Randall & Quilter (R&Q) Investment Holdings, the specialist non-life insurance and reinsurance legacy investor and program manager, has announced the formation and launch of a legacy insurance focused collateralised reinsurance sidecar named Gibson Re, which is being capitalised to the tune of roughly $300 million by investors.
Gibson Re brings R&Q’s long-standing ambition to have a reinsurance sidecar vehicle to life.
The company has been discussing the possibility of a collateralised reinsurance sidecar structure, as an aligned vehicle for bringing investor capital into its business, since at least early 2019.
As we explained in July, the work to form a sidecar was already well-advanced, with R&Q targeting a $500 million vehicle to fund the growth of its legacy and run-off insurance business, with the project named Race Re.
But, names change and ambitions have to be tempered to meet investor market appetite, so now we have a roughly $300 million Gibson Re legacy reinsurance sidecar instead.
Interestingly, where as most sidecar sponsors typically want to own their structures, in this case it appears that the investors own and have formed Gibson Re Ltd. as a Bermuda collateralised reinsurer, to provide collateralised reinsurance capacity to support R&Q’s legacy deal-flow.
That’s a little unusual, in that R&Q does not have sole ownership of its third-party capital structure. Which perhaps provides a little less certainty for the company, but at the same time it has met its target of demonstrating it can attract outside capital to support the legacy underwriting business.
Gibson Re is a a Bermuda-domiciled collateralised reinsurer and will be capitalised to around $300 million by the investors backing the sidecar, which R&Q says will support roughly $2 billion of reserves for the company.
Gibson Re will reinsure 80% of all of R&Q’s new qualifying legacy transactions across a three year period, the company explained, while R&Q will take the other 20% to ensure alignment of interest.
Again, this is interesting, as most sidecar sponsors would promote the structure as being an aligned pool of capital to promote growth of the business, where as in R&Q’s case it has been explained as a collateralised reinsurance pool, that has the ability to take 80% of the legacy risks it originates, if they qualify.
In return, R&Q will be paid 4.25% in annual recurring fees of Gibson Re’s reserves for at least a six year period, with the ability to earn potential performance fees as well if the legacy and run-off business delivers positive returns.
By design, R&Q said that, “Gibson Re will transform Legacy Insurance into primarily a recurring fee-based business.”
When we were told some of the details of the project that was called Race Re, the fee income was expected to be 4.5%, so it seems the investors have negotiated that side of the structure down a little, while performance fees were initially pitched at 15% of returns, after a hurdle of 6%.
Based on a profitable earn out across $2 billion of premiums, it’s clear R&Q could generate very high revenues from this strategy, as long as the business performs over the duration of the sidecar cycle.
This kind of fee-related revenue can compound with the launch of additional sidecars, or new Gibson Re capital raises, making R&Q’s business very flexible.
It also makes growth important though and puts the onus on R&Q’s underwriting teams to continue delivering quality originated run-off and legacy business.
If Gibson Re proves profitable, which really comes down to the quality of the legacy business and risks sourced by R&Q, then it could become a driver of recurring revenue for the company and provide it with an efficient model to seek out additional growth.
But this model does mean that R&Q effectively gives away a significant proportion of the risk-linked returns associated with the subject business that qualifies to be written by Gibson Re.
Meaning the company may have to, both, work harder to secure the same level of legacy business related revenues and also ensure the quality of the business it writes is high to get the necessary associated performance fees.
It’s perhaps notable here that R&Q’s legacy business segment experienced a 60% decline in underwriting income and as a result fell to a loss for the first-half of 2021. Overall R&Q reported a pre-tax operating loss of $23.5 million, on the back of the legacy underwriting loss and also high corporate expenses.
The company put this down to timing of legacy transactions, with at least two expected to close in the second-half of the year.
William Spiegel, Executive Chairman of R&Q, discussed the launch of the Gibson Re sidecar and provided more details in his commentary.
“Our announcement of the formation of Gibson Re starts the transformation of R&Q’s Legacy Insurance business from being balance sheet intensive with episodic earnings to a more capital light and predictable, largely recurring fee-based model. Gibson Re is a $300 million Bermuda-domiciled collateralised reinsurer owned and funded by sophisticated insurance investors. Our Legacy Insurance business now joins our Program Management business in generating most of its future revenues from annual recurring fees,” Spiegel explained.
Adding that, “R&Q is repositioning the business to become an asset manager for Legacy Insurance business, focusing on our core strengths of insurance origination, underwriting and claims management. This change reduces our reliance on the capital markets to support our growth.”
There will, of course, still be a reliance on the capital markets, as the funding of the Gibson Re sidecar is now an important strategic lever for R&Q, necessary to continue driving the growth of the business.
In addition, further sidecar capital raises are going to be required as well, in order to allow for growth beyond the roughly $2 billion of reserves Gibson Re is designed to secure.
Spiegel explained the benefits of the transition to a more capital light model, with third-party investors set to now provide a significant proportion of R&Q’s underwriting capacity.
“The launch of Gibson Re simplifies our Legacy Insurance revenue model from one with lumpy Underwriting Income and seasonality (historically only ~30% of our Legacy Insurance transactions complete in H1 and ~ 70% in H2, measured by reserves acquired) to one with a predictable and high-quality recurring Fee Income. Importantly, by reducing the capital intensity of Legacy Insurance, we free up capital to support our previously announced progressive dividend policy and reduce our reliance on the equity markets for additional funding,” he explained.
R&Q will also need to plough freed up capital into growing the business as well, on both its Program and Legacy sides. The quality of its origination is going to become a key lever for growth going forwards, as R&Q transitions to this more fee income focused business model.
Spiegel then provided more details on how the structure is expected to work for R&Q, saying, “For the next three years, Gibson Re will reinsure 80% of all of R&Q’s qualifying Legacy Insurance transactions. Gibson Re’s capital allows R&Q to acquire approximately $2 billion of insurance reserves, and R&Q will be paid annual fees of 4.25% on reserves ceded to Gibson Re, plus potential performance fees. R&Q will manage Gibson Re for at least six years, and after seven years, R&Q will offer a commutation of the outstanding reserves.”
A commutation clause is vital in a structure like this, as the third-party investors backing Gibson Re will not want to be on the hook for the liabilities it has written over the longer-term.
How this commutation clause is written is another key point in the structuring of an insurance-linked securities (ILS) vehicle focused on legacy business, as it needs to align the needs of the ceding company (R&Q) with those of the investors, while also ensuring the investors can get out if they want to.
If the business ceded to a legacy sidecar like Gibson Re develops adversely over time, the investors will not want to recapitalise it and will want to cut their losses. Conversely, if it develops well, the investors will want the certainty that they have an option to recapitalise it, you would imagine.
The sidecar strategy looks like it is here to stay for R&Q, as Spiegel also said that, “If all of Gibson Re’s capital is deployed by 2023, Legacy Insurance should generate run-rate Fee Income of approximately $50 million. It is anticipated that we will raise a new sidecar after three years for ongoing capital support of the Legacy Insurance business.”
So that would be $50 million of fee income for R&Q’s legacy business over a roughly two year term it seems. That seems quite an ambitious earn-out rate and would require the full $2 billion of reserves to be secured pretty quickly in the lifespan of Gibson Re to hit it, it would seem, but very profitable for R&Q if the business can be sourced in good order and matures profitably.
Legacy business can deliver a lot of its profits upfront though, so realising the commission will be reliant on getting the premiums in, while the performance fees will likely be earned later in the Gibson Re vehicles first cycle.
R&Q has bullish targets, now including the addition of the Gibson Re sidecar to its business model.
Spiegel said that, “With the formation of Gibson Re, we expect FY 2021 Pre-Tax Operating Profit to be relatively flat to FY 2020, depending on the timing of completing Legacy Insurance transactions. By 2023, if we deliver on our business targets, we expect to generate run-rate Fee Income of greater than $140 million and Pre- Tax Operating Profit of over $90 million, assuming Gibson Re capital is fully utilised.”
He also said that R&Q’s dividend payout ratio could be significantly above its 25 – 50% range, which would be funded by excess capital created by the establishment of Gibson Re.
R&Q has been targeting the launch of this sidecar for some year’s now, but the strategic rationale has changed from a more typical pool of capital to support doing more and larger legacy or run-off deals, to one where the investors own the structure and look set to take the lions share of the risk premium originated by R&Q’s legacy business.
There’s nothing wrong with that, it certainly puts the emphasis on a capital light approach, where the quality of origination, underwriting and management of the legacy risks will be the deciding factors between profit and loss.
The sidecar will provide significant firepower and leverage for R&Q to grow its legacy business. But it is more dependent on that business being sourced more quickly, perhaps on more business being sourced than before and on delivering the returns needed to satisfy the investors return requirements, it would seem.
R&Q is the second legacy player to launch a reinsurance sidecar, after Premia Holdings launched its Elevation Re vehicle in late 2020.
Find details of numerous reinsurance sidecar investments and transactions in our directory of collateralized reinsurance sidecars transactions.