Nephila Capital, the largest insurance-linked securities (ILS) investment manager with $10 billion of reinsurance and catastrophe-linked assets under management, is increasingly targeting the insurance market as a risk capital provider in order to tap new sources of return.
Providing capital to insurers is effectively what reinsurers do and Nephila Capital, as a third-party capital backed reinsurance asset manager, is no different. The firm invests in catastrophe bonds, industry loss warranties, derivatives linked to catastrophe risk and weather risk, as well as underwriting collateralized reinsurance contracts, to channel returns to its investors through funds, portfolios and private mandates.
Increasingly though the ILS manager is finding success in accessing returns derived from catastrophe risks through providing reinsurance capital to property insurance businesses. By providing some of its third-party capital backed reinsurance underwriting capacity to insurance companies, enabling them to start-up or reach their next level of growth, Nephila is using reinsurance capital as a financing tool, as well as the more typical direct hedging seen in a traditional reinsurance contract.
In a recent deal with State National Companies it appears that Nephila Capital is, through the provision of reinsurance capital, enabling State National to produce more business by supplying it with some of the capacity necessary to underwrite it. State National is then effectively able to issue more insurance policies using the reinsurance capital that Nephila has provided it with as a source of capacity.
State National Companies is a program business provider, bridging the gap between reinsurance capital and insurance market opportunities. By entering into an agreement with it, Nephila Capital can help State National Companies insurance affiliates to grow their business, using the capital ultimately sourced from third-party ILS investors.
So this deal boils down to Nephila Capital’s third-party sourced reinsurance capital being leveraged to provide a growth opportunity for State National Companies to write more business. This gives Nephila a source of return from property catastrophe insurance business, which is what it seeks from all its reinsurance and catastrophe linked investments. These returns will be assumed into the Nephila portfolio and directed into various funds and mandates to benefit the firm’s investors.
A State National Companies SEC filing states:
We have experienced additional demand for our program services from an increase in hedge fund sponsored reinsurers and other institutional risk investors. One recent example of a significant program with an institutional risk investor is Nephila Capital Ltd. Nephila is a hedge fund with approximately $10 billion in assets under management that participates in the reinsurance market for catastrophe exposed property business.
Nephila is currently accessing the U.S. market through our insurance subsidiaries and we estimate gross writings under this program for 2014 to be approximately $50 million, upon which we expect to earn ceding fees of approximately $1.2 million this year. In addition, we have recently entered into a new arrangement with Nephila under which we have granted Nephila the exclusive right to produce U.S. property insurance, predominantly in areas potentially affected by catastrophes, for us during 2015 and 2016.
Under this arrangement, we have agreed to provide Nephila up to $400 million of premium capacity for 2015 and 2016, and Nephila has agreed to produce minimum premiums written of $300 million for 2015 and $400 million for 2016, with equivalent ceding fees paid to us on such amounts whether or not the minimum premium levels are produced, subject to our maintaining our “A” A.M. Best rating and potential reductions to the extent we do not have the authority to write the particular policies they desire to have written and they write such policies through other providers.
It is interesting that State National Companies notes that its facilities are also in demand from others in the alternative reinsurance capital and hedge fund reinsurance space, who have clearly noticed that by working with a program business provider they can access catastrophe insurance returns in a different kind of way, to the benefit of their investors.
Entering into an agreement like this makes perfect sense for Nephila Capital. It allows it to access the returns of catastrophe insurance business, leverage their third-party sourced capital to back underwriting of risks that are (currently) facing less competition than the reinsurance market is seeing and boost their portfolio returns by accessing business other ILS managers are not targeting (yet).
We will likely see an increasing number of deals like this, particularly while the property catastrophe reinsurance market remains so competitive. They give an ILS manager access to new sources of return, while also offering a different type of diversification. As such it is to be expected that these deals will become more popular, as will the financing of primary insurance market players for returns, by being a reinsurance or risk capital provider rather than simply a straight reinsurer.