TigerRisk’s Jarad Madea explores the evolution of the insurance value chain…
The boundaries between policyholders, agencies and carriers are shifting and new entity structures are emerging, offering greater value for stakeholders. For advisors, this will require a wider suite of skills.
The insurance value chain continues to evolve with companies becoming more specialised. New types of entities and new structures are flourishing from MGAs to fronting operations and, in the US, reciprocal exchanges.
While these entities and structures all take different forms and play distinct roles, they are all part of the evolution in the relationship between risk and capital, which is being driven by a changing risk environment and revised expectations from ultimate investors. We believe our industry is just at the beginning of a journey that will see a significant restructuring of its business operations and capital framework.
Underlying these developments is a valuation arbitrage between insurance services and insurance risk bearing vehicles. The arbitrage is clear to see in valuations of both publicly traded entities and private M&A transactions, with insurance services businesses trading at long-term premiums while balance sheet entities are trading near cycle averages.
Steady fee-based, low-volatility earnings are more appealing than balance sheet risk, susceptible as it is to underwriting volatility, and this creates enormous potential for further bifurcation between managing and assuming risk.
Reciprocal exchange model on the rise
The reciprocal exchange model, which is gaining momentum in the US, points to one of these innovative structures. In the reciprocal model there are two entities. Firstly, the reciprocal exchange, which is a risk-bearing balance sheet entity owned by its policyholders.
Members provide surplus contributions, which are tax-efficient as they amount, in addition to premium payments. Policyholders are not seeking similar capital returns as typical shareholders; they are looking for adequate insurance coverage and the cost of capital is therefore much lower than in the traditional model.
“When it comes to capital structures, the insurance sector is undergoing a phase of great innovation”
The second entity is the attorney-in-fact. This is the management function, and the fee-earning business which is independent of the reciprocal exchange and typically a highly valued business. It may be owned by the reciprocal exchange in older vintage models, or by separate third-party investors in recent formations.
At TigerRisk Capital Markets & Advisory (TCMA) we have played a significant role in the growth of reciprocals. There are now approximately 70 such structures in the US. Eight of these have been established in the last five years and TigerRisk has played a key role in seven of those formations across structuring, advisory, capital raising and reinsurance brokerage.
The reciprocal model depends on a US legal framework, but we believe the principles are transferable to other geographies. TCMA has held discussions with insurance players in Europe and London about how a similar model could be developed in those markets.
Innovation requires a complete skill set
While reciprocals are one of the fastest-growing new structures, there are many other models and transactions evolving from this shifting landscape.
For example, there are now approximately 15 dedicated fronting companies in the US that provide balance sheet capital and licences but pass on the core capital risk to other reinsurers and capital markets investors.
Other recent transactions have involved utilising Lloyd’s capital providers, affiliate-owned balance sheets and other third-party capital vehicles.
We believe the best structure is one that combines a variety of disparate balance sheet solutions and capital providers including reciprocals, fronting carriers, Lloyd’s vehicles, other primary and reinsurance capacity providers and more.
However, it is critical to keep in mind that structuring alone will not create profitable underwriting and a profitable underwriting model is paramount for any of these structures to ultimately succeed.
In this evolving relationship between balance sheet and fee-based entities, there are many permutations and doubtless more will arise as market leaders continue to innovate.
As the market is evolving, those of us helping to shape these strategies need a suite of skills to match and as the leading risk to capital strategic advisor, TigerRisk has built in these capabilities from the ground floor.
The skill set covers new company formation structuring, strategic and M&A advisory, capital raising, rating agency advisory and reinsurance/capacity solutions.
When it comes to capital structures, the insurance sector is undergoing a phase of great innovation. It will take innovative advisory services to keep pace and to take advantage of the opportunities.
Jarad Madea is CEO at TigerRisk Capital Markets & Advisory