CastlePoint Holdings Ltd., is a Bermuda-based holding company providing property and casualty insurance and reinsurance business solutions, products and services primarily to small insurance companies and program underwriting agents (PUAs) in the United States. Subsidiaries of CastlePoint include: CastlePoint Bermuda Holdings, Ltd., CastlePoint Management Corporation (CPM), CastlePoint Reinsurance Company, Ltd. (CPRe) and CastlePoint Insurance Company (CPIC). The company was incorporated in November 2005 and commenced operations in April 2006, in order to originally capitalize three specific market areas opportunities:
traditional quota share reinsurance or insurance risk-sharing capability
program underwriting agents to write program business
unbundled insurance company service providers supporting program business.
Following the March 2007, IPO, the shares of CastlePoint began trading under the ticker symbol "CPHL" on NASDAQ. Being domiciled in Bermuda has clear advantage over being US-based. While the favorable business environment for companies based in Bermuda remains open-ended (currently income, capital gains, or corporate income taxes are not imposed on the island), CastlePoint, CastlePoint Re, and CastlePoint Bermuda Holdings have received written assurance from the Bermuda Minister of Finance that no taxes will be imposed through 1Q16. This should enable the company to develop and deliver cost-effective insurance and reinsurance products, thus creating a competitive advantage.
Relationship with Tower
Tower sponsored CastlePoint's formation. As a result, both companies entered into a long-term strategic relationship whereby CastlePoint provides traditional quota share reinsurance to Tower, as well as other types of ancillary reinsurance coverage, providing CastlePoint to secure a stable source of traditional quota share reinsurance and insurance risk-sharing capability to support its anticipated future growth. Under the long-term strategic relationship, Tower cedes 40% under the brokerage business and 50% under the traditional program business quota share reinsurance agreements, and through a related quota share reinsurance agreement cedes 85% of the specialty program business and insurance risk-sharing business to CPRe.
The lion's share of this business should be generated from traditional quota share products (sharing premium and losses from the first dollar, paying the ceding company a commission to cover the expense of producing the business), but includes property-casualty per risk excess of loss, catastrophic excess of loss ("cat"), and aggregate excess of loss as well. This segment's primary target markets are small insurance companies with statutory surplus of less than $100.0 million, offering both commercial and personal lines (low to moderate hazard risks). In addition, we would anticipate CastlePoint would also provide risk-sharing solutions to larger insurers when and where it makes strategic sense.
Insurance risk sharing
Similar to quota share reinsurance, CastlePoint shares premium and losses from the first dollar and pays the other party a fee. CastlePoint focuses on insurance risk-sharing solutions with customers writing policies with low-to-moderate hazard risks. The three units of this segment are 1) property-casualty product program business similar to the commercial and personal lines underwritten by Tower 2) specialty program business outside the programs offered by Tower and 3) providing risk-sharing solutions (poolings) to insurance companies. This segment's primary target markets are small insurance companies with statutory surplus of less than $100.0 million. CastlePoint plans to acquire other insurance companies. Through insurance risk-sharing arrangements, CastlePoint's customers are able to better manage surplus, the financial strength rating and/or state licensing limitations, and expand premium writings.
This segment relates to business written on an individual policy basis by PUAs and aggregated from other retail and wholesale agents on behalf of insurance companies. Following a prolonged soft market (the result of increased competition, lower commissions, and deteriorating profitability, much of this business went away), the program business became an underserved niche. CastlePoint plans to differentiate itself by offering a broader line of product and structure. CastlePoint targets programs that generate a minimum premium volume potential of at least $5 million.
CastlePoint offers a comprehensive set of insurance services separate from the various underwriting lines of business. Claims handling, policy administration, insurance technology and consulting services (program and product design, actuarial and loss reserve analysis, loss prevention and control, operational audit support, reinsurance placement and handling, captive formation and management, rent-a-captive formation and management, and regulatory compliance) provide the majority of these business services. These services are available on a bundled or unbundled basis, providing CastlePoint a means to facilitate the marketing of its insurance and reinsurance products.
CastlePoint plans a broad line of insurance offerings including - commercial package, fire, and allied lines, commercial general liability, workers compensation, professional liability, commercial auto, personal auto, personal dwellings, and commercial and personal inland marine.
M&A AND STRATEGIC INVESTMENT EXPECTATIONS
With respect to mergers and acquisitions, we think management will be opportunistic in the coming years, especially within the US market. Though for most sectors, acquisitions have been an important portion of a company's growth story, insurance companies typically have avoided straightforward balance sheet acquisitions. In CastlePoint's case, the company prefers to first invest capital in organizations seeking capital relief, access to geography, access to ratings, or with owners looking for an exit strategy.
A major part of CastlePoint's overall strategy is to build a distribution system that sources a significant portion of its overall business by making strategic investments in some of its clients (using Tower as a starting point). This should provide CastlePoint with a more stable, predictable, and profitable sources of business from its strategic clients. In addition, in order manage the market cycle better management intends to expand/ contract the amount of business from other third-party clients depending upon the market conditions, while maintaining a stable base of business.
Recently, CastlePoint acquired a US licensed insurance company in order to provide insurance risk sharing and program business solutions and entered into another risk sharing agreement. Within the next year, management has indicated plans to acquire at least one additional US licensed insurance company, either with little or no pre-existing business or with ongoing insurance operations, and with broader licensing, which would permit CastlePoint the ability to write insurance business in more United States jurisdictions on both an admitted and non-admitted basis. The purchase price for these companies should be based on the value of the target company's insurance licenses (in the company's experience, typically between $100,000 and $200,000 per each state license) and the amount of its statutory capital and surplus, as well as the value of the business if an ongoing operating insurance company is purchased. Over the next several years, we expect CastlePoint to maintain a healthy flow of acquisitions, based more on strategic investments in companies seeking one or more of the aforementioned attributes.
During 1Q07, the company received a Financial Strength rating of "A-"from A.M.Best. Again in July 2007 A.M. Best reaffirmed its rating.
OUTSOURCED INVESTMENT PORTFOLIO
At the end of 3Q07, the company had $675.4 million in invested assets, cash, and cash equivalents, of which 73.2% was in fixed income securities, 6.0% in equity securities, and 2.0% in investment in partnerships and common trust securities. At this time, CastlePoint's investment portfolio continues to be managed externally by BlackRock, Inc. The fixed income securities continues to carry a rating of AA based on a weighed average basis, with about three-quarters of the portfolio being "A" rated and less than 10% BB or below. The investment book yield on the invested assets was 4.7% for 3Q07, compared to 5.5% for the same period in 2006. We would not anticipate any major changes to the current make-up of the portfolio at this time, as we anticipate both metrics move higher, reflecting growth of invested assets and a longer duration in the investment yields.
The overall investment portfolio is "AA " rated, and the total exposure to subprime mortgages is approximately $11.0 million (2.1% of total available-for-sale investments), $9.0 million of which is rated "A" or above, and only $0.1 million is rated below investment grade and relates to mortgages issued in 2005 and prior.