State National Companies has seen growth in its program services business, where it enables capital and capacity to access U.S. insurance business through fronting for it, thanks to capital market alternatives to reinsurance and ILS players.
State National provides program-services business which see it fronting for insurers, reinsurers and ILS players that want to access U.S. market business, but who don’t have the necessary rating, the ability to access the business or in some cases are offshore (or alien insurers or reinsurers).
State National effectively underwrites the business on its rated paper while the capacity provider reinsures the risks underwritten. Fronting companies are common in the insurance-linked securities (ILS) space now, but in the case of State National it is a little different as it fronts insurance policy business in programs or portfolios, which allows reinsurers to access U.S. based insurance business, turning it into reinsurance portfolios, that they otherwise could not.
In its results State National reports that its ceding fees, the fee it earns from business it provides fronting for, have increased significantly. State National reports that ceding fees increased by $3.4 million, or 38.3 percent, to $12.2 million in the third quarter of 2014 from $8.8 million in the third quarter of 2013. For the first nine-months of 2014 ceding fees hit $33 million, which is up almost 47%, from $22.5 million in the equivalent period of 2013.
Part of the fronting State National does is for what it terms ‘institutional risk investors’, which you can read to mean ILS investors, ILS managers and also hedge fund reinsurance entities.
This allows ILS players and other alternatives to traditional reinsurance to access U.S. insurance business returns, which otherwise may not have been available to them. It also allows them to effectively create new reinsurance portfolios, by partnering with producers in the U.S. who can construct portfolios that are fronted by State National and ultimately reinsured by the ILS capacity.
One such ILS manager that is working with State National Companies is, of course, Nephila Capital the largest ILS asset manager in the marketplace.
Nephila Capital has an agreement with State National Companies that provides the ILS manager with access to fronted insurance which it can provide reinsurance capital to cover. This broadens Nephila’s reach and distribution of its capacity, while State National benefits from the growth in premiums written on its paper and as a result earns increased amounts of ceding fees.
Nephila are just one company working with State National though. State National sees the growth of ILS and capital market alternatives to reinsurance as positive for its business.
“The increased role of capital markets alternatives to reinsurance, the capitalization of recent hedge fund-backed reinsurers and the growth of the off-shore reinsurance market generally should drive demand for our services, as these firms typically do not have direct access to the U.S. market,” State National explains in its latest quarterly report and its management reiterated this during its earnings call.
The growing ILS market and the increase in hedge fund backed reinsurers is now making a difference to State National. The firm explains; “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 currently accessing the U.S. market through our insurance subsidiaries,” the State National report continues, going on to explain the relationship; “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.”
Effectively this means that Nephila Capital has secured access to a source of risk, where it can put its reinsurance capital to work, likely in business that would not have been available to the ILS manager through other, more traditional or renewal based routes. It also allows Nephila to put its capacity to work in areas where rated paper is important to the underlying cedents as well, leveraging the fronting State National provides.
As a program business provider, State National Companies helps its re/insurance clients bridge the gap between reinsurance capital and insurance market opportunities. Through its agreement, Nephila Capital can help State National’s insurance affiliates to grow their business, using the capital ultimately sourced from third-party ILS investors, while paying it an attractive ceding fee.
State National stands to benefit from the growth of the ILS market, the use of third-party capital in reinsurance and the growing trend towards hedge fund backed reinsurers. All of these new or recently formed markets are keen to access new sources of business. State National clearly has an appetite to deepen its relationship with new capacity providers such as ILS and sees it as an opportunity for growth.
Of course as you may have noticed above, Nephila Capital has the exclusive right to access U.S. property insurance risks through State National, a very smart agreement to have in place as there is no doubt that other ILS managers would also love to access this type of business. That does mean that State National should focus future marketing efforts on attracting capacity providers, such as ILS, covering other lines of business outside of U.S. property catastrophe risks.