Third Point Re reported a net loss of $183.6 million for the first quarter of 2020 due to COVID-19-related investment volatility – but the company still had big reasons to celebrate. For the first time since its inception in October 2011, it made an underwriting profit.
“This first quarter … was a landmark for us in that it’s the first quarter in our 33 quarters as a company that we’ve reported a sub-100 combined ratio [at 97%]. It’s really the result of a lot of hard work over the last two years to reposition the company to a specialty reinsurer,” said CEO Dan Malloy in an interview.
“For our first six years we were a hedge fund reinsurer, willing to run a higher combined ratio in order to get sticky assets,” he said.
Executive SummaryThird Point Re lost money due to COVID-19-related investment volatility, but the reinsurer made an underwriting profit for the first time since its birth in October 2011. Here, CEO Dan Malloy explains how the company reached this important milestone.
Malloy explained that Third Point Re previously had a strategy to write a lot of long-tail business, aiming to make money on the investment side, absorbing underwriting losses, and regularly reporting combined ratios of 105. (Combined ratios below 100 indicate an underwriting profit).
“It wasn’t like we were writing 105 because we were unlucky. We were writing 105 and expecting 105 because we didn’t write property cat,” Malloy confirmed.
However, two years ago, Third Point Re got the message “loud and clear” from its ratings agency, AM Best, that it needed to start making an underwriting profit and carry combined ratios below 100.
That’s when the company began its transformation into a specialty reinsurer, opening the door to new lines of business, pulling out of other lines and hiring a team of seasoned underwriters.
Third Point Re’s first quarter loss was driven primarily by a negative 7.3% investment return on market volatility during the COVID-19 crisis. During the month of April, however, the reinsurer gained back around 40 percent of that loss as equity markets rebounded.
Malloy described some the steps that he and his team have taken to bring about the turnaround and make underwriting “a positive contributor to our overall results….”
Third Point Re used to have a large portfolio of Florida homeowners’ business. However, Malloy said the assignment of benefits (AOB) phenomenon “has torn through that market and is beginning to threaten the solvency of insurers.”
(AOB is a document signed by a policyholder that allows a third party, such as a water extraction company, a roofer or a plumber, to “stand in the shoes” of the insured and seek direct payment from an insurer. After Florida hurricanes, some contractors have used AOB to file inflated claims and then pursue lawsuits against insurers when claims are disputed or denied.)
Third Point Re saw the problems looming with AOB before a lot of others in the market, “because we were writing only quota share.” Many catastrophe writers probably didn’t know there was a problem until they had a cat loss, Malloy affirmed.
“As a result, we decided to cut our [Florida homeowners’] portfolio back dramatically from seven accounts to two accounts over the last few years.” The remaining accounts were kept because Third Point Re was able to make improvements to terms and conditions.
He cited the example of one former client who was counting on AOB legislation in Florida to knock off 10 points from its combined ratio.
“But we were not willing to take the gamble that the legislation was going to bite the way people hoped it would,” Malloy emphasized.
“I personally won’t believe the loss ratios in Florida will get to where they were historically [at 30%], until you see a caravan of Mercedes leaving the state, filled with all the plaintiff attorneys going somewhere else to make money,” he said with a laugh.
“Hey, I can’t keep losing money, you know? I can’t count on being lucky.”
In its early years, Third Point Re was fairly active in the non-standard auto sector, which was considered profitable but highly volatile.
“We found it actually was not that volatile, but it was consistently unprofitable.”
Traditional companies looking for volume, which are willing to settle for 5 percent margins, will snap up non-standard auto, but will ultimately end up losing five points, he explained.
So once again, Malloy and his team pared non-standard auto clients from nine to three. “It’s smaller, but instead of losing money, we make money, so that was another transformation.”
The three remaining non-standard auto clients are all insurance companies, with their own claims departments with management who get bonuses if they make money, while the loss-making accounts were managing general agents who were paid on volume, rather than on profits.
“The bigger the clients’ retention, the better we do as a reinsurer,” he explained.
The company’s re-underwriting efforts are showing up in its results, leading to a reduction in gross premiums written (GPW). During the first quarter, Third Point Re reported GPW of $204.1 million, a 36.1 percent drop from the $319.6 million reported in Q1 2019.
The decrease GPW was primarily due to certain contracts that were not renewed, including one multi-line contract for $103.2 million, which no longer fits its underwriting criteria.
During the interview, Malloy said this contract was a perfect fit for the company when it was a hedge fund reinsurer, but not as a specialty reinsurer seeking underwriting profits.
He explained that this was a retrocessional contract that would have booked a 105 combined ratio. Under its old strategy, Third Point Re would have paid out about $100 million, aiming to make 5 percent-8 percent on that money, earning a profit of $20 million to $30 million, he explained.
While that is business still probably makes economic sense for Third Point Re, “we made the commitment to our regulators, to our rating agency and to our clients that we are not in the business of booking 105 anymore.”
“These decreases in premiums were partially offset by new contracts bound in the current year period, including new property catastrophe and specialty contracts in line with our changing underwriting strategy,” said the company in its Q1 results statement.
New Areas for Premium Growth
Malloy discussed some of the areas where the company is growing its premium.
“We’ve said ‘no’ to commercial auto for years because we couldn’t find the right partners to align ourselves with.” However, that market is changing, because a lot of re/insurers have lost money and have been forced to be more disciplined.
With improvements in ratings and terms and conditions, “we’ve put our toe in that water just as other people are leaving,” he affirmed.
Malloy said the company is also looking at excess casualty and professional liability, because there’s been a lot of blood in the water in that area. Big companies, such as AIG, Zurich Insurance, Lloyd’s, Liberty Mutual, are cutting back limits and raising prices “because they haven’t been charging enough for a decade.”
“So, we’re watching that space with a lot of interest and now have a small involvement in that.”
In addition, Third Point Re has supported and made investments in some specialty MGAs, including one that has set up a captive and ultimately aims to form an insurance company. “They have been putting capital into it and they take 10 to 15 percent of every risk that they write,” said Malloy.
“If they don’t do it right, they’re going to lose money, both as an MGA and as risk takers, This is somebody who has previously gone down the MGA route, set up an insurance company, gotten it rated, sold it, and is doing it again. So, I trust them. But, in the words of Ronald Reagan: ‘Trust but verify.'”
They’re aiming to get three years’ track record under their belts before they attempt to get more investors and seek an AM Best rating.
“They’re going to bring it onshore and form their own insurance company, so they don’t have to rely on other people,” Malloy explained. “It’s a multiyear process, and we’re going to be working with them to create their own specialty insurance company rather than being an MGA relying on other people’s capital.”
Another chunk of new business is coming from an agency that specialized in coastal homeowners’ business. Previously, the agency had a binding authority from Lloyd’s but recently lost capacity as part of the market’s retrenchment.
“When that happened, the owner of the business said, ‘Never again,'” said Malloy.
Third Point assisted in the setup of a rated insurance company with a small investment alongside the owner. In addition, Third Point Re backs the insurer as a reinsurer and has a seat on the company’s board. “We have monthly calls where we hear how the new company is progressing. The owner is proud of progress to date and he certainly is putting his money where his mouth is.”
Malloy noted that about 10 percent of Third Point Re’s volume this year will come from these very strategic relationships being developed with companies that also are putting up their own money.
“Just reinsuring someone who gets paid on volume doesn’t work. But if they’ll accept terms and conditions, which makes them a risk-taker, and they are willing to write a check to take risk, we’re happy to support them in a market that’s improving.”
Malloy said he could cite a hundred examples where people with binding authorities walk through the door, make promises and then back out at the last minute because they’ve gotten a better offer – one where they didn’t have to take risk.
Malloy said Third Point Re is relatively insulated from COVID-19-related exposures due to its conservative underwriting position and “the measured way that we’ve moved into new lines of business.”
“For instance, when we went into the property cat business, we decided to not write risk excesses and quota shares because they’re more difficult to model,” he affirmed. “We particularly look to avoid portfolios that are very heavily commercial.”
As a result, Third Point Re doesn’t expect much of a COVID-19 loss coming out of its property portfolio, “which is certainly an area where a lot of other people are very focused on.”
He didn’t admit to being prescient about COVID-19, but business interruption is part of commercial policies and “those have been historically proven to be hard to model from a cat perspective.”
Malloy cited the example of Super Storm Sandy where the models “were wildly off because nobody anticipated buildings in lower Manhattan would flood.”
For the three months ended March 31, 2020, Third Point Re recognized net losses of $9.5 million, or 6.5 percentage points on the combined ratio, relating to COVID-19. These losses were driven primarily by contingency exposures (event cancellation) as well as certain casualty and multi-line quota share contracts.
Malloy attributes much of the company’s successful transition to its talented team.
Over the last several years, to facilitate the company’s transformation, Third Point Re has hired group of experienced underwriters including, David Govrin from Berkshire Hathaway; David Drury from Chubb; Tracey Gibbons from Allied World Reinsurance and David Sinclair from TransRe.
“I’ve been asked many times: ‘Why are they coming to a little company like yours?'”
What is Malloy’s answer?
“Well, you can either let the institution define you, or you can help shape the institution. When David Govrin joined us, he said, ‘I can’t call up Warren Buffett and tell him to do things differently.'”
But Govrin is now a partner at Third Point Re and he and the rest of the team “are making a big difference,” said Malloy. “I don’t have to sit there and harangue them to do what they need to do. They get it, and their compensation is tied to that.”