Last time I wrote about how MGAs could access capital to help them build balance sheets to diversify their sources of capital. Today, I have solutions for how to bring capital to another part of the industry – reinsurers.
With a few exceptions (Convex, Vantage, someone I’m forgetting?), a new reinsurer hasn’t been formed in 20 years. I don’t have the full list of reinsurers created between Andrew and Katrina at my fingertips, but it’s somewhere around two dozen if memory serves.
There are some good reasons for this – the emergence of ILS, lower returns on cat business, bigger insurers deciding to retain more risk, etc.
However, we have also seen nearly every reinsurer created between 1993 and 2005 absorbed into a bigger competitor through M&A.
At last count, there are five remaining independent “reinsurers” (several of whom have evolved into larger primary operations) – Ren Re, Everest, Axis, Arch, and Lancashire.
The end result of this is less choice for insurers. Buyers are far more dependent on Swiss and Munich than they were a decade or two ago.
If one of those were to run into trouble (investment losses, cat losses, a major underwriting mistake), it would send shockwaves through the insurance world as insurers scramble to diversify.
The obvious solution to this is to create new specialist reinsurers. We don’t need a dozen – three or four will do the trick.
But even if we all agree this should happen, someone has to be willing to put up the capital and nobody is currently willing to do that.
So what’s the answer?
Back To The Future
I feel like there is an obvious solution. When there was a lack of capital coming into the industry in the 80s and 90s, Marsh and Aon started venture groups to create new capacity.
These worked out very well. Stone Point is the successor to the original Marsh group that created many Bermuda entities.
It would seem the market participant most interested in creating new reinsurers would be the large brokers. There is the obvious motive of cheaper reinsurance leading to cheaper primary coverage for their corporate clients.
But beyond that, it doesn’t take a genius to see we have way too many capital light primaries who are way too dependent on reinsurance. There will be a future capacity crisis.
If you’re a large wholesale broker, do you want to wait for the crisis and then scramble in a panic to help your favorite MGA find reinsurance so they can renew your client?
Or do you want to help bring that capacity ahead of time and avoid an unnecessary spike in reinsurance costs?
So it would be wise strategically for the large brokers, especially those that place a lot of MGA business, to start thinking now about how to create new reinsurance capacity.
The obvious objection would be they shouldn’t be investing directly in reinsurers because it would hurt their valuation. True, but there is a work around for this for some of the private equity backed brokers.
The Related Party Reinsurer
If you’re a broker with a large, diversified private equity backer (say KKR or Apollo), you can have them lead the investment.
For example, KKR is the lead investor in USI. If USI felt their clients’ insurers needed more reinsurance capacity, why not have KKR form a new reinsurer?
Recall one of the reasons brokers started all those Bermuda insurers and reinsurers in the first place was they could guarantee flow to the startup.
Oh, I’m sorry, not guarantee. That would be illegal. But yeah, we all know it was guaranteed.
Also, the concern in the past with broker backed reinsurers was whether Marsh or Aon would send them bad business to help more important clients. If KKR was the source of funds, USI would not want to burn them, so they would make sure the newco got quality placements.
One could argue CRC would be a good candidate but, given their ownership by Stone Point, this isn’t necessary. Stone Point has plenty of other ways to participate in underwriting operations, so they can easily get access to reinsurance capacity in other ways.
Just for the record, I’m not advocating USI do this. I have no idea if it makes sense for them.
A Nearly Free Lunch
I’m coming at this more from the PE backer perspective. If you’re a big PE like KRR, Apollo, Carlyle, etc. and already own a broker, starting a new reinsurer makes a lot of sense.
You get to fund a new capacity provider with advantageous distribution and without the risk of getting stuffed with business nobody else wants.
There will also be plenty of willingness for other PE shops to participate in the deal because they are sheep and, if KKR is leading, they will gladly throw in $100M of their own, so KKR can reduce its net exposure.
This improves the financial returns as you can make extra fees for leading the investment and receive warrants as the lead investor which juice your return.
From the broker perspective, they get to solve a client problem without affecting their own valuation. They still get valued on EBITDA and generate incremental high margin reinsurance brokerage.
Reducing The Appearance Of Conflict
Is it financial engineering? Absolutely! But it’s a lot more honest engineering than carving an existing insurer into half “MGA” and half “balance sheet”.
The reinsurer will be completely independent and have the ability to do business with other brokers and the “cousin” broker will only place a small portion of its clients’ reinsurance needs with the new reinsurer.
Furthermore, having the link be through a common PE owner makes it look more independent than when it was Marsh’s own balance sheet starting insurers and reinsurers with an obvious conflict of interest.
Will PE still be reluctant to invest in a balance sheet? They likely will, but it’s an irrational reluctance.
By creating a reinsurer tied to one of their brokers, they get higher and more certain returns with lower execution risk. It’s really a no brainer.
Addendum: Coming To America
Finally, I should note, there is no reason these new ventures have to be domiciled in Bermuda. Given the changes in global tax regimes, there is arguably no material disadvantage to creating a US based reinsurer.
Setting aside the political capital the PE sponsor could earn by forming the first domestic reinsurer in decades, setting up shop onshore does eliminate some burdensome compliance issues around ownership, capital return, future M&A, access to talent, etc.
There is probably a whole separate article I could write on this topic down the road but I wouldn’t be surprised if the next big reinsurance startup is US based, particularly if they pick a friendly regulatory state to domicile in.