Lancashire reacts creatively to third-party reinsurance capital, settles Sandy ILW


Insurance and reinsurance group Lancashire Holdings announced its first-quarter 2013 earnings today, revealing what looks like a decent quarter helped by a lack of catastrophe losses achieving particularly strong return on equity compared to a year earlier. CEO Richard Brindle mentioned the impact of third-party capital inflows on the reinsurance marketplace, but stated that Lancashire is reacting creatively to this new market dynamic.

Lancashire has been active in third-party reinsurance capital management for some time, having a history of involvement in sidecar and investor backed underwriting vehicles through its Sirocco, Accordion and Saltire efforts. In February Lancashire announced it would consolidate these efforts and facilities within a new brand called Lancashire Capital Management showing it has ambitions to grow its use of managed external investor capital to back its underwriting where appropriate.

Lancashire then appointed Darren Redhead, previously of hedge fund reinsurer D.E. Shaw Re, as Head of the new Lancashire Capital Management division (“LCM”) in March, replacing its long-serving chief underwriting officer Simon Fascione who left the firm earlier this year.

We wrote last week that Lancashire are likely preparing the launch of another Accordion sidecar as it has registered a Bermuda SPI called Accordion Reinsurance II Limited on the 14th of March. So with its third-party capital activities now consolidated within a capital markets division and another sidecar in the works, which sources tell us Lancashire may be raising funds for right now, it’s no surprise to see third-party capital getting mentioned in the firms results press release.

Group CEO of Lancashire, Richard Brindle, commented; “In reinsurance the advent of third party capital has provided both threats and opportunities.” He added that rate pressure from this influx of capital and the additional capacity it has created, has been dramatically seen in the catastrophe bond and industry loss warranty (ILW) markets, with supply increasing and prices decreasing.

However, despite the influence which third-party capital is exerting on reinsurance pricing and market dynamics, Brindle said that he wouldn’t bemoan the advent of new capital. “Rather than bemoan the advent of new capital, Lancashire is reacting creatively with new products that leverage our unique knowledge of non-catastrophe business and combine this with our leading catastrophe and capital modelling capabilities,” Brindle stated.

This is the sensible statement and approach at this point in the evolution of the convergence reinsurance market. Positioning itself as ready to react innovatively to the influx of capital will give shareholders confidence in Lancashire and also put the firm in a strong position to not get left behind if the convergence trend continues apace.

Brindle added that he welcomes new hire Darren Redhead, who leads the new Lancashire Capital Management division. Brindle said that Lancashire Capital Management will; “Deploy Lancashire’s underwriting expertise on behalf of third party capital providers in the field of insurance and reinsurance.”

Other interesting insights from the Lancashire results include the fact that it is using capital optimisation to explore and assess the best way to use different types of capital for its own reinsurance purchasing, given the abundance of capacity. Brindle said that this has helped the firm achieve a “Significantly improved risk-adjusted portfolio.”

Elaine Whelan, Group Chief Financial Officer, at Lancashire said that trading conditions, looking ahead to the mid-year renewals, are anticipated to get slightly worse and that the firm may return earnings generated in 2013 to shareholders towards the end of the year. This is a message likely to feature in a number of firms reports over the rest of this year if the rate environment doesn’t encourage them to deploy as much capacity as in recent years.

Gross premiums written decreased in the quarter by 8.2% on Q1 2012, primarily driven by Lancashire’s property retrocession book as the firm reduced exposures and due to worsening rates and terms. This is perhaps also a result of increased competition for property retrocession business created by some of the third-party capital backed retro writers, listed funds and ILS specialists which have entered the market in recent years and have experienced growth.

On Accordion, the results show that in Q1 2013 some $52.6m of cessions were made from Lancashire’s property retrocession book to its Accordion sidecar facility compared to $54.0m in Q1 2012. The firm also continued to take advantage of available industry loss warranties (ILWs).

Lancashire’s ILW which was exposed to superstorm Sandy has now been factored into the results after the firm said that it reached a settlement on it. This is interesting, as we had understood the ILW to have a $20 billion PCS industry loss trigger but PCS has so far only reported an $18.75 billion loss estimate.

The ILW was, we understood, for $40m of cover, but Lancashire’s results press release says that its Sandy loss estimate which stood at $44.5m was now down to $28.9m, after reinsurance and reinstatement provisions. We contacted Lancashire to try to clarify this and were told by an investor relations spokesperson that a settlement had been agreed with the ILW counterparty using a commutation agreement to establish the payout, but that it could not disclose any details of how this was calculated.

Lancashire must be pleased to have secured this settlement, although should the PCS loss estimate rise above the $20 billion at the next reporting interval it may not be quite so happy with the early settlement. However after PCS reported the same estimate for two reporting intervals most of the market is not expecting that number to rise any further now, so perhaps this has been a shrewd decision to settle by Lancashire.

The Lancashire Capital Management division reported a share of profit of $2.9m for Q1 2013, reflecting Lancashire’s 20% equity interest in the Accordion sidecar vehicle and 16.9% interest in the Saltire vehicle. Last year the share of profits for the equivalent segment was $2.9m for Q1 2012 related entirely to the Accordion vehicle.

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