Fully collateralised catastrophe cover has helped to fill some of the pressing needs of the retro market since the hurricanes of 2005 dented capacity. But is it still too far outside the mainstream to achieve the key players’ goal of meeting all buyers’ reinsurance needs?

When Validus bought rival Bermudian reinsurer IPC Re in 2009, the market wondered what Jim Bryce would do next. The longstanding IPC chief executive didn’t seem the type to go quietly into retirement.

In November last year, the market got its answer. An announcement revealed that Bryce would be chairing a new retrocessionaire, Aliseo Re, which would start offering $300m fully collateralised retro capacity to reinsurers from 1 January 2011.

During the Monte Carlo Rendez-Vous, a couple of months before Aliseo Re was announced, news of a new catastrophe fund offering fully collateralised retro cover started to emerge.

By December CATCo, as the new entity is called, had raised $80m by listing shares in its UK-based closed-end fund on the London Stock Exchange’s Alternative Investment Market (AIM) segment. In addition to the AIM-listed closed-end fund, CATCo also runs an open-ended fund in its domicile of Bermuda. The company is targeting $1bn in investments and pitching itself to the top 35 reinsurers.

These new entrants could prove a shot in the arm for a sector that has, in recent years, been blighted by prohibitively high prices and a lack of capacity. After hurricanes Katrina, Rita and Wilma hit the USA in 2005, the traditional retro market all but shut up shop.

While prices and terms have softened since then, buyers still sometimes struggle to get all they need. Can these new fully collateralised players give retro buyers and investors what they want? And what impact are they having on the traditional retro market?

In high demand

CATCo chief executive Tony Belisle contends his firm has become a hit with buyers and investors alike. He argues that, unlike many catastrophe funds, which offer coverage for single risks in single territories, CATCo stands out because it offers protection in multiple jurisdictions and is not limited to property-catastrophe retrocession. In addition to property, it writes marine and aviation risks. It also aims to be the core retro provider for the companies it protects, assuming all the various risks they want to lay off.

The biggest selling point is the full collateralisation of the coverage, with the money held in a separate trust fund. Traditional retro writers can find the security offered by such products tough to beat, particularly given the continuing post-financial crisis jitters.

“Buyers love it,” Belisle asserts. “Buyer demand is phenomenal – it is far beyond our capacity and has exceeded even our expectations. We are now out trying to raise additional money because the buyer appetite was so great.”

He contends that such is the appeal of CATCo’s approach that it has even attracted overcapitalised reinsurers who can afford to retain more risk and were not looking to buy retro this year. “The reason is we are offering a portfolio-wide solution,” he says.

He adds that companies have said they will pay additional premium if CATCo raises more money in the first quarter and is able to offer more coverage. “We are topping up the existing deals in the first quarter.”

Others agree that the fully collateralised retrocessionaires are gaining recognition. The concept has been around for several years: a series of private equity and hedge fund-backed firms, among them Aeolus Re and DE Shaw’s reinsurance division, sprang up on Bermuda in 2006.

“The collateralised markets have stuck with it and seem to be part of the normal way of thinking,” says BMS Re managing director Jonathan Morris.

Belisle goes so far as to say that some types of retrocession will eventually be provided solely by the fully collateralised players. “I think what you will see is that super-catastrophe cover should only be in collateralised form,” he says.

Threat to tradition

Belisle also claims that on seeing CATCo’s product, some traditional retrocessionaires have taken fright because of the potential competitive threat. “Originally one of the big writers actually called me into their offices and said: ‘Maybe we want to buy up all of your protections so we’ll fill up all of your capacity just to get rid of you’,” Belisle says. “That conversation has happened before and it will probably happen again.”

CATCo’s presence is certainly attracting the market’s attention. While contending that some buyers still prefer security with rating agencies’ seal of approval to the fully collateralised type, reinsurance broker Willis Re Specialty non-marine managing director Jonathan Marsh concedes: “The reliance on fully collateralised capacity continues to increase.” He adds: “It will be interesting to see what the new entrants like CATCo and Aliseo bring to the table for the 1 April renewals and the rest of the year.”

Morris at BMS agrees. “CATCo offers a specialist product in some ways and [it is] not suited to everyone. In overall terms it doesn’t have a huge amount of capacity, but we are aware of them getting on programmes – it has done well there,” he says.

There is a sense that fully collateralised retrocession is not quite the panacea that some suggest. Despite Belisle’s claims that some retrocessionaires are running scared of CATCo’s products, there are many indications that traditional retrocession – also known as ultimate net loss (UNL) retrocession – is still playing a big role in most buyers’ programmes.

In some quarters there is a lack of comfort that the fully collateralised retro product will behave like regular reinsurance when it comes to making a claim. Private equity-backed providers of collateralised cover will want to recoup what appears to be unused capital as quickly as possible to begin the next underwriting years, meaning buyers need to ensure they can still access the money if claims from the covered year roll in after the renewal date.

“There is a place in people’s retrocession buying for collateralised products and, on the face of it, the security is fantastic,” says Morris. “But that’s on the face of it. You do run into timing issues. You have got to make sure that if there is an earthquake, for instance, there are adequate reporting clauses so you can hold on to the money.”

Morris acknowledges that some of the money is released according to certain triggers in collateralised arrangements, but he adds: “It’s not like having a more open-ended traditional player on the books where you just advise them that there might be a loss. Your cover note doesn’t disappear on 31 December.”

Belisle at CATCo says that his firm is trying to forge strong, long-term relationships with the reinsurers it serves. “In the deals we have done we have become the core protection for each company we have protected,” he says. “We just want strategic partners. We want guys we really respect as underwriters, and we only want 10 or 12 strategic partners that we protect year in, year out, and where the price is very healthy year in, year out.”

Collateralised funds may have some way to go before they win the market > over. The private equity-backed funds’ need to generate adequate returns for their owners means they may not be as relationship-driven as more established retro writers. “The traditional retro market is still primarily relationship- driven,” says reinsurance broker US Re’s executive vice-president Joseph Fedor.

“The collateralised market is tiptoeing into that area, but they generally look for quite high returns because they are a hedge fund type provider of capacity and generally they want a reasonable level of return for the level of risk they are taking.”

Still outside the mainstream

Many buyers are viewing collateralised retro as a specialist tool rather than an all-purpose product, meaning it has not yet truly entered the mainstream. “People are prepared to buy collateralised cover but the majority of retro buyers are still looking for cover that gives them worldwide protection, which the collateralised funds don’t generally do,” Cooper Gay reinsurance director Patrick Ellis says.

Because the collateralised funds tend to focus on high layers to get their returns, some feel a buyer is unlikely to rely solely on this form of cover. “You do need a mixture of more regular cover that you can conceivably collect from on minor market-changing events rather than just the events that completely change the reinsurance landscape,” Ellis says.

Equally, it seems not all investors are buying into the fully collateralised concept. Aliseo Re did not start writing on 1 January 2011 as planned, and sources suggest the company is now trying to look for new investors.

Bryce confirmed that Aliseo did not start writing as planned, saying this is because the company is still discussing structural matters with legal representatives. Investors have previously turned their backs on alternative retrocessional covers. Lloyd’s insurer Catlin, for example, abandoned the $150m flotation of its sidecar reinsurer Long Bay Re last year.

As a result, it appears that the most recent entrants have not yet made a big mark on the traditional retro market. “Their impact has been minimal, to be honest,” says US Re’s Fedor.

The newcomers’ foray into retrocession has been countered to an extent by some M&A-fuelled departures. PartnerRe’s purchase of Paris Re, for example, has curbed the latter’s underwriting of motor retrocession in the UK market. PartnerRe cut the coverage at the 1 January renewal because it was concerned about the accumulation of exposure that resulted from combining Paris Re’s UK motor retro book with its existing reinsurance underwriting in Europe.

Similarly, Marsh at Willis Re reports that M&A is stunting the traditional market. “The traditional rated UNL capacity continues to reduce, mainly owing to M&A activity over the past three years, with Validus Re acquiring IPC Re, and Max Re and Habor Point merging,” he says.

The good news for buyers of traditional retro is that, in general, rates are falling. Recent catastrophes have not been sufficient to trigger retro programmes, particularly in the peak zones of Europe and the USA. Market participants contend that prices were down by between 5% and 10%.

Buyers should not start celebrating just yet, however. Rates are falling more slowly than in the original reinsurance market, meaning the two sectors are out of kilter. This is affecting buyers’ perceptions of the product. “Retro might be costing you less money, but relative to your inwards reinsurance book, it is probably looking more expensive,” Morris at BMS says.

Buyers test value claims

Some companies are starting to lose patience with the fact that, while they have been buying retro for the intervening years since Hurricane Katrina in 2005, they have not been able to collect on it because of the high attachment points, even though the market has seen some sizeable catastrophe losses since then. This is making underwriters’ claims to management that retro is good value sound increasingly hollow.

Coupled with this, the years of scarce cover post-Katrina, along with reinsurers’ solid levels of capitalisation, means that they have grown more accustomed and more able to retain risk.

Changes are afoot, however, that could trigger greater dependence on the retro market. The European Commission’s forthcoming Solvency II capital regulations could result in more demand for reinsurance, and in turn more need for retro to help absorb this. In the more immediate future, many expect the latest incarnation of Risk Management Solutions’ US hurricane model, due to be released at the end of February, to increase perceptions of risk and thus result in more demand for protection.

With deteriorating pricing, reinsurers can also expect worse results. “I wonder whether that will make people less bold when it comes to retaining more of the cat risk,” Morris at BMS says.

And though prices are still high, they are at least heading towards more acceptable levels. “I think we are now getting to a stage where the attachment points are more realistic and more justifiable for people to purchase these covers,” Cooper Gay’s Ellis says.

Although newer forms of retrocessional cover are coming gradually to the fore, it seems buyers are still finding comfort in the devil they know. GR