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Greenlight Re squeezed as capital erosion threatens collateral clauses

Greenlight Re is coming under significant pressure as it faces the prospect of losing business as a result of capital erosion.

Heavy losses on the investment side of the business have caused Greenlight Re’s capital levels to fall substantially, opening the reinsurer up to the triggering of collateralisation clauses on various reinsurance deals.

The uncertainty around Greenlight Re’s capital position has led some in the market to speculate that the reinsurer’s renewal book could come under pressure in the run-up to 1 January.

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As of 30 June, Greenlight Re’s shareholder equity stood at $650.9mn, a 23 percent decrease year on year and down 21 percent since 31 December 2017.

The decrease in book value was largely driven by the $180mn net loss reported by Greenlight Re for the six months to 30 June.

During that period the investment side of the business, which is managed by David Einhorn’s DME Advisors, reported a loss of 15.2 percent. This compared to a loss of 2.5 percent for the same period in 2017.

Certain contracts between Greenlight Re and its cedants hold the provision that the cedant has the right to cancel the contract or demand Greenlight Re puts up a certain amount of collateral in the event of a reduction of capital or surplus, or a ratings downgrade, below a certain level.

Such clauses are also used more widely in the industry, and typically trigger once capital has dropped by 20-30 percent.

Market sources have speculated that Greenlight Re has had to post collateral against some of its liabilities, with this perhaps having been offered to cedants before capital erosion would have allowed the formal triggering of the clauses. However, The Insurance Insider was unable to verify any specific examples of this at the time of writing.

This publication was also unable to substantiate any instances of Greenlight Re losing contracts as a result of its reduced capital position.

The reinsurer has taken measures to alleviate the pressure on its collateral clauses with plans for a $100mn debt issuance, which will be used to bolster capital and buy back shares.

It is also thought that Greenlight Re can easily access additional cash to post collateral, not only via bank facilities but also by tapping the assets held on the investment side of the business – more than 80 percent of which were deemed as “highly liquid” by AM Best in its September 2017 rating review.

The carrier also holds cash on its balance sheet ,which it is able to draw on.

The current pressure on Greenlight Re is intensified by its forthcoming AM Best review, the work for which is currently underway.

The rating agency affirmed its A- financial strength rating for Greenlight Re in September last year. The rating carries a stable outlook.

At the time, AM Best commented on Greenlight Re’s “strong risk-adjusted capitalisation, experienced management team and strong enterprise risk management practices”, as well as the overall implementation of the business strategy. However, it noted that these positive factors were partially offset by the greater investment risk associated with its alternative investment strategy.

On a Q2 conference call, CEO Simon Burton said his firm’s BCAR – AM Best’s capital adequacy ratio – was “quite healthy”.

He went on to say: “There remains a reasonable buffer there that we do not consider constrains us operationally in the short term. There are more factors that go into the rating process than that. But purely from a capital perspective, we feel quite comfortable.”

Some in the market are looking to the outcome of the Greenlight Re annual AM Best review to gauge how much weight the agency will place on the investment performance of the total return reinsurers.

From an underwriting perspective, Greenlight Re posted a modest profit in the six months to 30 June. The carrier reported a first-half combined ratio of 97.3 percent, a 1.2-point improvement year on year and equivalent to a $7.6mn net underwriting profit.

The reinsurer runs an extremely lean expense base, with an expense ratio of just 2.8 percent for the first six months of 2018.

Nevertheless, Greenlight Re has had a challenging 2018 as the poor investment performance has overshadowed any improvement on the underwriting side of the business.

The company’s book value per share fell by 5.3 percent in the 12 months to 30 June 2018, to sit at $17.38.

The company has also faced additional pressure as a result of the new US tax reforms.

In June Sunesis Capital founder Manal Mehta, a critic of the company, noted that the changes threatened to put the company into the passive foreign investment company (PFIC) category and thus drive it out of business.

Last year’s tax reform legislation singled out offshore reinsurers, enacting measures designed to curb the tax advantages of doing business in Bermuda and other low-tax jurisdictions.

The reform measure specified that unearned premium reserves could no longer be counted against assets, as they had been through last year, setting off a scramble among carriers like Greenlight Re.

Mehta asserted that the tax reform law would put pressure on Greenlight Re to take on more risk, including writing new business in areas being shunned by other reinsurers.

In responding to Mehta’s report, Greenlight Re said it intended to avoid being classified as a PFIC and is in the process of restructuring to ensure it meets the required proportion of insurance liabilities to assets.

Greenlight Re declined to comment on this report.

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