Investors are putting money into newcos to back teams they believe have “superior underwriting skills” because that’s where earnings will be generated in a hard market opportunity that coincides with a low interest rate environment, according to former Arch chairman and CEO Dinos Iordanou.
As previously reported, Iordanou is working on a (re)insurance start-up and is understood to have secured backing from private equity firms Hellman Friedman and The Carlyle Group.
Speaking on The ReInsurer’s latest virtual debate panel discussion this week, the executive wouldn’t comment on specific details of his new venture.
But he provided insights into the rationale for launching a start-up and of investors in backing newco carriers as he highlighted opportunities he sees in specialty and cat reinsurance, as well as specialty insurance.
Iordanou drew parallels between the current start-up opportunity and the Class of 2001, when a pricing correction that had already started in Q2 2000 was accelerated by the September 11 attacks the following year.
“Looking at the market today we have a lot of similarities, the rate increases and correction started because of the lack of lift from the asset side of the balance sheet… and the emergence of severity trends on the liability side which necessitated price correction in the market,” he observed.
“Then Covid-19 comes and it creates uncertainty. So it has a similar feel to the 2001 time frame and for that reason there is quite a bit of interest from private equity and other investors to put money into newcos. They prefer new teams, no old liabilities and the ability to enter the market in a welcoming environment,” Iordanou continued.
The investment environment for (re)insurers with low interest rates means their interest is only in backing start-up teams they believe have superior underwriting skills, as they expect most of the earnings will emanate from underwriting activity, not the asset side of the balance sheet, he said.
“And they also understand that the market is open to new entrants, meaning the capacity they’re going to bring to the table, especially if coupled with capable underwriting teams, is welcomed by the clients and the distribution channel,” Iordanou added.
“Only in a hard market are new entrants welcomed… that’s what we see and we’re trying to see if that’s an actionable set of circumstances,” said the former Arch executive.
He added that key to decisions around building out a start-up would be the ability to attract “A+ talent” to the segments where opportunities exist.
“Putting a strategy together and finding capital is the easy part. The difficult part is to find the people that are going to implement that strategy and execute in the marketplace,” he said.
During the debate, fellow panelist PK Paran, global co-chair of DLA Piper’s insurance practice, backed up the comments about investor focus on underwriting track records.
He pointed to PE firms such as The Carlyle Group and Blackstone that have invested in the sector and gained a strong understanding of it, adding personnel to their own operations that have deep industry expertise.
“Funds like that are here to stay. They are really investing in management teams and businesses as a whole and they really understand the importance of the underwriting,” Paran said.
Lower return expectations
Speaking on the same panel, the founding former CEO of RenaissanceRe and TigerRisk co-founder Jim Stanard suggested that the current opportunity looks different from those he has previously engaged in because cycles are “less peaky” and “the business is getting smarter”.
“Some of the things that drove cycles in the mid-80s and 90s were really bad underwriting and misunderstanding returns in the business in addition to shocks on the loss side.
“I think that organizations are smarter now and some of the excess returns available in those early cycles are not available in a cycle like this,” he said.
But in a low interest rate environment the executive suggested that the alternatives available to investors are a lot less attractive, which means the expected returns needed to attract capital to the insurance sector are likely to be lower.
As previously reported, Stanard is understood to be actively looking at opportunities in the sector and is believed to be a party in the Ariel Re sales process.
Stanard wouldn’t comment on specific opportunities but did say that there had been a shift from the mantra of size as an imperative to survival.
“I think now we’re in the part of the cycle where you’ll see some of the smaller things start pushing back against the idea that you can’t survive if you’re not big,” said the market veteran.
He agreed with Iordanou about the ability that hard market conditions give a start-up to get access to business.
“That’s the hardest thing for a start-up, to acquire business. It’s not even so much the profit margins available, it’s just that you can get the business which you can’t really do in the soft market without getting killed,” said Stanard.
Meanwhile, Barclays equity analyst Ivan Bokhmat said that the fundamental relationship between investments and premium for carriers will maintain upwards pressure on rates.
For reinsurers in particular, he noted that the ratio between investments and premiums means that a 100 basis points fall in interest rates needs to be countered by a 300 basis points increase in rates.
“In fact US interest rates have been down 1.5 percent so far, so it’s very easy to comprehend why rates have to go up,” he said.
With social inflation in the US, Covid-19 and other large loss activity, “so far it feels as if the balance of new versus retired capital has still generally been in favour of market hardening”, he added.
M&A flow picks up after Covid pause
After a Covid-19 driven lull, the volume of M&A activity is picking up through the latter part of 2020 and is expected to gather pace into next year as buyers and sellers focus on core operations in the current market environment, according to participants in our latest virtual debate.
Zurich’s head of group M&A Dalynn Hoch said that companies had adjusted to the virtual environment and would continue to deploy capital as they had before, with 2021 expected to be a “busy year”.
There continues to be consolidation for scale and for diversification, as well as a re-emergence of take-private deals and IPOs.
“But I’d say a really important topic we’re hearing is focus. The conversation coming out of CEOs and from discussions with other carriers and companies is the need to have focus on the core and think about what we do with the non-core.
“You’re starting to feel in the second half of 2020 as well as going into 2021 more transactions around businesses that perhaps for one carrier are non-core but could fit really well with another carrier and their book of business,” said Hoch.
DLA Piper’s Paran described the situation in the early days of Covid-19, when “one deal after another” was being put on pause.
Well-advanced transactions were more likely to be taken to completion as parties wanted to see them through and were able to adapt to the new environment to finish them remotely.
But some larger strategic transactions were paused as groups looked to get to grips with the pandemic and focus on employees.
“But now just as all those deals were put on pause at the same time, a number of them are coming back online.
“Groups now want to move forward, they’ve got to grips with it to a certain extent, they may want to recast financials where there has been the impact of Covid directly on a line of business but they really want to get going again in the real world,” he reported.
Watch “M&A and start-ups: born out of a crisis” in full below or click here:
- Ivan Bokhmat, European Insurance Analyst, Barclays
- Dalynn Hoch, Head of Group Mergers & Acquisitions, Zurich Insurance Company
- Dinos Iordanou, Former Chairman/CEO, Arch Capital Group Ltd.
- PK Paran, Global Co-Head of Insurance, DLA Piper
- Jim Stanard, Former Chairman and Co-Founder, TigerRisk Partners
- David Bull, North American editor, The Insurer (Moderator)