Nephila’s results start to confirm original thesis for acquisition: Markel CEO Gayner

The original thesis for buying into the insurance-linked securities (ILS) sector with the acquisition of Nephila Capital is now starting to be confirmed for Markel, as the ILS managers’ results improved dramatically and its funds are substantially all above their high-water marks after 2023.

This is according to Markel CEO Tom Gayner, who writing in his latest letter to shareholders explains that he expects Nephila Capital will now begin to rebuild its ILS assets under management.

The drivers are a more successful performance for 2023, but also the very important transaction that Nephila and Markel arranged, where the ILS manager cleaned up its legacy reserves and eliminated trapped capital for its investors, through an arrangement entered into with the help of an adverse development cover (ADC) from its parent.

Gayner said that in 2023 Markel, “benefited from strong market conditions in the property market. Both through the property risks we continue to write, and the economics we earn through our activities at our Nephila business.”

He expanded to say, “Several years ago, we shifted a meaningful portion of our larger property exposure to Nephila. We did so because we believed that Nephila’s capital providers worked with different cost of capital hurdles. As such, we believed that large property exposures for the Markel Group would be better served through the ILS market rather than on a traditional insurance company balance sheet.

“This idea worked. You can start to see it in the 2023 results.”

Moving on to discuss the ILS manager unit’s 2023 performance, Gayner wrote that, “Nephila produced excellent returns for its investors this year. And, as should be the case, they earned both management fees and profit share compensation in 2023. (Note, that the profit share contribution remained modest since some funds started 2023 below their high-water marks. Now, substantially all funds are above those marks. Future profitability for Nephila stands to improve meaningfully as a result.)”

Adding, “These results start to confirm our original thesis for the Nephila acquisition.”

He explained that Nephila Capital earned $22 million of pre-tax earnings for 2023, which was up from a loss of $16 million in 2022.

Gayner then explained that the way Markel has shifted property and catastrophe reinsurance risks away from its own balance-sheet to be backed by third-party capital from Nephila’s investors has changed the shape of the economics, but is starting to pay dividends.

“There are also accounting and timing dynamics that arise from having our large property exposures backed by capital from the Nephila investor base instead of our traditional operations. Namely, we will recognize our income from property exposures via management fees and profit shares from Nephila, as opposed to points of combined ratio profitability reported by the Insurance engine,” Gayner explained.

“Writing large property risks through Nephila also caps the downside risks to the Markel Group from large losses when the wind blows, earthquakes shake, and things go bump in the night. Whichever way we recognize the good news from profitable operations in property insurance at Markel Group, it works to the benefit of our shareholders.”

Looking ahead, Gayner said that Markel is anticipating that Nephila’s ILS strategies will gather increasing interest from investors and that this will turn into growth of assets under management.

“We expect that Nephila’s results will begin to attract positive attention from their investors,” Gayner said.

“We expect assets under management to begin to grow again following the underlying performance of what Nephila investors earned in 2023.”