The Derivative - Reimagining Risk and Reinsurance (& Cat Bonds) with Chris McKeown of Vantage Risk

Episode Date: October 7, 2021

We’re looking into the far reaches of the search for yield in this episode, diving into investors’ interest in so-called Cat Bonds, or catastrophe bonds, and the world of reinsurance and ILS (insurance-linked securities). Yes, even the biggest risk-takers need backing – and we’re talking Reinsurance with Chris McKeown, Chief Executive of Reinsurance, ILS, and Innovation at Vantage Group Holdings. Take a trip with us and daydream about Bermuda as we define reinsurance: the secondary market & their clientele, capital protection, the risk transfer process and what efforts go into sorting through claims, what disaster gaps are, and how reinsurance is helping aid areas in vital need of protection. We’re discussing Cat(Catastrophe) bonds, ILS, Pop & Drop Hurricanes, Climatology, tight ecosystems, secret handshakes, and why Bermuda is the central hub for reinsurance. Chris explains the importance of adjusting models to deploying capital, why cat bond investors rely on these models, and what structural issues the business of reinsurance is facing in an upside market, trying to bring investors in. Chapters: 00:00-02:39 = Intro 02:40-10:43 = Taking on Risk in the Hurricane Belt 10:44-32:41 = Off-loading Riskvia Reinsurance, Capital Deployment & Investor portfolio protection 32:42-38:21 = Cat Bonds & Structural Issues in an Upside Down Market 38:22-52:35 = Climate Change, Adjusting Models & Defining Capital in a Tight Ecosystem 52:36-58:05 = Favorites For more information about Vantage Group Holdings please visit vantagerisk.com Don't forget to subscribe to The Derivative, and follow us on Twitter at @rcmAlts and our host Jeff at @AttainCap2,  or LinkedIn , and Facebook, and sign-up for our blog digest. And visit our sponsor, the CME Group at www.cmegroup.com to learn more about futures and options. Disclaimer: This podcast is provided for informational purposes only and should not be relied upon as legal, business, or tax advice. All opinions expressed by podcast participants are solely their own opinions and do not necessarily reflect the opinions of RCM Alternatives, their affiliates, or companies featured. Due to industry regulations, participants on this podcast are instructed not to make specific trade recommendations, nor reference past or potential profits. And listeners are reminded that managed futures, commodity trading, and other alternative investments are complex and carry a risk of substantial losses. As such, they are not suitable for all investors. For more information, visit www.rcmalternatives.com/disclaimer

Thanks for listening to The Derivative. This podcast is provided for informational purposes only and should not be relied upon as legal, business, investment, or tax advice. All opinions expressed by podcast participants are solely their own opinions and do not necessarily reflect the opinions of RCM Alternatives, their affiliates, or companies featured. Due to industry regulations, participants on this podcast are instructed not to make specific trade recommendations nor reference past or potential profits, and listeners are reminded that managed futures, commodity trading, and other alternative investments are complex and carry a risk

of substantial losses. As such, they are not suitable for all investors. Welcome to The Derivative by RCM Alternatives, where we dive into what makes alternative investments go, analyze the strategies of unique hedge fund managers, and chat with interesting guests from across the investment world. So reinsurance generally, when you think about collecting all the volatility from the balance sheets of the large insurance companies around the country and around the world, you know, that creates a very asymmetric business. It's not, and so it doesn't lend itself to sort of normal metrics for a lot of investors.

It's a bit of a head scratcher to understand because you're collecting a number of tails. You're diversifying hopefully those tails, but they are all, you know, so it's a right-sided outcome. And so to be concentrated in certain risks creates volatility that, you know that you'd rather obviously find ways to dampen. And so as an industry, we look at things called what we call the disaster gap, where events happen in certain areas of the world. Take Haiti, you can take a lot of places where that infrastructure isn't there yet. And what are we going to do to help encourage that. And in the meantime, in developed areas, we still have a lot of work to do in terms of selling a product that consumers will buy and consumers will continue to buy. And so I see insurance as a growth market and reinsurance as a growth opportunity.

Hi, everyone. Thanks for joining us today. We've got a doozy for you with this episode as I try and wrap my head and in turn your heads around the world of reinsurance, insurance-linked securities, cat bonds, and the billions of dollars that switch hands between insurance companies, Bermuda-based reinsurers, and some of the largest investors in the world. Our guest today is Chris McCown, the Chief Executive of Reinsurance and ILS Advantage, a tech-enabled and data-driven private reinsurance company based in Bermuda. Welcome, Chris. Thanks, Jeff. Thanks for having me. No worries. Did I do okay on the last name? I forgot to ask you the pronunciation.

It's fine. It's pronounced McKeown, but you're close enough. I got the M correct. So where in the world are you? I'm at my house. I'm located in Concord, Massachusetts. All right. Known for some colonial time. Yeah. Some people call it the birthplace of our nation. But it's got a lot of history to it, a lot of literary history as well. It's a great place to live and just outside of Boston, which is the hub of the universe.

Great city. A stock city, though. You're supposed to be down there in Hartford, Connecticut, in the insurance capital of the world. It was the insurance capital of the world. I think that might have shifted a little bit over the years, but insurance seems to be congregating in London, Bermuda, and certain cities in Europe.

But Hartford's still a big city for insurance. That's true. Never worked there, never lived there. And do you travel to Bermuda then quite a bit? You guys are headquartered there. Yeah. Vantage is headquartered in Bermuda and I, my formative underwriting years were spent in Bermuda 12 years and then moved back to the States in 09, lived here in Concord since,

but have started up and been involved with a couple of startups in Bermuda since then. So you commute back and forth. It's a pretty easy commute except for the last year and a half. But yeah, it's a readily available jurisdiction and place to get to and great place to do business. Awesome. I was supposed to do the Newport to Bermuda yacht race once, but didn't make it. I did Newport to Black Island instead, but that was just as fun. So Newport to Bermuda yacht race once, but didn't make it. I did Newport to Black Island instead, but that was just as fun. But so never been to Bermuda. So I'm putting it on the list.

It's a great place. Lovely people, lovely weather, a really business focused government and regulatory body that, you know, it's been a real success for the insurance and reinsurance business in particular and increasingly for the ILS investors. Awesome. So give us a quick personal background yourself, how you ended up in the insurance business and then culminating in Vantage Launching and your role there? Sure, yeah. That'd be going back a long way. But like a lot of people, I landed in insurance reinsurance somewhat by mistake or by luck.

But I started my career as a reinsurance broker for Guy Carpenter, which is a subsidiary of Marsh & Clennon. Worked there for 14 years and then moved to Bermuda in 98 and started working for a company called Ace Tempest, part of Ace, which is of course now the Mighty Chubb, and became an underwriter portfolio manager there in 04, was recruited by Citadel Investment Group to build out a pretty pioneering effort in the reinsurance space through funds managed by Citadel into what's called the collateralized reinsurance or early ILS space and did that for a few years. And then in 2009, went back to Guy Carpenter.

And then, as I say, in 2013, I started a company called New Ocean, which was an asset manager dedicated to the ILS space and now just recently came back into the reinsurance space after doing a little bit of a tour in the insurtech world for the last couple of years to join Vantage, as you say, data-driven, tech-enabled vision that is chaired by our non-executive chair, Dino Cirodano, who's got no end of enthusiasm and energy and charisma for the business. Very successfully ran Arch Capital for years. And then our CEO is Greg Hendrick, who's got a broad intellectual curiosity across insurance and reinsurance and how we can purpose build a company for the future of what we see. The emerging issues that are affecting our society, but also insurance in particular.

And that's Vantage that got me excited to join the team. And it's an all-star team. It's been great. And so I want to say Blue Ocean, but it was New Ocean. New Ocean. Yeah, there was a Blue Ocean. We're running out of names. That's why you see new a lot. And, you know, there's Ocean, there's, yeah, Point. Point is a very popular name of reinsurance and insurance companies. But yeah, so Vantage, when we came up with Vantage, the list was fairly short of viable names that had some punch to them. But yeah, we started Vantage just a year ago, literally. We got our funding and our AMBEST rating in the month of October 2020. So all during COVID, it's been a real journey to be here to talk about Vantage insurance, reinsurance, and what we call ILS, insurance linked securities.

And quickly on your new ocean, that was your own, that was a hedge fund, essentially? It was, you could call it an alternative asset manager, basically. Yeah, that would be described as the idea is that you provide access directly to the insurance risk through investable vehicles for third party investors, pension funds, family offices, sovereign wealth funds, hedge funds, who can, you know, who can invest in a variety of forms. There are funds and then there are what's called special purpose insurers. And there's a mix of, or a spectrum, I should say, of investable alternatives for, you know, for non-insurance companies who don't want to, or non-investors who don't want to own an insurance company through private equity, nor do they want to own it through public equity, that this is an

alternative way to access that risk. And then Vantage, I'll just quickly touch on, you mentioned, so you guys were backed by PE launched a year ago. So who are those private equity firms? Yeah, we're proud to have Carlisle and Hellman and Freeman as our effectively 50-50 owners, along with management, of course, that have seen the issues that have started to plague the insurance business. There was a little slow moving, but if you can see the trends, the timing has been great. Large balance sheets have been withdrawing from certain lines of business. We have an increased frequency of events driven by climatology that need to be addressed, and the use of technology and data is going to be instrumental in our business going forward and unburdened by legacy systems, legacy reserves, or legacy ways of thinking.

They provided a billion dollars of initial equity capital to us, which is not, I wouldn't call it table stakes, but in the insurance reinsurance world, you'd certainly have to have a certain amount of capital to A, to get a rating from, we have an A rating of A minus, as well as to be accepted as a counterparty credit to insurance companies and other trading partners. So very happy to be launched by knowledgeable private equity firms in this space

with, as I say, Dino C. O'Donnell and Greg Hendrick at the helm. It's been a great journey so far. Awesome. Those are two good names to have on the investor list. So let's start at the top if we could. Could you define exactly what reinsurance is and what the purposefulness of it is? Is that a word? Purposefulness? Yeah, definitely. It's a very purposeful, very purposeful business.

Dig in for us. Reinsurance. Sure. Yeah, I appreciate for some of your listeners, this might be a little bit of a diversion into another world and some of the nomenclature might need a bit of translation a diversion into another world. And some of the nomenclature might need a bit of translation, but I'll do my best. Reinsurance is basically the secondary market for insurance. Insurance companies perform a very vital role in finance, both consumer and commercial insurance,

providing liquidity in the case of insurable losses, whether they're liability losses or, you know, I think of large scale hurricanes or earthquakes that affect a large swath of a portfolio that an insurance company might write. They look to the reinsurance business, reinsurance market to offload that risk and provide themselves liquidity and financial flexibility around managing those liabilities on their own balance sheet. So reinsurance is effectively insurance for insurance companies. And there's a secondary market, or I should say tertiary market, Jeff, of what we call retrocessional reinsurance. So reinsurers provide that capital and that capacity to insurance companies who obviously in turn face the customer. Behind reinsurance companies, there's another round of trading that's called retrocessional

reinsurance, mostly amongst reinsurers themselves, but also where ILS, insurance-linked securities, third-party investors also play a pretty significant role. And into the purposefulness. Sure. Insurance in this day and age, when we're all thinking about how we sort of impact our globe and our society and each other, insurance has always been there to provide protection for losses to your automobile, to your home, to your business. And that reason for being allows societies to continue, economies to thrive and societies to rebuild after disasters like Hurricane Ida and the European floods this summer, that's a vital function to provide that financing and resiliency to natural catastrophes in particular,

but also the pandemic and liability crises, such as in the past, asbestos or environmental issues is where the insurance and reinsurance business plays a vital role of finance. And so that is great. And I think the issue that we're all grappling with as an industry is, are we doing enough? enough protection and insurance across the globe, across all societies to provide that economic resiliency for the engine of economies. And the answer really is not yet. Insurance is fairly concentrated in developed countries and the infrastructure and the overall commitment and the ability to commit to an insurance market is just beginning in large parts of the world. And so as an industry, we're always looking for ways to follow the law of large numbers. The more diverse your portfolio of insurance risk is, the better off you're going to be as an insurance company. And so to be concentrated in certain risks creates

volatility that you'd rather obviously find ways to dampen. And so as an industry, we look at things called what we call the disaster gap, where events happen in certain areas of the world. You take Haiti, you can take a lot of places where that infrastructure isn't there yet. And what are we going to do to help encourage that? And in the meantime, in developed areas, we still have a lot of work to do in terms of selling a product that consumers will buy and consumers will continue to buy. And so I see insurance as a growth market and reinsurance as a growth opportunity in a never increasing sort of world. It's more, there may be more risk because of like climatology and pandemics and what have you, but there's certainly a more of

an awareness of risk in our society that, that we, you know, we need to address as we, as we, as we grow. And I love that, but it's not all altruistic, right? Like people are in the business to make money. Absolutely. Yeah. But as they should, they're taking on that risk. So it's a risk transfer process, right? That's right. Yeah. And that's what sort of is a natural sort of confining aspect of our business. There's some areas that some risks that you can't make money on and that's, you know, you avoid those risks. But again, going back to the concept that the more, the larger the pool of risk that you're insuring against, the better off your results should be, assuming you can get the price, you know, that should be encouraged. And insurance is generally, when we talk about reinsurance,

it really is focused in fairly developed areas, North America, Europe, Asia. And those are sort of the concentrations of risk that we deal with in the reinsurance space. And who are the customers of reinsurance? The biggest insurance companies in the world we're talking, right? Yeah, they all, the large national names that you think of in the United States and global insurance companies all buy reinsurance for a variety of reasons, providing earnings protection, capital protection against various lines of insurance and reinsurance that they themselves write. And just lay that out in numbers for us. So USAA is my insurance. So they maybe want to cap their liability at $10 billion or something. I don't know the numbers. And then if they have $15 billion of risk, they'll offload that extra $5 billion to

the rancher? That's correct. Yeah. I mean, USA is a unique company, but all companies have a mission and have a need to continue to supply a sustainable product to their customers. As I say, USA has an extra mission above and beyond for ex-service members and their families. But the idea is that to maintain and protect the capital base, their own balance sheet, to continue to provide those products for years and years means that they want to seed some of the volatility away from their balance sheet. So in servicing their members or their insurance, they will, you know, will continue to write business in certain areas that are prone to natural catastrophes and will not want to sort of shut that off, right? They want to provide that service and that product, but that adds up. And so you end up with an exposure to events that would be meaningful from either an earnings perspective or even potentially from a capital perspective.

And hence, that's the piece that they then ask reinsurers to provide coverage for in a tranched way above where they're comfortable maintaining the risk on their balance sheet. And would it be fair to say like in parts of Florida or Louisiana or Texas, like you either couldn't get hurricane insurance or it'd be prohibitively expensive for individuals if there weren't reinsurance, if the insurance companies couldn't offset that risk? Yeah, over the years, the reinsurance pricing has become part of how insurance companies manage their risk and manage their own pricing. There are, as you know, in the United States, every state has an insurance commissioner that protects consumers and thinks about the aspect of the business insurance companies, then think about how the pricing of the risk and including the reinsurance price gets passed on to consumers. In some places, it's too burdensome, honestly, and states step in. You have states with state mechanisms like Florida and other states have wind pools that are endorsed and sponsored by the states,

but also in most cases to encourage private capital deployment to the extent that we can find that balance. Sometimes there's not enough price to pass on and they are not insurable, but in those cases, the state steps in. But generally speaking, again, the insurance business strives to rationalize the pricing for the risk and find product that consumers can buy. And then who are the investors? So family offices, pensions, endowments, like big institutional investors we're talking? Yeah. I mean, you think about, so if you wanted to invest in insurance companies, you have a few choices, right? You could be a large private equity firm with a long runway of watching

valuation grow, or you could buy a lot of reinsurance companies that are publicly traded. You could buy the public equity too. That's another equity that you're purchasing or it's a long-term private equity play. To access the actual risk, the investors, as you mentioned, have created and the business has created what we call ILS, insurance-linked securities, which is a broad term. securities you need to put in quotes because while some of it is securitized, that is cap bonds, which are 144A securities, a lot of it is not. They're just private transactions that are crafted as securities, but they're not necessarily liquid securities. But the idea is that you as an investor, whether you're a pension fund, a sovereign wealth fund, a family office, a large asset aggregator can invest specifically in the

insurance risk, bypass the market risk, bypass the execution risk, the management risk, and really sort of laser in focus to say, I want to be exposed to Florida windstorm or Louisiana windstorm. And I will take the premium that you collect as a reinsurer. I'll take a share of that premium and provide you capital to participate in that risk specifically. Yeah, like nobody wakes up and say, I want to be exposed to Texas wind, right? So they're saying, oh, I love this constant flow of income. And I know that there's this risk on the other side of it, right? Yeah, the benefit. I'm sorry.

Go ahead, Joe. Yeah, go ahead. The benefit to investors is really on the portfolio. It's directionally non-correlating risk. When you think about the classic case we bring up is 2008. In 2008, with everything going on, and there were losses, by the way, in the insurance business that we had Hurricane Ike in 2008, which was a fairly large hurricane. But it worked in the sense that since it wasn't correlated, the insurance sector and the ILS business did very

well in 2008. So it's a protection. I think of it as an investment portfolio protection. And it does create yield. It does create positive premium as well, which is a benefit for the risk that you're taking. But as a proportion or as a component piece, excuse me, of your investment portfolio, it's quite compelling because it is directionally non-correlating to equities, to debt, to other alternatives. And it's super interesting to me because it's essentially what we deal with guys all the time, selling options, right? You're selling these far out of the money, very unlikely to happen options, collecting a premium, able to reinvest that premium into, like you say, in 2008 would have been great to be getting coupons in to put back into the market at the lows. So I can see the. Desire for the institutional investors. Yes, just how how do you guys view that? If it's a short option, how do you view the probability of it having to pay out? How do the investors view that probability of it having to pay out? Yeah, that's the reinsurance. Generally, when you think about collecting all the volatility from the balance sheets of the large insurance companies around the country and around the world, that creates a very asymmetric business. And so it doesn't lend itself to sort of normal metrics for a lot of investors.

It's a bit of a head scratcher to understand because you're collecting a number of tails. You're diversifying, hopefully, those tails, but they are all, you know, so it's a right-sided outcome. So many, many years, eight, nine years out of 10, you're collecting the premium. The one year out of 10, and what makes it challenging is that the one or the one and a half to two years out of 10, whatever it is, you have a loss and or you think you have a loss. So part of the liquidity premium that you get is because or illiquidity premium, if that's the way you refer to it, is because you could have a year where you aren't sure that the contract is going to pay, but your collateral is still held against the risk until it develops fully and is known.

And so you can take the losses this year, Hurricane Ida that occurred earlier this year. A lot of complexities to that event that will create a long time frame in which we will finally understand the full, you know, full economic impact of that event. So you lose, because it's illiquid, that money stays in the contract until the finality of that contract, of the underlying reinsurance contract, which could take up to three years. Until they sort out of people's claims and what the damage was actually caused by it. That's right. I was going to save that for later when we talk cap bonds but i'll dive into it now like to me you wrote and i read the uh what's the website the bermuda am whatever like they're saying reinsurers could lose 20 billion on

hurricane ida right you're reading those articles and then it turns out to be much less usually and it seems like there's this thing of like, oh, the losses weren't from the hurricane. It was from a flood. That's right. So how does that work? It seems a little like parlor gamey. But I mean, I guess it's all just contracts are contracts. They delineate what gets paid out and why. They do, although there's still a little bit of flexibility in how the contract wordings

can work. And we're learning with every event. But generally, insurance companies expect to pay the claims and have their reinsurers pay peri-pursuant to how those claims are paid., if it's not clear in the contract wording exactly what is covered, what isn't, you know, you can have some, some issues, but, but Hurricane Ida is a good example, Jeff, where you've got, you've got wind damage and then you've got flood damage. They happen to, the flood damage is generally, you know, sort of seen as the Northeast. Ida is almost two different events in a way. The Northeast was a flooding event. And then in Louisiana, it was more of a wind event,

although there was a lot of rain that was dumped in the state of Louisiana on a very already saturated, unfortunately saturated area of the country that will exacerbate the actual settlement of those claims. So the estimates come out, you're right. The estimates come out from these models of the industry uses and industry sources,

centralized industry sources that do a survey of insurance companies and say, you know, this is what we think it might be. But until the claims professionals get on the ground and start settling claims and looking at the property and saying that's water a, if it's a homeowner's coverage and it's flood, that typically goes into the national flood insurance program and the insurance, the homeowner's insurance company doesn't pay that. So you have to really, you have to go through it kind of claim by claim until you get a clear sense of where the, where the loss sort of manifests itself, whether it's on the insurance policy,

whether it's in the flood program run by the federal government. And that just takes a while to sort out. It's particularly exacerbated this year because with COVID, as everything else, things are slower. And the slower it takes, the longer it takes for you to settle a claim, generally speaking, it becomes more costly. You think about if you can get in and assess it quickly and agree with the homeowner or the business owner in what the claim should be paid. But as time goes on, things tend to deteriorate and then the loss can escalate. So the amount of time is a problem because of COVID, because of lack of labor, supply chain disruption, infrastructure issues. There are all sorts of things that will

create a more complex claim outcome in IDA. And that's why it's going to take some time to sort out. All right. And then two more on reinsurance. Why Bermuda? Why are all these things in Bermuda? Go ahead. Sorry. Why Bermuda? No, that's okay. I mean, Bermuda became sort of the jurisdiction of choice, really. I mean, not all reinsurance is done in Bermuda, by the way. I guess you go back, if you wanted to go all the way back 300 years plus, reinsurance started at Lloyds of London. Lloyds of London still plays a very prominent role, as do a number of large reinsurance companies in Europe, like Munich Re, Swiss Re. But Bermuda became a jurisdiction of choice really in 1992 after Hurricane Andrew, where it was, there is, the Bermuda Monetary Authority is there with a jurisdiction framework, which is very,

very strong. It's part of the UK from a court and legal standpoint. And so it was seen as a place that has, it's closer to the United States. It is a low tax environment. So the idea was to write volatile lines of business and attract talent to Bermuda that has then just created a market in and of itself. So the class of 92 was six or seven companies that started, it was a class of 2001, as we call, as referred to it, not as many companies, but larger and more successful companies over time. And then it's, there's a marketplace there with people with solid regulatory framework.

Now it's self-fulfilling almost. It's self-fulfilling, exactly. And hence, these were generally the model was private equity built drive to a certain liquidation event and move on. Along the way, it has also become the place for asset managers who are dedicated to insurance linked securities. So they also have, with the stock exchange and the BMA, have found a home there to participate in the marketplace alongside the traditional balance sheets. And then what, I don't know if you know,

but like Third Point and Greenlight had set up their reinsurance companies that they were going to invest back into their hedge funds. Is that still a game being played or is uh it is it is but it's um sort of i think less so of a of a model honestly going forward um but the yeah the idea is that you can write uh uh longer tail lines of of going back to my point there are there are lines of insurance about sort of how losses uh develop over time. I just used a property cat example where it's going to take months and months to understand what Hurricane Ida, but there are liabilities out there that sometimes take years and years to

understand. And so those long tail lines mean you can collect the premium for a number of years, invest in alternative strategies that get you extra yield on the investment portfolio. And the combination is more powerful. I think I've never worked for that type of a company because I like to focus on the risk on the liability side. And I think that if you focus and you know you're getting paid for that risk, then it's a better outcome than trying to minimize that risk, but maximize the risk on the asset side. And so, yeah, there are still companies out there pursuing that strategy, but it's mostly now, when I think of a traditional, at least advantage, the balance sheet is very, very conservative, very boring assets. All high level of T-bills and short term duration and very highly liquid.

And that's the majority of investment assets that go against the insurance, reinsurance business today. Well, you don't want to get upside down, right? Like if they were selling short IDA, or not IDA, but Ike in 2008, and their hedge fund was down 40%, they've got a cash problem, right? They got a cash problem. Yep. You need to be somewhat,

you need to be liquid in the reinsurance business, I guess it's because you don't know when the events are going to happen. And then the contracts are due. So it's hard to get that right, that balance right. And so that's, I think that it's been proven by the folks who have tried and continue to try. And we'll see how it all plays out. And so we mentioned CAT bonds, that's short for catastrophe bonds. That's hurricanes. What else? Does it cover all sorts of catastrophes?

Seems like we have an ever increasing number of catastrophes in the world. Yeah, it does, unfortunately. No, they're fairly prescribed in, they rely on a third party objective view of what the risk is. And so there are model vendor models out there that provide that that view of risk. And it's really in places like US hurricane, US quake, some, some Japanese risk as well, both Quake and Typhoon. And in certain cases, Europe, it's a more highly concentrated portfolio of risk where there's modeling available and there is third party validation. And the pricing is such that it's attractive to cap on investors. So we advantage, we've already issued a cap on, for instance, on an industry basis.

So you buy it on a derivative basis that those investors are keen to find that yield, but it's very, very limited in terms of what coverage does it afford. So the one structural issue overall with the business is that we talk about insurance companies. You mentioned your insurance company, USA. You think of it's the best rated company, one of the best rated companies in the country. It's got it's got a huge balance sheet. You add up all those insurance balance sheets. I lost track, but it's somewhere between two and three trillion dollars. The global reinsurance marketplace is capitalized to about six hundred and sixty billion. And then that secondary market I talked about, the retro market is about one hundred billion. And then that secondary market I talked about, the retro market is about 100 billion. And the cap bond market is just shy of 100 billion in notional. Sorry, when I talk about

the collateralized reinsurance, the ILS space is about 100 billion and a portion of that is cap bonds. So what you have is sort of an upside down market really in terms of access to capital because pension funds and the general investment community is much larger than what that shape of that structure I just referred to. So we need to find ways to bring more investment investors in to grow the business and build a more sustainable structure that's not sort of upside down in terms of a trillion dollars buying from a $660 billion to a $100 billion marketplace. But the cap bonds and the cap bonds are just a portion of that $100 billion up until now, at least. We'll help with that. Hey, pensions, instead of selling uncapped variant swaps on the S&P, buy some

cat bonds. Sure. Yeah. Yeah. There's a learning curve involved, but all of us are doing our best to try to explain and demystify the business and provide quantitative output that is comfortable for investors to digest. So speaking of the quantitative output in the modeling, so I don't know if you can talk specifics of that bond you mentioned, or just in general, like what are the probabilities that get assigned and what sort of yield are we talking about?

And what does all that look like? Yeah, I mean, generally speaking, the cap bond market participates even further out the curve than so it's at the tail end of the reinsurance. So they're really picking up what we call expected loss, or in our jargon of very small percentage outcomes. So the coupon on that tends to be a single digit, low to mid to upper single digit coupon. It's a floating rate instrument. So you post your collateral, it makes what it does in terms of the underlying asset,

and then you get the coupon above. But that's where it's been oriented. And as I say, it's been very singular in terms of the type of peril that the cap on investors are willing to take. And it's certainly out the curve. It's at the tail end. So you're really, it's beyond where the reinsurance marketplace is going to provide efficient capital to its customers. And you mentioned the retrocessional trades. Like, can I go long these? If someone's buying it, can I go long the outcome? Like most of our, a lot of the people we have on the pod

and some of our investors, they want to profit on a left tail event, right? Like here we're selling short the left tail event. So yeah, I'm just, how can I buy it? Yeah. You can buy it. There are, there are derivative instruments called ILWs, which are industry loss warranties. So you can, you can, you can buy those in an ISDA form that says, you know, I, I, I think the likelihood of a category five into Miami is much higher than the industry has priced it at or has modeled it at, excuse me. So, you know, I, I'd be willing to, to buy that risk. It's, it's available. It's a very small market.

It's a single billions of dollars. And it's a, you'd have to be very patient, right? Because the night, the 1926 hurricane hit Miami was in 1926. We all, it seems like everything's happening about every 100 years. We have a pandemic. It's been 100 years. So maybe we're due in 2026 for the Miami hurricane. But you'd have to be patient on that trade. And what would you be spending? Who knows? 1% a year or something? Not even that much? No, you'd be spending more than that. Really? All right. So yeah, it doesn't make sense on any normal, realistic timeframe.

So we mentioned it some, but how does climate change play into all this, right? That's kind of an unknown and a clog in the mission. It's unknown, but it's fundamental, right? There was an article in the New York Times this summer. We were all used to looking at the maps, unfortunately, the pandemic maps. But this map showed the United States

was almost sort of cleaved and two. The western part of the United States is the driest I think it's ever been. And the eastern part of the United States is wetter than it's ever been. So you've got global climatology. Then you've got localized conditions that manifest themselves in ways

that are very into the, what your long-term models are telling you. Your, your hurricane model, look at empirical evidence going back to, you know, a hundred years plus run and, and, and simulate a, you know, a set of outcomes for you. But if it hasn't taken into account those conditional probabilities that you're shifting seemingly on an annual basis and not more, more, more likely, uh, quick, more quickly, excuse me, then, you know, you could, you could find yourself caught out insurance and reinsurance contracts or annual contracts for the most part. So when you buy them and it's because there's no liquidity, really, you own them for that year. It's hard to sort of hedge against what you then decide is a conditional issue

that you didn't, wasn't necessarily contemplated in the model. So it's a challenge for us to understand the local. This year, for instance, when you think of an Atlantic hurricane, you often think of seeing it form off the Sahara, coming off the Sahara, coming across the Atlantic and sort of winding up, and maybe it goes into the Gulf, and maybe it goes up the East Coast. This year, we saw a lot of what I call pop and drop hurricanes, which all of a sudden, there's a hurricane in the gulf yeah and accelerates over

the that warm blob that's the water that's in the gulf and then it and it's full of moisture so it drops you know four five six inches biblical types of rainfall and and uh there's no it's a different type of a hurricane honestly than the cape verdian Verdean forming hurricane. So, you know, does that is that mean is that part of the new climatology that we have to deal with and thinking about those types of events and how do we adapt to them as an industry? All that is, you know, it needs to be discussed. And we just we just hired a meteorologist to help us understand that and to see what, you know, what type of product innovation we need to think about and how we deploy capital in a more meaningfully profitable, sustainable way. Right. It seems to me like at best, it's going to make it more volatile, right? Like your model is going to be, anyone's model is going to be wrong more often because of

the changes coming. Which will make a market. The market has fallen into a little bit of complacency around vendors providing that that analytical framework and everyone using the same the same models to to tell them what their view of risk is advantage. We have it up there and we're going to view risk differently because of just what you just mentioned. It's going to it's going to create volatility, which doesn't mean that there isn't opportunity to deploy capital in a smart way. And so whose models is the industry using? They each have their own model, each of these reinsurers, or it's kind of a general stochastic approach? It is, yeah. There are principally two to three model providers, RMS, AAR, CoreLogic now

that provide the underpinning for a lot of the industry's view of risk. The rating agencies rely on those models. Cap bond investors rely on those models. So they're important and we use them as well, but it's like any model, you need to kick it around, particularly given what I just said

and how adaptable are they? It's not just climatology either. They have embedded in them certain, we mentioned it earlier, but certain expectations in terms of an average claim in a certain type of windstorm in the state of Louisiana, the state of Florida, that is also on the table for the reasons I mentioned earlier, infrastructure, cost of goods, cost of labor, and governmental action, governmental oversight and authority can also affect that outcome. You think about consumer protection and governments that are thinking about that. So all those things need to be added to the model. And then we haven't even gotten into there'll be a whole nother podcast.

But is the data that the model is based on, is that accurate? Is that correct? Our ecosystem in the insurance businesses, we allow the insurance companies to collect the data provided to the brokers, the brokers to provide to reinsurers, reinsurers then, is there a way to objectively validate that data to begin with. Insurance companies who are worried about that are exploring better ways to access data and there are better tools, obviously, in this day and age to assess how accurate the data is. Is the data, is the asset that you're insuring exactly where you think it is? Is it built the way you thought it was? Is it on the roof that you think? And just real-time data, right? Things degrade over time.

And so have you taken all that into account? And I think the data will get better and our ability to assess it obviously has to improve as well. The whole game needs to be continually developing. The data is like 2 million people's homes in Houston. They're individual roofs and whatnot, right? So that's a big nut to crack.

And so the brokers are passing that on to the insurance. Well, the insurance companies collect it, right? Or their agents collect it. You think about your policy. It may not have even been inspected. It may have been done from an office saying, I kind of know the type of, you know, Jeff sent me. I actually remember it was a drop down of like, what's your roof of shingled rubber?

I can't remember the choices, but yeah. So, you know, you fill that out diligently and accurately. You know, does that happen in every case? And then does it, are the assumptions made against whatever that information is, that data collected in the appropriate way and thought about from the insurance company standpoint? Everybody's striving to obviously understand their portfolio. You have to remember, it's only 30 years. It's been 30 years ago. Insurance companies didn't even collect the underlying data.

They just, in Hurricane Andrew, that was a surprise in 1992. It wasn't that long ago. I know it's not old, but insurance companies didn't didn't actually know what their their count of policies were in any one county or any one zip code. What they what the characteristics of their portfolio were in any sort of fine details. It was the models that I just mentioned who created the need and the desire and the framework, I should say, to collect the data to then start to analyze it. So we're 30 years in, technology is getting better and better, providing us, you know, not, and then not to get into sort of machine learning and figure out even better ways, faster ways to understand the data. We need to do a better job at staying on top of the data as it evolves.

No, we love machine learning here. So Vantage, you guys are using machine learning, what do you call it, machine learning or AI or a combo of the two? It's becoming more prevalent. We are just starting out. So we've got the storefront open. We've had a great start to our business on the reinsurance side. Insurance takes a little longer because you've got 50 states, 50 jurisdictions, 50 licenses you need to bring through the process. And so that's taking a little longer, but we're very happy to have the front of the store open, so to speak. And in the back, we're certainly looking at all those technological developments and data. We've hired a large team of data scientists, data engineers to start understanding the data that we're collecting and then provide output, whether it's human or

machine driven, to give us better insights into risk. Yes. And do you feel like that'll become a winner take all for the insurance industry, right? Like the more, the bigger you are, the more data analytics you can do and the more data you have and the more you can spread out your risk. And it seems like, yeah. I think so. And so you'd think the large carriers would have an advantage and you certainly, you read about the war chests or the, you know, the, I guess you'd say the, the amount of money that they're spending on, on data and data mining, you'd hope so. But sometimes the benefit goes to the smaller and nimbler player who can find that insight quicker and take advantage of it. So that's certainly what Vantage is hoping.

And then I'd say there's a lot of risk that is commoditizable or homogeneous risk that you can put into and understand. There's a lot of risk. On the insurance side, we're writing DNO, ENO, so directors and officers liability and errors and emissions liability. That's not as susceptible to just the machine learning because companies change and the environment changes, whether it's the threat landscape from cyber or societal norms change. Does ESG have an impact on how companies operate and how they'll be held accountable for their actions? And so things like that are harder to sort of say that you can grab data that's available and crunch it and those more idiosyncratic risks.

But certainly a large portion of the insurance business can be seen through better data can be provided to give us better insights, yes. And it seemed like, to me, like one huge cap bond fund that rolls exposures and doesn't have an end date, right, and has a huge, right, if I just have a cap bond on Grand Isle, Louisiana, that might be pretty risky and it rolls every here. If I have the whole Gulf Coast, plus Florida, plus Japan, now I have a diversified portfolio and I'd rather sell options on a diversified portfolio of stocks than just Netflix. Yes. Yep. And that's the challenge for the cap on market. Those investors want it to grow. They want it to expand. And it's just that the

product isn't as adaptable in a lot of places for a lot of peril. So they've got into the private collateralized reinsurance space to collect that diversification and to sell more option. And it's less liquid. It's not a 144A security. So that limits some of their appetite, but it's an arena that needs to grow in our business. That $660 billion is great. We're all proud of how much capital we have to put to use for society. And according to people like Swiss Re and others, it's probably a third to a fourth of what it could be, what it should be as a global enterprise. So it still needs to grow and we need to rely on these investors to help propel us to think about how we can grow the marketplace. And it's always weird to me when I've in the past explained like, oh, reinsurance insures the insurance. And then people are like, well, who insures the reinsurers? It seems like there's a missing leg at the end. But that's probably why it's only 600 billion. There's only so much capital that's willing to reinsure the

reinsurers, right? So you have to build that capital base. A lot of it is because we're all being judged more or less by the same yardstick. We all run a very similar capital model. So it provides for less growth of the marketplace, whether you're running an S&P model or an AMBES capital model. It becomes a compressed arena of where things get traded. And you really need to think about longer term outcomes and different and different capital structures as well that might be more flexible over the over the over time and provide more, you know, a better return across the whole curve. I don't know if we touch on this confining capital model. No, I just I just touched on it a little bit. I mean, it's it's it's an interesting business that a lot of people, as you say, have heard of,

but then don't really know where the, I used to joke about like, what's this, is there a secret handshake or something? Because it's a, it's a fairly tight ecosystem. It's, it's well, it's been around for a long time. But it's, it's, you know, control, You have to have a rating. You have to be able to provide your your long term plan to, you know, outside outside credit rating agency and pass muster. It's fairly centralized in terms of its distribution model. At least the reinsurance market is predominantly the production pipeline is through the large brokers, Aon Marsh, Willis. It's a very, very few producers of that business. And then you run these models that most of the competition run. So that creates a bit of a confining view and a closed ecosystem that we're not here to disrupt anything. We're, you know, we're happy to be dealing with our distributors and working with the analytics that we have.

But I think as an industry, we all have to, you know, think about whether there's some limitations to that and whether it does, it does not encourage, you know, further investment, further capital to come in if, you know, to provide a better, a better return across the curve, as I say. So those are just some challenges we have, we'll always have as an industry. We're all trying to solve them. The producers are trying to solve them. The rating agencies are aware of it and thinking about stress testing your capital and keeping you, making sure that you understand the responsibility for your balance sheet and the risk that you're taking. But, you know, it just, it always helps to have literally third-party

capital come in and push and pull and poke holes at the, and then find ways to, you know, expand our business. And that is a valuable role that a lot of these third-party investors have played over the years and hopefully continue to play. It's like you need a got milk campaign. It seems like it's always in the news for the wrong reasons. Yeah, nobody really likes insurance. It's always something to complain about. It's like the weather or the airlines. Reinsurance especially is like, oh, these rich hedge fund guys in Bermuda are trying to do this or that. And you're like, no, we're actually trying to provide a valuable service to the planet here.

We'll finish out with some of your favorites. Favorite Bermuda spot or custom? Favorite Bermuda spot or custom? Favorite Bermuda spot or custom? Well, I'd say if you're closing a deal, a dark and stormy on any bar along Front Street is a nice way to celebrate. And you don't have to wear Bermuda shorts and high socks either. Gosling's Black Seal Rum. Black Seal Rum and Barrett's Ginger Beer is the classic. All right.

I love it. Favorite investing book. Favorite investing book. I've just gotten halfway through Noise, which I found intriguing, but I've been, I've been sort of preoccupied with some, some business stuff. So I haven't gotten back to that. And then the other one that was interesting to me is a book called resiliency, which was written a number of years ago. I can't remember by an MIT professor, not, not, not, I guess, not investment books, but more business books. Those are, those are two that I've, I've really enjoyed the resiliency book in particular. I feel like I've read that, but I business books. Those are two that I've really enjoyed, the resiliency book

in particular. I feel like I've read that, but I can't remember the author here either. I'm looking around my shoulders. Favorite Boston restaurant? You a North End guy or lobster or what? Yeah, no, not North End. There's a, there's a, there's a restaurant called SRV on Columbus, Columbus Avenue. That's a nice, uh, it's Italian, but it's on the North end, but it, uh, it's a great, great vibe. And you don't really have the Boston accent. So where did you grow up? I did. Yeah, I know. I'm sorry about that. Uh, so all your listeners, but, uh, I somehow avoided it. My parents from, from New York city. And I didn't, I just never, just never had it for whatever reason, but I did grow up here.

I got a good one. If you want to hear it, the you can't park that car here. That parking's for the fish market only. Throw in a wicked Pista and you'd be all set. Favorite. You went to Syracuse, right? You're an upstate New York guy like myself. So favorite Syracuse athlete. Oh, favorite Syracuse athlete. You know, I regret, I got there right after the Louie and Bowie show,

but when I was touring, I, that's, that goes way back, Louis Orr and, I forget his first name, Mr. Bowie show but when I was touring I uh that's that goes way back uh Louis Orr and uh yeah I forget his first name Mr. Bowie um and uh and then I liked then playing with them was a guy named Marty Head who was a favorite fan favorite because he was uh not a tall not a tall guy and he was bald it was Marty Head so his name was He wasn't the most famous Syracuse athlete. There's tons of them and they were all awesome.

And those were all basketball, I'm assuming? Basketball, cyclist, Ron Cycler. Basketball was more of a thing when I was there. Football was always a little... We had Joe Morris and Mercury Morris. We always had a few pretty cool players, but the team didn't really perform in those years.

And lacrosse has always been good. The Gates brothers and the yeah, they're, they're pretty, pretty, pretty stunning athletes as well. Yeah. I went to actually Gates brothers. Lacrosse game in the dome was one of the coolest things I've ever done. Yeah. There you go. That's pretty special. Yeah. And that was my answer i was hoping you're going to bring up the gates brother um and then finally but right i don't know what they're doing didn't they start a league or something they started a league in canada i

think or yeah i think so or yeah yeah state new york yeah uh and then finally favorite star wars And finally, favorite Star Wars character? Oh, boy. Oh, boy. See, I have to confess, I guess. My brother should be on the list. My father and my brother are both engineers, math guys, really into that. So you can look on my poster behind me. Yeah. I like that. I like the Rey.

I like Rey, the character Rey. There you go. Yeah. I like that. I like the Rey. I like Rey, the character Rey. There you go. Yeah, she's great. So we're going to have to do my Star Wars Fans Guide to Investing. So we list all these asset classes and what Star Wars character they would be. But I don't have reinsurance. There's reinsurance? Or cap bonds in there. So, yeah, we're going to add those to the poster.

Well, Rey starts with RE. Is Rey already taken she's not that that was made pre uh pre-ray so done done and done all right chris this has been fun thanks so much uh thank you jeff enjoy your weekend and uh next time you're in chicago or i'm in boston we'll uh we'll grab a beer or something. That sounds great, Jeff. Thanks for your time. Thank you.

All right. The Derivative is brought to you by CME Group. CME Group is the world's leading and most diverse futures and options exchange. For more information and educational resources about futures and options, visit cmegroup.com. You've been listening to The Derivative. Links from this episode will be in the episode description of this channel. visit cmegroup.com.