Renaissance Re, the Bermuda-based reinsurance underwriter and manager of increasing amounts of third-party capital, believes that Covid-19 uncertainty means “substantial amounts of collateral will be trapped” at the end of 2020, the firms CEO Kevin O’Donnell has said.
Trapping of collateral has always been expected, given the uncertainty over potential losses facing reinsurance and retrocession programs that are collateralised by insurance-linked securities (ILS) fund managers, or structured as quota share vehicles such as sidecars.
As we’ve explained before, some ILS funds may find collateral trapped for a long-time, even on treaties and reinsurance arrangements where pandemic coverage had never really been envisaged.
It’s clear some ILS market losses are coming because of the pandemic, as certain ILS funds have already been marking down some positions due to the uncertainty.
The scale of ILS market losses remains uncertain though and will likely come down to wordings, exclusions and their adequacy, but it looks likely that the collateral trapping may be sufficient to reduce available ILS capital as we approach the end of year renewals.
Speaking during his reinsurance firms earnings call last week, Kevin O’Donnell, CEO of RenaissanceRe explained that reinsurance and retrocession capacity are going to be impacted by the Covid-19 pandemic and that trapping of collateral may be substantial in his view.
“The market is uncertain about the breadth and depth of losses that could arise from Covid-19,” he began. “This uncertainty will reduce the market’s appetite for risk and constrain supply.
“We expect that retro capacity from third-party investors will be constrained. This will be another challenging year for third-party capital, as we believe substantial amounts of collateral will be trapped at year’s end.”
Annual reinsurance and retrocession contracts that will renew in January 2021 may be the most at-risk of facing trapped collateral, given their often broad exposure and the fact with some months of uncertainty ahead cedents may seek out extensions to hold collateral if the threat of business interruption and legislative action is still hanging over the industry come Q4.
He noted that the ILS market has faced trapped capital every year since 2017 and that the pandemic is a more correlated peril for investors to deal with. On top of which, end-investors also have other asset classes that they care about, some of which right now might offer significant opportunities.
“The likely result is another reduction in third-party capital, which will further constrain supply,” O’Donnell said.
But, as you might have expected, O’Donnell doesn’t believe this will be such an issue for RenRe and that his firms third-party capital platform may actually benefit from the pandemic fall-out.
He explained, “The story for RenRe partner capital business is different. Many of our capital partners have been with us for over a decade and while we do expect to see some redemptions, the capital arrangements that we have with many of our partners are long term in nature. Reducing our exposure to large and immediate redemptions.”
In addition to which, “We anticipate that current circumstances will accelerate the flight to quality that we have already seen in the third-party capital market.
“We believe that our partner capital platform is in an advantaged position, relative to other funds and given our structural advantages and broad access to capital will only become stronger.”
Not all the effects will be positive for reinsurance underwriters, like RenRe though, as they do still rely on some retrocessional protection and any dislocation in the ILS market will affect retro capacity availability.
But again, O’Donnell believes this plays into RenRe’s hands and strategy, as, “We can manage any reduced availability by simply retaining more risk, which is consistent with our strategy of retaining more when the price of risk is rising. Others may need to shrink if their retro reduces which will further reduce supply.”
But there are unknowns still, surrounding the Covid-19 pandemic and how it could hit property insurance towers and reinsurance programs, which would impact RenRe and also its third-party investor base.
In fact, from O’Donnell’s comments, it seems likely that RenRe’s third-party capital vehicles and ILS funds will in some cases be as exposed to trapping of collateral as any other ILS fund manager’s vehicles.
O’Donnell explained how he sees the Covid-19 exposure in RenRe’s property book, “About half our property cat book is residential, which is generally not exposed to business interruption. Further, due to the growth of our Ventures business we now share more than two-thirds of our property cat premium with Ventures and retro partners.
“This means we retain less than one-third of our gross premium, which reduces our exposure to an amount substantially less than our top line numbers might imply.”
But which also means that RenRe will likely call on its third-party capital partners to assist with paying any claims that do emerge, on the property side.
With the threat of any losses such as this also likely to result in collateral being trapped in its ILS-style strategies, particularly Upsilon given its collateralised reinsurance and retro focus perhaps, as well as Medici.
It’s harder to speculate on the potential for a hit to the joint-venture vehicles, DaVinciRe and Vermeer and given their ratings and balance-sheets they may not face the same trapped collateral pressures. But the investors behind them could still face some impacts, should RenRe itself take any Covid-19 losses within its property books.
O’Donnell summarised the implications of all of this, saying, “In the market, capital is now scarce and risk is now abundant.
“Given our strong capital and liquidity position we will be looking for opportunities to deploy more capital in the second-half of the year.”
Which bodes well for the third-party capital investors backing RenRe’s vehicles, just as long as the trapped collateral issue isn’t too substantial for them.
Inflows from third-party investors continued for RenRe through the beginning of 2020, meaning the company is likely well-positioned for the renewals in terms of capacity and may even be trying to raise more for the mid-year contract signing season.