The Intelligent Quarterly from the publishers of The Insurance Insider

Spring 2012

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As the financial crisis tightened its grip in early 2008, some commentators had already written obituaries for the private equity (PE) sector, whose ability to finance large-scale transactions with debt was a victim of the credit crunch.

Yet three years on and private equity - awash with liquidity and with easy access to debt markets - appears to be resurgent.

And the P&C (re)insurance industry is once again attracting strong interest from PE investors.

Alongside the traditional PE players that have injected fresh capital into waves of start-ups over the years are brand new participants lured by cheap valuations and the scent of wide-scale consolidation.

As we highlight on page 14, much of the new interest has focused on buyouts of listed Lime Street vehicles.

The lengthy courtship of Brit Insurance by Apollo and CVC was followed by confirmed takeover talks between Guy Hands' Terra Firma - a fund that has no history of investing in (re)insurance - and Chaucer Holdings.

But there is also activity across the pond, both in M&A and with PE funds reloa Click to enlarge ding for fresh investment in the sector.

Transactions in the latter half of last year included the Elliot and Wand Partners buyout of cat specialist ICAT to create Bermudian Paraline, and the acquisition of US insurer NYMagic by PE duo Goldman Sachs and TPG.

Validus - the New York-listed PE-launched reinsurer that has already taken out Lloyd's underwriter Talbot and Bermudian compatriot IPC Re - is undertaking due diligence on another of its neighbours, PE-backed Ariel Re.

A successful transaction would continue the sequence of deals where members of the Class of 2005/06 with investors looking for an exit have been snapped up by or merged with rival (re)insurers. These include PartnerRe's acquisition of Paris Re and Max Capital's tie-up with Harbor Point to form Alterra.

Meanwhile, Validus' founding PE investor Aquiline Capital Partners is in the process of closing its second fund, with a targeted size of $2bn. And Stone Point Capital - the former PE arm of MMC - has already invested close to 20 percent of Trident V, its recently closed $3.5bn fund (see page 13).

Return to health
So what is driving fresh M&A interest in the (re)insurance sector, particularly from PE buyers?
Stone Point CEO Chuck Davis believes a key catalyst is the broader recovery of financial health, particularly in corporate America.

"We've returned to a more vibrant M&A marketplace quicker than most people would have thought," he tells IQ.

"There's so much money, so much liquidity. Corporate America has $2tn of cash. Then there's $500bn unspent money in private equity that's unlevered - and now the debt markets are available again."

With historically low valuations for (re)insurers, a portion of that money looks to be seeking a home in the sector.

"Share prices are presently depressed, because of the poor rating environment and depressed investment returns - that's leading to lower RoE [return on equity] and therefore lower valuations," explains a senior corporate financier.

Because public shareholders are happy to take the cash in the current environment, "that's creating an interesting opportunity to buy companies at more attractive prices", he continues.

Upon a successful acquisition, PE funds would then typically target ways to boost the valuation of their investment over a 5-10 year holding life cycle, culminating in their exit at a generous premium either through an initial public offering (IPO) or sale.

PE strategy
Given the prevailing soft market conditions, the strategy might be as simple as preparing an acquisition for an upswing in pricing.

"The PE that's gone in may just be trying to buy platforms on the cheap for when the market turns," suggests a leading PE fund manager.

"Traditional PE can hold on to investments for 10 years, so you'd think the turn will happen by then."
Compared to publicly owned (re)insurers, those backed by PE can enjoy a more flexible relationship with their capital providers when opportunities arise.

Jamie Mehmood, a director in the corporate and institutional banking division of RBS, comments: "PE ownership should provide ready access to capital that will enable (re)insurers to take full advantage of rate movements post a major catastrophe, without having to revert to public shareholders, which can sometimes be a lengthy and uncertain process."

However, the PE source adds that, despite the relatively long-term window for PE investors, unless multiples start returning to historic levels of around 1.5x book for the sector, returns "are not going to be there".

The corporate financier also cautions against the "rating play" of buying a (re)insurer at book value and assuming sector valuations will return to historic levels as underwriting and investment improve.

"Buyers have to create value in other ways: by improving underwriting, improving investment returns and making the capital work harder," he suggests.

"There's a hope that some event will lead to rates improving and that the investment climate will improve - but you can't really base an investment case on that."

Of course, the creation of "efficiencies" has the potential to strike fear into management and employees of a company targeted by PE buyers.

"There's a recognition that a private equity buyer is going to be looking for their pound of flesh," one unnamed investor observes.

"Maybe with a different kind of shareholder everybody has to be a little more focused and work a lot harder."

Areas targeted by new PE owners might include tax efficiencies, wide-scale cost-cutting, more adventurous buying of reinsurance "to give less profit away", and refocusing on core areas of growth - which could involve placing lines of less profitable business into run-off.

Real consolidation?
For all the talk of M&A, some question the value of recent activity, describing companies engaging in some of the non-PE moves as "lemmings".

Deals potentially involving PE have been dismissed as "rearranging the deckchairs by bringing in new capital", rather than real consolidation that takes capital out of a market where there is excess supply.

However, according to Mehmood, while the initial impact may be to introduce new PE capital to the market, "given the likely intentions of PE this may act as a catalyst for future consolidation".

There are also questions over how long the window of low valuations will remain open as PE interest continues to grow - and how realistic the prices are that buyers are expecting to pay.

One leading investment banker tells IQ that private equity buyers see 0.8x trading multiples and think they can buy a company for 1x book.

"In reality, they'll need to pay 1.2 or 1.3x and then where's the return going to come from in a soft market?" he asks.

Meanwhile, Mehmood observes: "As this level of interest increases, pushing up share prices, it will be interesting to see at what premium to net asset value the attractiveness of the sector starts to diminish for PE."

However long their interest in the sector lasts, current activity points to a clear trend as public shareholders and management open up to potential PE buyers that are seeing opportunities at a time when (re)insurance stocks are cheap.

Click to enlarge