A slow romance

Private equity (PE) has not played the same decisive role in shaping the London market as it has in Bermuda.

Corporate capital of any description has only been present in the Lloyd's market for the last 15 years.

Before that, the capital for all syndicates trading on Lime Street came from Names - wealthy individuals operating as sole and unlimited liability traders - a system that had existed for hundreds of years.

Even as institutional, limited liability capital poured into Lime Street in the late 1990s and in the last decade - sweeping away these traditional Names in the process - it was primarily in the form of public equity or overseas (re)insurance companies (see pie chart ).

Click to enlarge And typically Lloyd's was overlooked while successive waves of capital crashed onto Bermuda's shores after each major market loss and dislocation - a process that created definable classes of Bermudian carriers (mid-1980s: US casualty crisis; class of 1993: Hurricane Andrew; class of 2001: 9/11: class of 2005/06: Hurricane Katrina).

This reached a low point in 2002 when the Lloyd's market was desperate for fresh capital after the shock of the World Trade Center attacks - but private equity appeared in thrall to the attractions of Bermuda.

Indeed, the controversial spin-off of Wellington's reinsurance business in 2002 demonstrated in stark fashion the respective fortunes of the two markets.

Wellington, a venerable Lloyd's insurer, needed to raise capital to survive the balance sheet traumas of the 11 September attacks - but private equity was nervous about putting capital into Lloyd's.

The result was to create Aspen, a company consisting of Wellington's carved-out reinsurance business financed by PE and located in Bermuda.

And Lloyd's resurgence since those dark days has captivated private equity just as it has overseas (re)insurers. It was a point acknowledged by the late Bob Clements in an interview with The Insurance Insider in 2007.

Click to enlarge Clements - who was effectively the forefather of the Bermudian (re)insurance industry and had a dedicated following amongst PE companies for all his various start-up successes - spoke to The Insurance Insider shortly after launching Ironshore with more than $1bn of private equity.

"Anyone who wants to do global business now views London as absolutely essential because there is an awful lot of business that only comes through the English speaking markets via London."

Clements and his Ironshore team got their wish in 2008 when they purchased Chaucer's Pembroke business, giving them a foothold in Lime Street.

Indeed, in the past three years there have been a number of PE-financed entrants into the Lloyd's market. These include Antares, backed by Lightyear Capital; Barbican, financed by Steel Partners and Carlson Capital; and First Reserve-backed Torus.

But it is the £880mn ($1.4bn) buy-out of Brit Insurance by the PE consortium Apollo and CVC - finally due to take place in March 2011 - that has dominated the headlines.

It is both the largest ever buy-out of a Lloyd's insurer and the largest pure Lime Street M&A transaction, surpassing the £600mn buy-out of Wellington by Catlin in late 2006.

This appears to have drawn other PE firms into the fray, including Guy Hands' Guernsey-based fund Terra Firma, which announced in February it was in talks with the listed Lloyd's insurer Chaucer.

Chaucer - which specialises in UK motor and energy - has been a perennial target of bid rumour for two years, but what is most remarkable about Terra Firma's interest is that it has no track record in investing in the
(re)insurance market.

Other private firms recently linked with investing in the sector include the PE duo Goldman Sachs and TPG, which last year bought US insurer NYMagic.

News of Guy Hands' interest simply confirmed predictions that Brit Insurance would be a catalyst for more transactions, and perhaps even the long-waited era of consolidation on Lime Street.

Nick Pope of Jefferies International remarked: "The increased offer leads to a much greater likelihood of deal completion in our view, and consolidation prospects across the Lloyd's stocks will be in focus."

KBW analyst Christopher Hitchings added: "We think private equity interest in the sector supports our view that M&A speculation will increase and we see this as a positive catalyst, as current low valuations do not adequately reflect the future return potential of most Lloyd's insurers."

The question is who will be next on the private equity radar?

Death of the IPO?

Over the last three decades private equity has made a beeline for Bermuda whenever a major market dislocation has taken place.

The US liability crisis of the mid 1980s, the post-Andrew cat crunch of 1993, the capital decimation caused by the hangover from the deep soft market of the late 1990s, the end of the equities boom and 9/11 all triggered the entry of PE-backed capacity when that capacity was scarce and expensive.

Historically, the strategy incorporated a rapid start-up and a PE exit three years later with the initial stake multiplied, but after having built a franchise value premium multiple in the book value of the company it had helped construct.

But those dynamics no longer appear to apply.

Not only are most of the Class of 2005 start-ups trading at a hefty discount, but the whole sector is struggling to get over the book value gain line - despite generally strong operating performance over the last five years. That has left some investors in the post-Katrina start-ups struggling to find the exit.

The model of getting in fast and then getting out fast at a healthy premium through an IPO has been difficult - and in some cases impossible - to execute.

With hindsight it may be that 2005 was not a proper hard market opportunity, where the only real winners were hedge funds that got in, got leveraged, then got out of the cat-only sidecars of 2006 and 2007 - the disposable reinsurer route.

And despite a stuttering return to health in the broader IPO market, at this point a post-event wave of PE-led start-up capital on Bermuda seems unlikely.

Perhaps with hindsight 2001 was the high watermark for the entrepreneurial insurance investor. After all, the 2002-04 hard market was genuinely hard across all classes globally and followed high-profile impairments at major players - freeing up market share and skilled staff in equal measure.

It may also be that 2005 was not a proper hard market opportunity, rather a US-only cat-specific proposition that coincided with a proliferation of short-term commoditised capital solutions. Looking back, perhaps the only real winners were hedge funds that got in, got leveraged, then got out of the cat-only sidecars of 2006 and 2007 - the disposable reinsurer route.

This article was published as part of issue Spring 2011

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A slow romance

Death of the IPO?