Chief Executive Officer of Bermuda located insurance, reinsurance and third-party reinsurance capital management group Validus Holdings, Ed Noonan, said on the firms recent earnings call that its AlphaCat ILS management segment turned down money from investors in Q2, as did the ‘smarter managers in the space’.
Validus has always prided itself on being able to find attractive opportunities in reinsurance and catastrophe risk for its third-party investors money to be deployed into, however in 2013 finding those opportunities has not been as easy, due to increased competition and lower rates, particularly on Florida business.
Ed Noonan commented that the Florida renewals were seen as quite competitive with rates down around 15% and as Validus expected the ILS market played a large role in Florida at the mid-year reinsurance renewals. Noonan said that for ILS managers, Florida represents a market that requires a lot of capital to be put to work due to the premium intensity of the business there.
Validus spotted the Florida market was likely to become a little overheated, Noonan said, and so chose to pull back from the wider Florida market, opting instead to put capacity into a number of private transactions where it felt the terms, conditions and pricing were better and more suited to its return requirements.
Noonan said that Validus deployed a considerable amount of capacity through private transactions and so only wrote Florida business that complemented its book. As a result its overall Florida book of business shrank meaningfully which helped it to improve its expected loss ratio by 1%.
Noonan explained how Validus is seen by its clients and why it does so well at renewals; “Our clients tell us that they get more and better analytical insight from us than from any other reinsurer by a wide margin. We work with them to improve their business by improving data quality, using deep underwriting attributes to affect risk selection and pricing and to help them understand where they stack up in the broader market. Consequently, we’re not hesitant to ask for preferred signings and private transactions. Our underwriters monetize our considerable investment in research and analytics every day in the market.”
Noonan also explained that with Validus Re’s reinsurance underwriting the aim is to outperform the broader market, not to track it. It found more opportunities at the July 1st renewals, where ILS managers were not so prevalent and rate decreases less apparent.
Validus chose to take advantage of the market conditions to increase its own retrocessional reinsurance coverage. This has helped it to reduce its 1 in 100-year probable-maximum-loss (PML) by $120 million and improve its net expected return on equity by 200 basis points over a similar period in 2012.
So despite rate decreases, which Noonan said the firm obviously does not want to see, Validus has still managed to put together a 2013 book of business which he feels is well-priced and high-quality. It is this ability that Validus has often been envied for by other firms.
Over the course of the second-quarter, Validus’ AlphaCat ILS fund and capital management segment took in an additional $72m in third-party assets. Noonan stressed that AlphaCat won’t take capital from investors unless it has the opportunities to deploy it in already identified reinsurance programs and layers. Again, Noonan said that Validus’ strategy is to beat the market rather than purely offer a beta return on it. This trend of discussing ‘beating the market’ does seem to be a new addition to Validus’ comments on the market, likely caused by the recent third-party capital influx and increased competition.
Even Validus has to turn down opportunities in order to maintain its underwriting and return discipline it would seem. Noonan commented on this; “AlphaCat turned away money in the quarter, as did the larger smarter managers in the space.”
It’s going to take some time for the market to establish whether any ILS managers have been putting capital to work without being sufficiently disciplined. In a market environment such as we have seen this year, it must be very tempting to keep taking capital from investors and put it to work where you can. That is not a strategy for the long-term though and it is the ILS managers that can prove a disciplined approach to capital raising, capital management and underwriting risks that will build the best reputations and will have the greatest success.
Noonan said that ILS doesn’t work across the entire risk distribution and there is an element of saturation in the market currently. He said that Validus’ reinsurance clients want the reduced cost of capital that comes with ILS but also want the stability and support of expert reinsurers to support their programs, Noonan feels like this is the platform that Validus has built.
When discussing the rate environment, Noonan showed that he, unlike some other reinsurer CEO’s, appreciates the discipline in the ILS space. However he also noted that Validus cannot sustain continued reductions in pricing. He commented; “The ILS guys aren’t undisciplined, it’s just that they’ve got a lower cost of capital. So I think we’re probably looking at a period of time where there is still excess margin in the CAT business on a broad level. But again, we couldn’t sustain a couple more years of 15% off.”
Noonan was asked on the earnings call whether he felt that ILS and third-party capital was beginning to move into other short-tail reinsurance lines of business. He said that many short-tail lines aren’t as conducive as catastrophe risk or as easy to sell to investors. He cited marine and terrorism as examples that are harder to package into an investment product for external capital at the moment.
However, Noonan did say that there are other areas that would be conducive to ILS entering the market. He cited flood as a real potential expansion opportunity for the ILS market, particularly if the U.S. government stopped providing the back-stop for flood risks. He also cited the renewal of the TRIPRA terrorism insurance back-stop as another possible avenue for ILS and third-party capital. But, he said that right now there isn’t that much focus on it as everyone is concentrating on catastrophe risk and that is where capital is largely deployed.
Read our other article on Validus’ latest earnings from Monday: AlphaCat increases contribution at Validus, PaCRe investment losses weigh.