Specialist fronting and program services primary insurer State National Companies has reported that the fee income earned in the fourth quarter of 2015 increased thanks to its program business fronting relationship with ILS and catastrophe risk investment manager Nephila Capital.
In Q4 2015 State National reports that total revenues from its program services arrangements reached $18.6 million, up 46.5% or $5.9 million from Q4 2014, as it helped bring reinsurance risk capital further up the value-chain.
Relationships such as the one with Nephila Capital are helping to expand this part of State Nationals income, as the growing desire to get capital closer to the source of underwritten insurance risk grows among insurance-linked securities (ILS) managers and institutional investors.
State National was among the first to take advantage of this trend, signing an agreement with ILS and catastrophe risk investment manager Nephila to help the firm place its reinsurance risk capital directly behind fronted insurance business.
This development is an example of the way efficient capital is disrupting the insurance to reinsurance value-chain, enabling innovative players to capitalise on taking steps out of the chain, reducing intermediary costs and bringing capital markets capacity closer to the source of risk.
In the fourth-quarter of 2015 State National reported that the Nephila Capital program relationship added ceding fees of $4.4 million, $3.5 million of capacity fees and $0.9 million of premium related fees, to its total.
That’s not the highest quarter, Q3 saw the Nephila relationship add $4.6 million of ceding fees, but when you look across 2015 the growth is clear. The relationship with Nephila began in the second quarter of 2014 and has been ramping up ever since.
State National forecast $13 million of ceding fees for 2015 from the relationship with Nephila Capital, but the actual full-year figure is reported as $14.2 million, $11 milllion of capacity fees and $3.2 million of premium related fees, so outstripping the firms expectations.
Nephila continues to have the exclusive right to use State National as a fronting carrier for U.S. property catastrophe exposed programs through 2019, having extended the arrangement last year, so the fee income earned will likely continue to grow.
Over the term of that agreement State National is due contractual minimum ceding fees from Nephila Capital amounting to $51.50 million over the four-year term to end of 2019. The recently signed extension to the arrangement moved out some of the fees that would have been due in 2016 to 2017 and beyond, enabling the program to ramp up.
At the rate the program has been growing, in terms of ceding fees for State National, the minimum over the four-year term seems easily achievable. We’d imagine that not being even two years into the arrangement, further growth should be expected as the program continues to expand.
The program is a great example of a symbiotic relationship in reinsurance and ILS.
For State National the relationship benefits it with additional fee income for underwriting business that it only retains a small amount of risk, retaining annual aggregate losses above a high attachment point (which it believes it would be difficult to exceed).
For Nephila Capital, it’s all about the access to risk in a more efficient manner, providing reinsurance risk capital to back primary property catastrophe programs outside of the typical reinsurance renewal cycle, while benefiting from leveraging State National’s reach and rated paper.
State National sees the current state of the reinsurance market as a growth opportunity, saying that “The increased role of capital markets alternatives to reinsurance, the capitalization of hedge fund-backed reinsurers and the growth of the non- U.S. reinsurance market generally, including syndicates of Lloyd’s of London and Bermuda-based reinsurers, should drive demand for our fronting services, as these firms typically do not have direct access to the U.S. insurance market.”
The increased demand State National has seen has helped to drive demand and increase the number of new programs sold. That’s helping State National to become a bigger player in the primary U.S. program insurance services market, and all while making use of other sources of capital and capacity, some of which are efficient and capital markets backed (like Nephila).
In that way the growth of program fronting can be seen as a disruptive force in the primary space, bringing reinsurance capital more directly to the source of risk, making price competitive and efficient, while also taking fees out of the typical risk-insurance-reinsurance food-chain.