TransRe, the reinsurance arm of Alleghany Corporation, is able to “punch above its weight” in the global reinsurancem market, thanks to its access to efficient third-party capital, Alleghany CEO Weston Hicks said.
The Alleghany group is actively working together to help TransRe expand on its strategic capital relationships, to help in this respect, as they look to continue leveraging investor appetite for reinsurance related returns.
The use of alternative sources of reinsurance capital has become increasingly important to traditional players, as they look to maintain and grow their market-share in catastrophe prone regions of the world.
The largest reinsurers are bulking up on their third-party capital arrangements now, as a way to augment and add elasticity to their balance-sheets, meaning other reinsurance players are steadily following suit.
TransRe and Alleghany have been active in the alternative capital space for some years now, utilising their quota share sidecar vehicle Pangaea (which has been at least $500m to $600m in size, perhaps now more), the relationship with ILS fund manager Pillar Capital Management (now at over $1.7bn of AuM) and other strategic capital relationships.
Weston Hicks, CEO of Alleghany, discussed some of this in the firms results late yesterday, explaining the importance of access to third-party and ILS capital, but also warning that investors need to understand what they are getting into and partner with the best underwriters.
“TransRe’s approach to the alternative capital market has been to utilize a combination of aligned capacity (through its sidecar, Pangaea), market-facing capacity (through Pillar, its 50%-owned alternative capital manager), and strategic capital relationships (through its unique exclusive agency relationship with Gen Re for North American business),” he explained.
These initiatives and access to third-party reinsurance capital in general, “Continue to play a major role in helping TransRe serve its customers in creative and cost effective ways,” Hicks said.
Hicks has always been vocal in his views on alternative capital and the insurance-linked securities (ILS) market, having previously likened the world of efficient alternative reinsurance capital to Frankenstein’s monster.
He said at that time that the market was untested against the “big one” and problematic because of potential incentive misalignments.
Certainly, ILS and alternative capital has now been thoroughly tested by recent years of heavy catastrophe losses, while incentives are more closely aligned than ever and investors are now leading many of these discussions and actively seeking out aligned partnerships with ILS fund managers or re/insurers.
Hicks has also highlighted the risks associated with fronting for alternative capital partners in the past, saying that re/insurers should be careful that they aren’t just chasing the reinsurance market tail and to beware they aren’t left holding it.
So Hicks views on ILS and alternative capital can be contrary, but it’s clear he sees an aligned approach as key to TransRe and Alleghany’s activities in this market.
Hicks is positive on the outlook for ILS, but recognises that after all the losses of recent years some changes are underway, “While we believe that alternative capital is here to stay, we also believe that investors are in the process of reallocating capital commitments toward asset managers that have demonstrated the ability to price and underwrite catastrophe risk appropriately.”
This is the much discussed flight to quality that has been seen in recent months.
“Finally, it appears that the alternative capital market has begun to recognize that it was supporting a deficient pricing environment in property catastrophe exposure. Investors in ILS funds are becoming more discerning, and managers are becoming more selective and demanding,” Hicks said.
Hicks clearly sees an opportunity here for TransRe to capitalise on this and to attract more of the alternative capital in the market to work with his firm.
In fact work is underway to achieve precisely that.
“We are working with TransRe to develop additional strategic capital relationships, which give TransRe the ability to “punch above its weight” in the reinsurance marketplace,” he explained.
It’s perhaps telling that Hicks also discusses climate change risks in his annual letter to shareholders, highlighting the challenge this brings to reinsurers and also to ILS investors.
Not notably he explains, “The easiest way to increase the probability of long-term survival is to reduce the amount of exposure that a company assumes by writing insurance and reinsurance relative to its capital base.”
Of course, you could underwrite less risk to achieve this, or you could underwrite more of it using someone else’s capital at levels designed to take volatility out of your book.
Hicks continues, “Of course, we could structure ourselves so that the probability of a major loss was infinitesimally small, but that would also mean returns on equity that our investors might not find very attractive; by contrast, an endless pursuit of higher returns on equity by dramatically increasing aggregates relative to capital in a largely commodity-like industry can expose a company to undesirable risk of ruin.”
Or you could use someone else’s capital to help you sustain your relevance in the market, continuing to steadily grow returns on equity with the additional benefits of fee income and reduced volatility, by handing off a share of losses to investors.
Alignment is a narrow tightrope along which the reinsurance industry currently treads, you might be forgiven for reading into this.
Of course, this is precisely how alternative capital is being used by many traditional players right now. It is helping them manage PML’s, it is driving fee income, it is helping them avoid having to shrink their books and it does seem this is likely to accelerate as climate related risks have an increasing impact on the market.
Something for investors to ensure they carefully consider.
Their capital can be seen as a lever for efficiency, helping traditional re/insurance market balance-sheets go further and do more, all the while sustaining traditional business models.
It raises questions of alignment, of where losses fall and of independence versus aligned (in terms of management).
As everyone seeks to get this balance right there is going to be a lot of change in the reinsurance and ILS market, a lot of noise regarding alignment and a lot of trial and error in finding precisely where alternative capital best sits.
Alleghany’s TransRe has continued to grow in the last year, adding 15.1% and 13.2% to premiums written in the fourth-quarter and full-year 2019 respectively.
But the company also reported a technical underwriting loss, with a 114.4% combined ratio for Q4 and 100.9% for the full-year.
Catastrophe losses are the main drive of this underwriting underperformance, as TransRe reported them as $224 million and $301 million for the three months and year ended December 31st 2019, respectively.
Not only will some of TransRe’s third-party investors in its Pangaea collateralised quota share sidecar vehicle likely have shared in some of these losses, so too will some of its providers of collateralised retrocession.
Other strategic capital relationship investors may also have helped to reduce the ultimate impact of catastrophes for TransRe in 2019.
It’s likely alternative, third-party and ILS style investor capital is already helping TransRe and Alleghany in moderating the impacts from catastrophes and climate related weather events.
As the company expands these partnerships, alternative capital will become an ever more important lever for the company, as it is across re/insurance.
Which ultimately will cement direct access to third-party investor capacity’s position in the industry’s capital stack.