Conventional Reinsurers Move into Alternative Capital

Everest Re, formerly the reinsurance arm of the Prudential, is one of many retro buyers newly converted to the ILS market.

Paul Schultz, the chief executive of Aon Benfield Securities, says the Bermuda reinsurer is a “great example” of the trend. “They are managing capital in different risk buckets.”

Everest’s first tentative participation in the alternative capital arena came about five years ago when it purchased some limited retro protection through industry loss warranties (“Bluffers Guide”). More recently Everest Re has thrust aggressively into ILS, becoming one of the largest issuers of insurance-linked securities. The activity lies behind its recent premium growth, in defiance of the softening market, Schultz contends. “Everest shows some of the benefits of embracing the ILS market, as opposed to looking at it as a threat,” he says.

Everest Re came to the catastrophe bond market in 2014, when it sponsored two bonds in quick succession through its special-purpose vehicle, Kilimanjaro Re. In April, the SPV sold the reinsurer $450 million worth of five-year retro to cover its book of assumed U.S. earthquake and windstorm risks. Bond buyers from the capital markets vacuumed up the risk, so the Kilimanjaro bonds pay the investors less of a premium than originally planned. That reduced the cost of the retro for Everest Re. Meanwhile, bondholders’ cash is invested solely in ultra-safe U.S. government paper. The architect of the deal, and the bookrunner, is Schultz’s Aon Benfield

Securities, while the Bank of New York Mellon, one of America’s cat-bond cash-management leaders, is handling the money.

The success of the issue prompted Everest Re to seek more of the capital market’s seeming largesse last November. Kilimanjaro Re’s second issue provides $500 million of five-year cover against U.S. and Canada earthquakes. Both bonds would be triggered by industry losses of a stated magnitude, as measured by the Property Claims Service (see “Trigger Happy”). Although investors stand to lose everything if a massive loss event happens, the risk is pretty low. Standard & Poor’s observes that the first bond would have been wiped out only by the San Francisco earthquake of 1906 or the Florida hurricane of 1926 (which struck before the quaint practice of storm-naming).

In the case of the earthquake-only bond, total insured losses from a single shakeout will have to hit $1.075 billion before the retro pays—but only six such events have occurred since the year 1700. That said, Bill Leith, senior science advisor for earthquake hazards at the U.S. Geological Survey, recently told a roomful of Lloyd’s underwriters that the Big One in California is statistically overdue. A 7.8-magnitude quake southeast of Los Angeles would do property damage costing $112.7 billion, he said.

The losses retroceded by Everest Re to the capital markets are very high-level, what the pricing analysts describe as “tail values.” However, the cash backing the bonds is ultimately insuring pretty run-of-the-mill risks, albeit against rare events. The retro reinsures Everest Re, which in turn reinsures most of the leading carriers in the U.S. and Canada. The commercial property they cover under primary policies makes up about two thirds of the risks retroceded under the Kilimanjaro earthquake bond. Personal lines risks make up the rest.

When the capital markets provide Everest Re with a cheap way to lose its tail risk, it can offer cheaper reinsurance to its insurance-company clients. That means they in turn can offer cover for less. What’s the upshot? Everest Re’s premium income has grown, even as reinsurance prices are falling generally. Gently rising commercial property insurance prices have leveled off, and at least part of the trend can be attributed to the lower overall cost for insuring against earthquakes and hurricanes.

The Kilimanjaro Re cat bonds aren’t the only things allowing Everest Re to offer cheaper reinsurance with rock-solid security from the capital markets. Everest Re has set up a sidecar called Mt. Logan Re. It’s one of the largest in the business. The special-purpose reinsurance company takes a fixed percentage slice of specified reinsurance risks underwritten by Everest Re. Mt. Logan is separately capitalized, partly with cash from Everest itself, but 85% of its money has been invested by third parties, directly or through fund managers. By October, 2014, the sidecar’s capital had reached $370 million, about 50% more than was planned when it was launched in February 2013.

As with the cat bonds, investors showed an unexpected appetite for the investment. Their response “exceeded our expectations,” says Mt. Logan chief executive Rick Pagnani.

Mt. Logan is a prime example of an arrangement that allows fully collateralized property catastrophe reinsurance to be offered by a conventional reinsurance company. It also shows just how keen investors have been lately for such indemnity-related investment opportunities. A reported $170 million of the cash capitalizing Mt.

Logan has been invested through the reinsurance-focused hedge fund Stone Ridge Asset Management (which is also a substantial holder of Kilimanjaro Re bonds). New York-based Stone Ridge, which has more than $2 billion invested in the reinsurance sector, is effectively a mutual fund. It targets primary investors through registered investment advisors (RIAs), thus allowing anyone with a financial advisor and a large wad of cash to underwrite Acts of God. 

In yet another application of alternative risk transfer techniques, Everest Re provides whole-account quota-share reinsurance of the Lloyd’s business underwritten by Catlin Group. Now in its fourth year, the arrangement is worth almost $50 million. Everest Re’s “SPS” sidecar, Syndicate 6112, takes a small percentage of all of the risk underwritten by Catlin’s widely diversified Syndicate 2003, which is the largest at Lloyd’s. The deal gives Everest Re exposure to a broad spectrum of the risks that are brokered in the Lloyd’s market. Unlike most sidecars, which are fully collateralized, Syndicate 6112—along with all of Lloyd’s carriers—is highly leveraged. But it is mutualized, so its paper remains highly rated.