grow this club of investors over time, but only as opportunities allow or as and when the market pricing environment changes. A key feature of Kinesis will be its ability to react to opportunities using its special draw facility, through which it aims to be able to support client, and investor, needs at short notice.
Brindle continued; “We want to expand our investor club. But the concept is, that we have a sort of annual draw where we do the 1/1 book, which will be mainly the multi-class product, but we’ll certainly look at other products, there may be property cat opportunities or something like that. But then we can do what we call special draws through the year and we reckon that we can do a special draw within a week, ten days sort of period, which is very quick if you think about it.”
“And that’s because we put in a lot of hard work in educating our investors, getting legal agreements signed and all of that stuff. And we are constantly on the lookout for market dislocations and niches, although there aren’t many at the moment, we are constantly on the lookout and this special draw feature should enable to react extremely quickly to any dislocations.”
Over the longer term the ambition is to grow Kinesis’ assets under management, but how long that takes will depend on the reinsurance market and what opportunities are available. Rapid growth could be an option should the market face a dramatic series of loss events which moved rates upwards and made underwriting new business more attractive.
Darren Redhead explained; “There’ll be natural growth with the Kinesis multi-class product, but as I mentioned we will be going for specialty products mid-year as well, so we’ll be product driven over the next two to three years as we grow. We could expand dramatically over a very short period of time. So with no loss activity as Elaine mentioned it will be a two to three year grow out, to where we want to get to on a multi-class specialty products. But if there is a market dislocation you could potentially get there a lot quicker.”
Redhead gave some final insights into Lancashire’s thinking on alternative reinsurance capital; “Collateralized reinsurance is here to stay, and is a major component of the reinsurance market. Indeed, it seems to have changed our industry in how additional capital will be deployed in future after major events. It cannot be ignored, nor should it be, it should be embraced as an opportunity. Lancashire now has a vehicle that is both market facing developing its own business and has the ability to raise funds quickly to provide sizable solutions for our clients.”
Kinesis will be interesting to watch in years to come, perhaps particularly interesting should the market suffer major losses and Lancashire get the opportunity to scale up its third-party reinsurance capital management unit more rapidly.