Legacy solutions to provide casualty sidecar investors with more security over capital exits come at a negligible cost to projected returns, Enstar argued in a fireside chat at ILS Connect in New York City earlier this month.
The firm has been looking to the ILS market for deals, including the need for run-off solutions to support capital release for investors affected by post-event trapping.
The size of ILS capital trapped market-wide was said to be around $5bn-$10bn, including deals impacted by Covid losses which had taken longer than expected to settle, according to Anguel Zaprianov, EVP at Enstar Group.
In July, Enstar closed a deal to take on the reserve risk of the AlphaCat portfolio, noting that it would reinsure certain 2019 and 2020 business written by an ILS platform, for which it would receive $350mn in premium.
In October came news Enstar had created a forward exit option (FEO) for third-party investors in Fractal Re, a Bermuda collateralised reinsurer that will provide $270mn of capacity to US MGA Starwind Specialty’s portfolio of casualty programs.
The deal is structured with Fractal Re providing reinsurance to State National, the fronting carrier that is facing Starwind.
Enstar is providing an option to individual capital providers to exit after seven years, which they may exercise or not, in return for a fee.
All parties to the deal including the investment manager Stone Point have put a stake of their own capital into the Fractal sidecar to ensure alignment.
Asked about the cost to investors of exercising the FEO, Zaprianov framed it as “about 150 basis points” off the deal’s internal rate of return (IRR).
He said: “If you look at a scenario where in seven years’ time, investors are able to novate the reserves at zero cost, versus where we ended up doing it, investors will sacrifice around 150 basis points.”
Zaprianov added that he thought it “unlikely” that it would be possible to transfer the risk at zero cost, and that the example scenario was a guide to potential pricing of an FEO, but that this would vary per transaction, depending on factors including the portfolio of risks and deal duration.
He added that many investors are unable to invest in structures without a definitive maturity date. “For some investors, the FEO allows them to go into the vehicle versus not invest at all,” he said.
There is nothing in the FEO that would prevent investors from exploring run-off deals with other legacy markets in the future, while on the other side, the FEO ties Enstar into providing the exit.
Zaprianov continued that, of three main components driving the internal rate of return (IRR) in a casualty ILS investment, the FEO would count as least significant.
“By far the most important contributors to the deal’s IRR will be the quality of underwriting by the cedant and the loss ratio it produces, and the returns made on investing the float,” he said.
Specifically, on the Starwind deal, the MGA’s track record was an important factor.
“Starwind is one of the biggest MGAs in the US. It’s very, very well diversified, about $2bn-plus of premium a year. There is a very long history we could rely on in terms of the business that they’ve written, the loss ratios they have, and the experience of the management team. So that’s one component of how we view these transactions.”
A second component was having comfort around the front State National and how it sets reserves. “How the reserves are set is obviously very important. We also need to understand the reserve profile at the time of the novation. We’ll look at the loss ratio. We will project what that reserve profile will look like, then price the risk accordingly.”
In the case of there being disagreement over the reserves, the deal includes a mechanism to manage that process.
LPTs to release trapped capital
In terms of a more conventional loss portfolio transfer (LPT) deal to release trapped capital from ILS vehicles, Zaprianov said pricing generally depended on where the reserves are relative to the cedant’s view of reserves.
“If they are under-reserved, the deviations could be large. But there is no such thing as an average LPT.”
The firm said that, as trapped capital has “been an issue for the ILS space for a while”, there is a market need for liquidity options.
“We get the sense there is lot of interest in a solution like this, from stakeholders including ILS funds, sidecars and fronting carriers,” Zaprianov said.
He added that Enstar had “an interest” in doing capital release transactions, and that each would be “fairly bespoke".
“If it was a property book, it would look different because it’s much shorter tail business and the novation option could kick in a lot earlier,” he noted.
He said $100mn of reserves was “a good guidance” as to minimum size of LPT deals the firm is willing to consider for ILS firms, adding “but if it’s a strategic area where we see potential we are happy to go with that”.
Addressing IRR on LPTs, he said: “We are a publicly traded company, our ROE is between 13% and 15%, so people can make inferences on what our IRRs are on deals.”
The legacy market is currently enjoying a healthy amount of competition, particularly for blocks of business “not that significant in size”, where there are plenty of markets that will quote.
Legacy markets have gradually been developing structures and terms that enable ILS investors to exit deals where capital became trapped by cat losses in the years 2017-2022.
However, development of solutions has been slow moving, as legacy players generally have more comfort in writing longer-tail casualty risks than shorter-tail cat portfolios.
As greater understanding develops between the two, shorter-duration run-off deals will increasingly be discussed.