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Vesttoo: Behind the noise

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Non-catastrophe start-up ILS platform Vesttoo is attracting a lot of attention, but market observers are cautious on whether its early steps will live up to the hype.

With sources putting its revenue already well into the double-digit millions, the start-up has been hiring staff at a fast pace.

Recent sign-ups include former Rewire/Swiss Re executive Stefano Sola, and it has recruited major names such as another Swiss Re alumni Jacques Aigrain to its board as chairman.

It is one of several players seeking to break boundaries in the ILS market by expanding into longer-tailed casualty business among other targets such as life risks, moving beyond the catastrophe space where business structures are more established.

But given the novelty factor of the casualty ILS deals it is striking, only a limited pool of people are familiar with its operations – and there is an ongoing debate within the industry over the durability of casualty ILS concepts more broadly.

Trading Risk spoke to the firm and other market participants to get a handle on how it is positioning itself, the way it transacts, and how the casualty market might be impacted by ILS arrivals.

Slice of premium income the target

Like peers such as Ledger, Vesttoo’s early marketing has pitched it as both being a burgeoning platform provider that could source risk for third parties and having some funds to transact risk under its control.

Some sources suggest that the firms may have to face a decision in future over which aspect to prioritise, as third-party investors trading business on the platforms might question whether the best business had already been funnelled towards their in-house funds.

However, Vesttoo points out that its investment vehicles have limits on risk allocation to certain perils, which can lead transactions to be passed to the platform.

Vesttoo said its revenues primarily derive from taking a slice of premium income on the transactions it handles, and it is thought to charge fee income on managed assets in its ILP vehicle.

However, it also said that it sought to collaborate closely with brokers and fronting providers to source risk, with banks to distribute to investors and in some cases with ILS managers who invest in some of its deals, rather than viewing itself as a pure competitor to any of those firms.

Chief financial engineer Alon Lifshitz said that the firm’s ultimate goal is to create a “commodity type of risk”, with a plan to offer secondary liquidity for its deals.

While this is not yet possible, it can already close deals in two-to-four weeks and Lifshitz says one of the keys to getting cedants on board has been providing them with quotes in a matter of hours.

From the investor perspective, he said that acting as the “Google Translate” for their access to insurance risk was crucial.

“Our goal was always to have a fully objective process,” he said. “A key constraint in ILS is that capital market players have difficulty understanding insurance risk and are challenged by the lack of transparency.

“When the [risk transfer] process is fully data driven, there is full risk transparency and we were able to bring ratings agencies along with us, facilitating the investment process.”

Vesttoo has set up a couple of vehicles to funnel risk to capital market investors.

The two main vehicles it has set up to date are the Vescor partnership with collateralised carrier Corinthian Re, which the firm says is set to issue its first structured securitisation by the end of August.

The firm says it plans to issue around $2bn in structured notes across half a dozen deals by the end of 2023, working with banks to syndicate products with investment grade ratings. Typically, a single deal the platform strikes might be worth around $25mn, but the first Vescor note will cover 23 bundled deals.

The company emphasised that Vescor is not operating as an investment fund, unlike its Insurance-linked Program (ILP) fund. The firm wants to grow the latter fund to cover $4bn of notional limit over time, with a large portion “already deployed and/or committed”.

There are specific, separate underwriting guidelines on the risk that the ILP can take – with limits on auto risk already reached, for example. Over time the plan is for it to take on life as well as non-cat P&C risk.

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Transaction sizes in question

Unlike a traditional ILS securitisation deal, which typically comprises a cat bond providing XOL reinsurance, the initial stage of a potential Vesttoo deal may be more like a sidecar structure, in that an MGA or other provider seeking reinsurance would transact a capped, collateralised quota share or stop loss with Vesttoo or Corinthian Re (an unrated transformer carrier).

The ceded premiums from quota shares are set aside in a trust fund by Vesttoo to cover potential claims under the quota share up to a certain loss ratio threshold, with letters of credit or other collateral backing the remaining limit.

This premium pooling appears to be the first step in creating more remote risk structures out of a pool of ground-up quota share contracts. Once it has traded a bundle of such deals to create a diversified portfolio – which would help to minimise the level of capital required to collateralise up to a certain return period - the ILS firm would then slice up and cede on the risk above this threshold via capped stop loss reinsurance in a tradeable, fully collateralised note format.

Its ILP is positioned to take “equity level” risk immediately above the retention, and Vescor is designed to take the more remote levels of risk from a bundle of multiple transactions.

Some of its transactions start off with a stop-loss contract in the first instance, and some participants see the firm’s “sweet spot” as more likely to lie in this area than in quota share coverages.

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But one of the fundamental questions around its transactions is whether Vesttoo is picking benchmark reference points that make the deals sound sizeable, when the actual amount of risk transfer involved is comparatively limited – particularly on XOL stop-loss deals.

For example, earlier this year it said it had struck a stop-loss deal for a Lloyd’s syndicate covering total written premiums of $270mn. However, sources said that the deal represented a much smaller sum of limit – Vesttoo said that in this case the amount of cover provided was $43mn.

Sources raised similar queries over the limit deployed via the ILP fund and how this translates into assets under management (AuM) and associated premiums. Vesttoo has not given specific figures for the latter metrics.

A large part of $4bn, if limits were in line with AuM, would rank it among the industry’s largest providers, but it is expected notional limits would be much larger relative to AuM for an insurance portfolio than in standard ILS reinsurance.

By way of comparison, peer Ledger Investing has written $524.8mn of total contracted premiums to date across all its transactions and its website says it has secured $180mn of capital, after having raised initially around $150mn to set up its Nanorock fund last year.

Collateral and leverage

Cedants that have transacted with the firm have quickly received solid collateral, sources said, such as banking letters of credit backing up Vesttoo’s obligations, although one source noted that some have come from “different choices” of provider than those most frequently used by other (re)insurers.

Part of its pitch to investors appears to rest on offering Vesttoo as more of an insurance add-on or enhancement to existing investment portfolios – in a similar vein to the total return reinsurer model and that pursued by MultiStrat Re.

In contrast, another casualty ILS vehicle, Ledger, puts more of a focus on trying to isolate underwriting return and taking limited asset risk.

Marketing information on Vesttoo’s website touts the firm as a way to “let your high quality assets work harder for you”, promising to deliver “BB spread with AA uncorrelated risk”.

Investors can earn additional spreads of 1%-3% on their posted collateral, with less than a 3% chance of losing income and the chance of a 10% loss under 0.5%, the brochures noted. This option of using investment-grade collateral applies to assets in the ILP fund and managed accounts.

The ILP’s total target returns are 6%-8%, the firm noted.

It added that it provided a very wide range of collateral according to cedant requirements, from cash, investment-grade bonds, letters of credit or other instruments.

Vesttoo said it does not use leverage to improve returns, beyond the agreed caps on loss exposure, but “it is a strategy we have been asked to explore”.

Despite Corinthian not having a rating, Vesttoo said it had partnered with the firm because of its “performance history, similar business approach and experience in utilizing risk mitigation techniques to build a diversified portfolio for non-cat reinsurance”.

The firm is led by Christopher Collins, who is also a managing director at Eos Re and who, before moving into insurance, founded venture capital fund Lighthouse Ventures. The group operates in collateralised specialty reinsurance and the transformer market.

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Casualty ILS impact

Interest in non-cat ILS has been on the up in the past couple of years, including from established ILS investors who are looking beyond cat risk, given recent losses in this sector, but who still want to focus their interests on pure underwriting risk detached from investment market fortunes.

On the cedant side, there has also been a drive to find alternative capacity and an explosion in fronting carriers who can retain risk and offer leverage, rather than acting as pure cut-through providers.

Vesttoo said it sees increasing demand “both for alternative non-cat ILS solutions on one hand, and for diversified, non-volatile insurance-linked investments on the other hand”.

“We are opening the market to a much wider group of investors, as well as underserved parts of the markets, that couldn’t obtain reinsurance coverage before.”

However, for all market participants the facts remain that so far the casualty ILS market is limited.

For now, the segment is mostly focusing on certain types of deal – auto is a popular target, given its shorter-tail nature. The commercial auto sector benefited heavily from lower Covid claims in recent years, although the segment is perceived to have a heavy exposure to social inflation and in the prior decade averaged combined ratios of 106%, SNL data shows.

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Structuring also plays a key role.

Vesttoo deals have an agreed automatic commutation at around the five-year mark, although cedants can agree the term from, say, four to six years and pay more for longer-duration deals.

For now the ILS market’s participation in longer-tailed risks can only extend so far into the tail – and cedants or fronting carriers will have to face taking back responsibility for loss development beyond that point.

Thus, the concept will rely for its long-term success not only in ensuring investors understand the risks they are taking, but also that fronting carriers and cedants are clear on the degree of risk transfer and collateral security they have in transacting on an ILS basis.

Another sceptic raised the question of whether investors are truly understanding the risk or seeking enough compensation for the potential volatility involved.

The source said “all of my antennae went off” when they heard Vesttoo saying that it can “underwrite any risk as long as we have the data”, adding that as well as having good data, “you need to understand the risk in old fashioned terms”.

Another who critiqued the “black box” model said that models are “only as good as the data” in an industry which can struggle to provide up to date exposure data.

However, Vesttoo said that it did additional due diligence on data provided by requesting submission files, underwriting guidelines, doing background checks, and inspecting the data received.

Casualty ILS: The rationale

Overall, the debate within the ILS market over casualty ILS can be split down the lines of those who see ILS instruments as ripe to apply more broadly in the sector, offering counterparties more choice in offloading risk to a wider range of investors, and those who query the need for non-traditional solutions in this sector and believe ILS is a tool that suits specific purposes.

For ILS purists in the latter mould, the casualty market does not have the same capacity constraints of a peak peril that cat or cyber risk does. Casualty ILS deals are targeting high frequency, low severity risks which typically carry a lower margin for insurers that are fuelling their target returns via volume and leverage.

Historically, casualty business made its profits via a heavy gearing towards investment return, not just underwriting yield, which also has the side effect of reducing its diversification benefit.

“Is it a solution looking for a problem or is it meeting a market need?” one source questioned.

Others might suggest that insurers as a whole still retain much more risk on balance sheet than other financial sectors and that short-term casualty market transfers of risk to ILS investors make sense to move away from that model.

Beyond theoretical concepts, the practical ability to quantify and model risks in this area through third-party vendors as with cat risk has also held back its development. However, the next-gen providers point to their data analysis as a crucial part of their value proposition.

Beyond proprietary analysis, cutting expenses relative to industry averages is another core focus for casualty ILS deals in general.

By going to the primary market and sourcing risk from MGAs, ceding commissions can be reduced compared to the hefty 25-35-point ceding commissions attached to proportional reinsurance risk.

However, some argue that the InsurTech sector more generally has cast doubt over whether high-tech firms can be successful in becoming less expensive originators.

For now, while ILS capacity is beginning to draw attention in this area, it is far from setting the casualty market alight. Comparing it to the cat ILS market’s presence in the mid-1990s is likely far more appropriate a benchmark than the post-2010 era of growth.

But the early pioneers are hoping that another few years of development will bring a market that shakes up the traditional long-tail sector.

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