NMPIP: Grant Advisory Board the Power to Enter into Investment and Retrocession Agreement with Cover Re

Governance Discussions
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NMPIP: Grant Advisory Board the Power to Enter into Investment and Retrocession Agreement with Cover Re

Summary

Unity Cover—the manager of Staking Pool 5, which is run by some of the Nexus Mutual core team members—has been in discussions with Cover Re (“Re”) for some time over a potential investment and retrocession deal.

I am proposing that the Mutual enter into an investment and retrocession agreement with Re, which would require members to grant the Advisory Board the power to:

  1. Enter into investment agreements with Re on behalf the Mutual
  2. Swap $15m worth of ETH into stablecoins, $12m for the investment and $3m for collateral
  3. Set up a trust account held in Terrapin’s name for the Mutual
  4. Transfer the stablecoins for investment to Re and collateral into the trust account
  5. Whitelist USDC and a newly developed “Funds Withheld Token” as payment tokens for the Mutual
  6. Agree to final terms with regard to investment, collateral accounts, and funds withheld terms with Re provided they are consistent with the descriptions provided below

I present the details of this potential deal for members to discuss and share their opinions ahead of an all member no-action vote.

Rationale

Re is a Cayman Islands-based company that reinsures a variety of business lines including aviation, business owners, commercial multi peril, personal and commercial auto, professional liability, and workers compensation, among others. These business lines are very stable relative to the business that Nexus Mutual has written previously, as Protocol Cover and other cover products have, historically, been more binary (i.e., resulted in either minor or quite large claim payouts).

Re is in a position where it can significantly grow its premium volume but requires additional capital to do so. On the other hand, Nexus Mutual has underwriting capital ready to deploy and is looking to increase cover volumes. These strategic aims are complementary and form the basis of the deal structure presented in this proposal.

If the Mutual were to enter into an agreement with Re, members could expect to pay a stable level of claims every year and the profit margin would be much more predictable.

Re has attached $45M in premium volume so far this year. It is committed to complete on-chain transparency as it pertains to transactions and proof of reserves between itself and insurance companies it supports. Their team is composed of the former founders and engineering leaders of Cover, a national insurance business in the US which launched out of Y Combinator in 2016. Reinsurance operations are headed by the former CEO of Willis Programs, a $5B underwriting entity, and the founding Chief Actuary of Greenlight Re.

Specifications

The deal has two main components:

  1. An investment of $12m into Cover Re SP1

  2. Retrocession Cover deal where Re shifts 15% of their underlying risk to Nexus Mutual

Glossary

  • Funds Withheld Basis. Notional accounting basis where liabilities are transferred but cash payments follow later once the actual claims/losses are known and are closer to being final.

  • Insurance Float. Assets an insurance company holds are called the “float”, and an insurance company puts these assets to work and earns investment earnings on this in the meantime.

  • Margin. Premiums (or cover costs) less claims.

  • Gross Premium. Premium paid by the end insurance user, usually the retail client.

  • Net Premium. The premium or cover cost paid to Nexus Mutual after taking out expenses and profit margins for both the insurance company and Re.

  • Retrocession. Where a reinsurance company transfers risk to another company (another reinsurer or Nexus Mutual)

Investment into Cover Re SP1

The first component of the deal would be an investment in Re’s open-ended fund, whereby any funds contributed are locked for a period of at least one (1) year and can be redeemed thereafter, though we would expect funds to be locked for multiple years to support the strategic partnership. Per Unity Cover’s discussions with Re, the proposed start date for this investment is 1-Jan-2024.

Returns on the investment into Re are expected to be in the 18%-22% range, which is driven by expected profit margins on the reinsurance business line, as well as holding the insurance float in US treasuries. These returns are variable as they are linked to the underlying performance of the Re business. While unlikely, it is possible that the entire investment is lost if claims experience is very poor. On the other side, positive claims experience will result in additional returns.

This requires two main aspects for members to consider.

  1. Willingness to sell ~$12m of ETH for stablecoins
  2. Attractiveness of the Re investment

Retrocession into Nexus Mutual

The second component of the deal would involve Re entering into a “retrocession” arrangement (i.e., the insurance term where a reinsurer transfers risk), whereby Nexus Mutual would receive 15% of the underlying business for 2024 underwriting year capped at $15m gross premium. On a net premium basis we would expect Nexus Mutual’s revenue to increase by ~$10.8m (this is the cost of cover paid each year). The expected margin on this deal would be lower but much more stable at $1.7m (with approx. $0.5m coming from cover costs less claims and the remaining $1.2m coming from interest/earnings on cash flow). Total losses would be capped at $3m above net premium.

In order to access this deal, Re must obtain approval by the Cayman Islands Monetary Authority (CIMA), as Nexus Mutual is not a licensed insurer/reinsurer. Unity Cover has been working with Re behind the scenes on this approval process and have received positive indications from CIMA this is likely to be approved if the following conditions are met:

  1. Deal operates on a “funds withheld” basis, meaning cover costs are paid on a delayed basis once the claim experience has become clear (likely over a 2-4 year period).

  2. Collateral of $3m is posted in a trust account owned by Nexus Mutual at the call of Re should the Nexus Mutual cover not pay out.

In combination, these two requirements essentially reduce/remove the credit risk associated with Re interacting with Nexus Mutual’s discretionary cover.

If approved, this would be quite an achievement for the Mutual, as it would demonstrate that the Mutual’s on-chain capital can interact with TradFi insurance companies, and this deal could serve as a blueprint for future deals.

It would also demonstrate there is a route forward for “wrapping discretionary cover” with a traditional insurance contract, which could open Nexus Mutual’s addressable market quite considerably. MakerDAO and other DeFi protocols are exploring tokenised RWAs— a deal such as this one would be the equivalent for the insurance world. Members should consider this potential strategic value over and above the raw deal terms.

Technical Requirements for the Investment into Cover Re SP1

The following engineering work would be required:

  • Creation of a token that represents the off-chain investment in the Capital Pool

  • Creation of an oracle that would be updated once per quarter and reflect the performance of the investment

Technical Requirements for the Retrocession into Nexus Mutual

The following engineering work would be required:

  • Creation of a token that represents the trust funds held off chain as collateral (similar to approach for the investment)

  • Create a funds withheld payment token named “nexusUSD” (working title) that Re can use to pay cover costs and receive any subsequent claim payments in until the resulting profit on the deal can flow into the Capital Pool (funds withheld). The Nexus Mutual Advisory Board would have the authority to mint “nexusUSD” to Re to pay cover costs.

Proposal Status

This proposal is open for comment and will close after a minimum of 14 days from the date of this posting.

The proposed timeline of this NMPIP and the on-chain governance vote is shared below.

  • 23 November 2023. Post NMPIP on the Nexus Mutual governance forum for members to review and comment on.

  • 7 December 2023. NMPIP is put on chain for an all member no-action governance vote, where voting will be open for three (3) days. Voting will come to a close on 20 December 2023.

  • 11 December 2023. The outcome of the NMPIP will be subject to a 24-hour cool-down period.

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Hi everyone, my name is Cliff and I am part of the RE team. We are all excited about this proposal and potential partnership. I would be happy to help and answer any questions.

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Karn from the Re team here. Our view is that this proposal is precedent setting and presents a path for us in partnership to address the global (re)insurance market. We’re here to support and answer any questions the community might have. Cheers!

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I think the investment seems great in isolation, the proposal fits well with the mutual’s goals and offerings.

I do think that this needs to fit within the broader context of the newly launched RAMM. Making a large investment that materially changes the treasury’s make-up in the very early stages of a mechanism that’s supposed to allow people to exit is of course controversial.

I’d suggest some guarantees on accounting (initially no changes until [?] quarters have passed, and then update every quarter onwards), or some changes to the RAMM’s parameters to ensure those that want to leave prior to this investment materially changing what they own, can do so.

The ongoing context surrounding the RAMM shouldn’t stand in the way of a great investment opportunity and, likewise, the great investment opportunity shouldn’t stand in the way of peoples’ plans regarding the RAMM and their exit relative to the treasury assets that they expected to own throughout the process.

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This is indeed an interesting opportunity for Nexus Mutual. I think there are two points that need to be addressed first before this can move to a comprehensive voting process:

  1. Can we have more detailed information about Re business and key metrics? Their team is impressive and the advertised APY is attractive, but can we have a better understanding of Nexus Mutual’s risk/reward exposure in this deal? Also, can you elaborate on the pre-existing relations between Re team and the Unity Cover team?

  2. The newly launched RAMM is currently in a beta phase and trying to achieve the objective of offering an exit at book value to NXM holders. The system is in its trial phase and will require parameter modifications in the coming weeks after the volume of NXM willing to exit at BV has been better identified - unless predictions end up being perfect, of course (which never happens).
    I am afraid that the proposed timeframe is in conflict with this objective and doesn’t give the necessary time required for these 2 projects to mature.
    The implications for current NXM holders willing to exist would be significant if this proposal was approved, therefore I would recommend either a) a guarantee that BV will remain the same for 24 months or b) giving the necessary time for the RAMM to end the fast ratchet phase and potential new parameters to be adopted.

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On the RAMM interaction with capital budgets etc:

  • It’s a valid point that the RAMM parameters might need adjusting.

  • Members voted to effectively allocate 30% of the capital pool to allow redemptions and the remaining 70% to support cover growth. Achieving both subsets of members aims.

  • This proposal would allocate $15m of the current capital pool ~$280m, which is around 5.3%.

This means even if we need to make material changes to the RAMM parameters there should be more than enough capital to support this initiative. So I don’t see this as a concern at all.

On relationship with Cover Re team:

I was introduced to Karn and the team earlier this year by Blockchain Capital (a large Nexus Mutual member) as they thought there was a strategic alignment of interests (BCap are not invested in Cover Re to my knowledge). So there are no pre-existing relations between the Re team.

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Interesting investment into the real world. One thing was unclear to me - is this an investment in the equity of Re or an investment into an account they manage? If the latter, is there any opportunity for the mutual to have a strategic, permanent investment in the equity?

Regarding the token w/oracle, etc. - would be important for all to ensure that the valuation is made according to an internationally recognized standard.

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We agree here on affordability, the issue being presented is more that there’s a material change in the composition of what NXM holders own (ETH converted to stables, and then stables to a less liquid, higher risk investment, denominated in $).

Given that the mutual is intentionally hamstringing speed of exits to maximize its own captured value, I think it’s only fair that people should then be afforded the time needed to exit under what is largely the current treasury composition. This can be done by either by speeding up the mechanism to exit, or to hold off on changing the treasury’s composition like this until such time that those who wish to exit without being exposed to the new investment asset can safely do so.

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Interesting investment into the real world. One thing was unclear to me - is this an investment in the equity of Re or an investment into an account they manage? If the latter, is there any opportunity for the mutual to have a strategic, permanent investment in the equity?

It’s a investment into Cover Re Cell 1, and it’s structured similarly to an investment fund with a usual 2%/20% management fee. So it’s not an equity investment.

The benefit of this approach are the clear redemption options, which wouldn’t exist with equity.

I’m less convinced investing in illiquid equity is the right strategy for the capital pool.

Regarding the token w/oracle, etc. - would be important for all to ensure that the valuation is made according to an internationally recognized standard.

Agree, valuation will be performed using appropriate accounting standards.

Given that the mutual is intentionally hamstringing speed of exits to maximize its own captured value, I think it’s only fair that people should then be afforded the time needed to exit under what is largely the current treasury composition.

Any switch out of ETH to stables would occur post 1-month after the RAMM launch, so there is alignment here with the previous governance votes.

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absolutely agree with your point 2 here.

I think the current beta phase was quite underestimated by the team here and many members of the mutual pointed this out.

It is nice to see @Hugh seeing this and being open to changes. But in my opinion the “might” is more of a definite.

I think a parameter change should be in effect before we implement this with Re.

Would be happy to learn more and possibly vote yes once the RAMM works as it was intended to. instead of the current underperformance it is currently facing.

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Please open up a separate discussion on the RAMM parameters if you wish.

I’m still clearly of the opinion that even if RAMM parameters were to change there would still be a very large buffer to allow for this deal.

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Thanks Hugh for the proposal.

As a matter of principle I oppose selling ETH for fiat/stablecoins under any circumstances. Basically if ETH goes up more than 20% in a year, this investment would be a net negative for the mutual and the book value (which is measured in ETH, not USD/stablecoins) could clearly go down, even in the best case scenario if the events turn out as predicted and described.

Since I believe that the chances of ETH going up more than 20% are very significant in the next couple of years, now that the bull market seems to be approaching, I don’t see how this proposal can be positive for the mutual. At the very least, the risks that it isn’t are very significant.

I would be voting against.

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That makes sense. Are there specific instances in which you think the mutual would seek to redeem? Ie, is there a return goal or would it just be in case of underpformance or liquidity needs.

Separately, understanding that there are two different pieces of the investment, I’d like to ask if each standing on it’s own is consistent with market terms and pricing?

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I can see this perspective.

The counterargument here is that material cover growth is almost certainly going to be USD denominated. This means to manage the asset/liability aspect of the mutual appropriately we need to shift some assets into stables to support it anyway.

There are good arguments why we should be holding more stables now (to match liabilities) but there is ample buffer in the capital pool so members (including me) wanted to hold more ETH.

More broadly than this deal we can either:
a) have quite limited cover growth and stay in ETH as much as possible or;
b) go for growth and start shifting some of the ETH into stables gradually as required.

I’m quite firmly on option b) as that’s the only real route to 100x growth from cover.

This deal would more than 10x cover revenue from our current position so is a perfect example of what this trade-off looks like.

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The mission is to grow a cover / insurance marketplace.

The demand for insurance in the digital assets industry is still very high but the protocol is capturing a tiny fraction of this opportunity.

If the Mutual wants to grow, it must expand its list of products and offer insurance, not discretionary cover. That will mean partnering with regulated insurance entities.

That obviously requires the appropriate asset / liability matching that comes with those regulations.

Opposing all sale of ETH to fiat/stables prevents the Mutual from pursuing most opportunities for growth.

The intention should be to grow the marketplace, not to run a long-only crypto fund.

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Hugh, thanks for your reply.

The problem I see is that you already (willingly or unwillingly) chose a) the moment that the book value was denominated in ETH/NXM. Cover growth is not worth a lot if book value goes down, and this deal has the potential of not only reducing book value, but more than offsetting all of the book value growth that is coming from the ETH covers, the new tokenomics and all of the ETH investments.

Furthermore, if you say that there’s not much growth in ETH denominated covers, if the plan for nexus is to grow x100 covers by covering real world risks, in Fiat currencies, then crypto covers would become a very small part of them, there’d be absolutely no need or reason to hold crypto, be a DAO, call itself DeFi, or have assessors vote in claims for which it’s unclear which proof can they assess. That would be a completely different enterprise with different assumptions and different focus, and if that is the case, I’d suggest just closing Nexus down, returning all funds to token holders and starting a new mutual.

The only way in which I could maybe support this deal, is if the funds for this deal were coming from lending. Using AAVE, depositing ETH to loan stablecoins, using profits to repay the loan.

Honestly, I was on the verge about leaving the mutual using the new tokenomics, I’ll definitely do it if this deal is passed as proposed.

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Whether the risk is stemming from crypto or not, future cover growth is much more likely to be stablecoin denominated.

ETH denominated covers can still grow a lot, but if we plan on growing covers by 100x, then I believe the major part of that can only really come from stablecoin denominated covers. That applies to both crypto and real world.

I’d welcome comments from other members on willingness to leverage the ETH to get the stables here rather than selling ETH. Seems a bit risky to me, but it could buy us some more time before having to convert some of the ETH.

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Thank you, @Hugh, for the overview of the proposal. I think this is an exciting opportunity for the Mutual.

Just a few questions from me:

  1. If ETH were swapped to stables, the swap would happen after the initial exit period ends, right?

  2. The Mutual currently has ~$4.7m in DAI held in the Capital Pool. Could the amount swapped for stables be less than the total $15m given the current stablecoin holdings?

  3. Between the investment and the retrocession deal, would the projected annual return across both be ~$3.9m to $4.4m for a 2-year projected total of $7.7m to $8.7m?

  • Investment return estimates from this section, applied to $12m figure:
  • Retrocession return estimates per this section:
  1. Is this deal open ended? Or is there a drop-dead date on members deciding whether or not to enter into this deal?

On concerns about underwriting cover in USD

Since Nexus Mutual launched in 2019, members have been able to buy cover denominated in ETH or DAI. Over the last three years, covers have been heavily DAI-denominated. Right now, ~51% of the Mutual’s liabilities are in DAI. Last year at this time, 73% of new covers were DAI-denominated covers. Whether it’s crypto-native users or traditional insurance firms, people have a strong appetite for USD-denominated covers.

I think that trying to minimise the amount of ETH required for selling is the ideal outcome, so if the Mutual can use the current DAI held in the Capital Pool toward this potential investment, that would reduce the amount of ETH needed to achieve the rest.

I do think this proposal is worth shifting some ETH into stables. I know members have had this discussion in the past and people are bullish on ETH, but holding more in stables better balances assets and liabilities and acts as a hedge against a drop in ETH price, as book value goes up when more stablecoins are held in the Capital Pool. On the Capital Pool ETH currently staked, members are earning ~2167 ETH/yr, which increases book value over time as well.

If the Mutual is going to grow cover sales, USD-denominated cover sales are likely to play a large part in that growth since that’s what we’ve seen from the market since the protocol launched in 2019.

I also have to agree with Hugh here that the amount proposed would not impact anyone’s ability to exit and between cover sales, investment earnings, and positive slippage from the RAMM, BV shouldn’t be negatively impacted.

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Thanks for the comments @BraveNewDeFi

  1. If ETH were swapped to stables, the swap would happen after the initial exit period ends, right?

Correct, swapping would happen sometime in January for the $12m investment, and perhaps a month or two later for the $3m collateral.

  1. The Mutual currently has ~$4.7m in DAI held in the Capital Pool. Could the amount swapped for stables be less than the total $15m given the current stablecoin holdings?

Yes it could, we’d still likely need ~$2m stables in the pool.

  1. Between the investment and the retrocession deal, would the projected annual return across both be ~$3.9m to $4.4m for a 2-year projected total of $7.7m to $8.7m?

Yes that’s correct.

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This is a very exciting and complex proposal.
It took me a bit to wrap my head around it.

I found it helpful to decompose into its sub-parts and address these separately:

A. diversifying part of the capital pool into stablecoins investments

So far this had/has been a no-go for members of the mutual (see reactions to the Uniswap proposal earlier this year)
The realities of the market must be faced though. As reminded by Hugh above:

Dopee also had a clear statement:

Now with the recent introduction of the RAMM and the possibility for members to exit at BV, mutual members who prefer to keep a 100% ETH exposure have the option to leave without (much of) a discount.

Btw this discussion feels certainly better to be had now with the ETH price back above $2k than a few months ago at half this price (and no certainty we don’t go back there…)

B. the actual investment.

A ~20% return on stablecoins is an attractive proposition, which obviously comes with risks attached.

Members asked many good questions above, and Hugh addressed some from the start & gave additional details:

  • equity vs fund/vehicle?
  • redemption?
  • token / on-chain price tracking?
  • relation between teams / conflicts of interest

Additional risk mitigation measures in place that I can see:

  • investment position limited to <6% of the capital pool
  • delegating powers for the agreement to advisory board: the AB members are the top (non-VC) NXM holders and couldn’t be more aligned with the success of the mutual. No shortcuts to expect here.

One question I’d have is for the Re team @Cliff and @karn :

→ what are you more interested in (i.e. incentivized for)?
Is it:
a) (premium) growth? via the 2-20% fee model…
or
b) writing profitable business? any incentives for this, for ex. any personal funds as co-investment alongside the Mutual in the open-ended fund? iirc this is something that existed for the Maple investment.

How should we understand the alignment of incentives with the Mutual here in case of (severe) underwriting losses?

C. New business for the Mutual

The retrocession deal described above means increased cover volumes in new business lines for Nexus.
This is the part that I find (really) exciting.

I want to underline 2 items from Hugh’s intro and a later reply above:

A final question to clarify things, and this is more a question for Hugh:
→ My understanding (imho not really explicit in the proposal): the new business / retrocession part of the proposal is contingent i.e. depends on the investment part being acted on, correct?

The New Business would be fine in isolation for Nexus, but to open up capacity to write this additional business, I guess Re needs more capital and asks the Mutual to invest.

Congrats for all the preliminary work. Looking forward to it!

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