Bermuda-based insurance, reinsurance and third-party capital management specialist Validus is using the lower-cost of ILS capital managed at its AlphaCat unit to maintain underwriting of risks which are no longer priced at levels suitable for its own balance-sheet.
Speaking during the reinsurance firm’s latest earnings call on Friday, CEO of Validus Holdings Ed Noonan explained that lower-cost ILS funding and an ability to upsize its management of third-party capital at the AlphaCat unit has helped the reinsurer to balance its underwriting without having to shed too much business.
The January renewals perhaps reflected this for Validus, as the reinsurer reported that Validus Re underwrote less U.S. and international property business, while AlphaCat wrote significantly more. Noonan explained that this comes down to cost-of-capital, that Validus has a different return hurdle to the AlphaCat investors, which means the firm can try to balance its use of capital in order to maintain underwriting levels.
Noonan explained on the call that this dynamic, of matching underwriting risks with the capital sources best able to bear it while still maintaining a hurdle rate, is a natural consequence of the current reinsurance market environment.
“I think it’s absolutely logical and follows the entire structural issue for the industry,” Noonan explained. “You’ve got pension funds that are willing to accept a return that’s, let’s say 4 to 500 basis points lower than reinsurers are willing to accept. And therefore, right now as prices come down, reinsurers should be reducing their exposures, while some of those exposures still are hitting the hurdle rates for institutional investors.”
This use of alternative, or third-party sourced, capital as a way to continue underwriting risks which no longer meet the technical hurdles for a reinsurer balance-sheet is a key reason that companies are increasingly looking to launch sidecar vehicles and to manage investors money alongside their shareholders.
Noonan continued; “As reinsurance rates have trended down, we are approaching equilibrium in that. It doesn’t mean that there won’t still be some growth in the ILS sector, but that natural spread between the two is narrowing.”
He went on to acknowledge that the shift in premiums written at the January renewals reflects this trend, that lower-cost capital can enable a reinsurer to shift premiums from one balance-sheet to another, which can help to protect market share and maintain lines.
“What you are seeing at January 1 is exactly that, just the difference in the cost-of-capital between the two sectors,” he explained.
CFO of Validus Holdings Jeffrey Sangster further explained that the shift in premiums is not simply a case of moving the same risks across to third-party capital.
“Of the $564 million of new capital that came into AlphaCat for 1/1, about 75% of that was deployed at 1/1, as planned, with the remainder planned to be deployed over the remainder of the year. So when you look at just the absolute magnitude of the increase in premiums at AlphaCat, that’s against a larger capital base that we’re deploying, so it’s not apples-to-apples comparing the increase there to the decrease at Validus Re,” Sangster said.
In a reinsurance market where cost-of-capital increasingly matters, AlphaCat and the third-party capital units of other reinsurance firms are likely to increase in priority. If rates remain low for some time we could see increasing shifts of risk from one balance-sheet to a third-party balance-sheet, making building a track record vital in order to attract capital, something Validus has done very well.
Overall Validus continues to stress the importance of the AlphaCat strategy and third-party capital management, seeing it as a core competence within the insurance and reinsurance group and a key tool that can be used to balance capital usage.
CFO Sangster explained; “Validus is very pleased with the continued strong level of investor support for AlphaCat and, with these new commitments, AlphaCat is now a top ten global ILS manager as measured by assets under management.”