The Intelligent Quarterly from the publishers of The Insurance Insider

Spring 2013

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Since 2000, private equity (PE) investors have sunk $36.5bn into the (re)insurance sector, tempted by the prospect of a hardening market and low valuations, and fuelled by easy access to financial leverage - with the exception of the 2008-09 financial crisis.

Yet angel investors have only managed to exit deals worth $18.9bn during that 11-year period - and a meagre $4.5bn was recouped from 2008-2011.

These statistics from (re)insurance specialist M&A shop Willis Capital Markets & Advisory (WCMA) don't make comfortable reading for PE investors in the sector, which usually seek to exit investments within three to five year time horizons.

The recipe for success is supposed to be a simple one: plough the money into a (re)insurance carrier, broker, agency or service provider; wait for a hard market where profits - and valuations - soar; and then list on a public exchange or sell at mouth-watering multiples.

The result? Happy investors and swollen fund coffers for the next round.

And, following that recipe, there is a long list of (re)insurance entities that have voiced plans to IPO in recent years.

Indeed, the IPO queue - featuring brokers, carriers, agencies and service providers - is snaking round the block (see table).

A closed door
However, with the exception of the much-hyped $104bn Facebook IPO in May (which promptly caused controversy over dealing technicalities, prospectus disclosure and a slumping post-launch price), the IPO market has largely been shut this year.

And, notwithstanding Chinese insurer PICC's planned $6bn IPO in Shanghai and Hong Kong, the (re)insurance sector is no exception to this investor malaise for new stocks.

WCMA head Tony Ursano painted a glum picture of the market from an investor's perspective at the InsiderScope event in New York earlier this year.

He described a (re)insurance sector where rates were improving, but noted that "there's no hard market yet". Industry combined ratios are estimated to be around 103 percent this year and surplus will reach an all-time high by the year-end if no major catastrophe strikes. "Return on equity is in the single digits - well below [the] cost of capital," he added.

On a macro level, interest rates are low and the global economy is depressed, leaving (re)insurance industry valuations - at 0.94x book - near their all-time low (see graph "Recovery in sight?"). Ursano added that a mere 21 of 66 US publicly traded (re)insurers trade above book value.

Hiscox Bermuda CEO Charles Dupplin noted that trapped private equity cash searching for an exit is one of the factors suppressing equity valuations in the (re)insurance sector (see graph "Trapped investments"). Click to enlarge

Citing the recent acquisition of Ariel Re's Bermuda-based operations by Goldman Sachs as an example, Dupplin argued that the desire of private equity capital to leave the space was exerting downward pressure and contributing to sub-book valuations.

"There is a queue of people trying to get out of the (re)insurance industry. If you look at the shareholder register of Bermudians, you will see a strong flavour of private equity in there," he told delegates at the Multaqa Qatar conference in Doha earlier this year.

Observers of the sector are unanimous in their belief that now is not the time to bring an insurance company to market. For some, the reasons are broader than the insurance market, while for others the reasons are more heavily insurance-specific.

James Britton, a financial adviser at Peel Hunt, tells IQ that the lack of flotations cannot be reduced to an insurance-specific phenomenon. "Unless the whole IPO market is going it's difficult to float an insurance company," he said.

He went on to note that even when the IPO market starts to take off this is not the moment for an insurance float. During a time when there are strong growth prospects people want a growth stock, like a technology company, he says. It is only later in the cycle when they have made money on the back of growth in tech-type stocks that they will look favourably on a diversifying play like insurance.

Another banking source, who wished to remain nameless, stresses that it is far too early for IPOs. "The Fidelitys, the M&Gs and the others of this world will only support an IPO when something has really built up momentum both as a sector and as an individual target.

"As a consequence, that typically means it's a little bit further down the line - maybe, say, three years from now when they can point not just to an improvement in rate adequacy but when it has translated into hard dollars in after-tax profits."

Michael Watson, executive chairman of PE-owned (re)insurer Canopius, frames the sector's IPO prospects as a function of timing.

"As things currently stand, I'm not saying that you couldn't get one done, but this whole sector is trading at a modest premium to historic book. By the time you take that into account you'd be lucky to list at book and it might even have to be at a slight discount," he opines.

"So why would we bother if we think that we can continue to compound book value - ideally at 15 percent per annum - for two, three, four years and list into a more conducive market place?"

Exits are here, here and here...
There is consensus among market commentators that PE funds have vast stockpiles of cash that they need to deploy, leading Ursano to predict that deal-hungry investors will remain at the centre of
(re)insurance M&A in 2012-13.

With IPOs off the cards, some PE funds have realised their gains (or losses) from their holdings via trade sales. Click to enlarge

Recent deals in the broking sector are testament to this "white hot" market, with carrier M&A deals fewer and farther between.

Notable PE-backed transactions in 2011-2012 include Goldman Sachs' purchase of Bermudian "Class of 2005" reinsurer Ariel Re and the £880mn acquisition of Lloyd's insurer Brit by Apollo and CVC that completed last year, explained Ursano.

In the weeks before IQ went to press, PE investors in three broking houses sold their holdings in what has been tipped as a "hot market" for (re)insurance distribution.

On 1 June, insurance distribution group Hyperion agreed to buy rival Windsor in a deal valuing the business at £95mn. The deal saw PE group Hutton Collins exit its 22 percent stake in Windsor. Hyperion also has a private equity backer in 3i, which owns 27.4 percent of the company.

3i is fuelling the rapid expansion of the group and has pencilled in a 2013 date for the IPO, sources said.

Also in May, insurance broker Lockton bought out the minority stake in its international operations from private equity firm Stone Point. Stone Point lent financial support to Lockton via its $1.1bn Trident III fund when the broker bought the international operations of Alexander Forbes in 2006 for £90.2mn.

Finally, sister title The Insurance Insider revealed that Ryan Specialty Group (RSG) is in talks to further expand its platform with the acquisition of US private equity-focused intermediary Sharebridge Holdings.

According to sources, RSG founder Pat Ryan and Sharebridge president and CEO Phil Moyles have been in discussions for a number of months as they look to strike a deal for the Chicago-based start-up to buy out Stone Point Capital's founding stake in the firm.

Ursano also cited the recent exit of the PE firm Parthenon Capital from AmWINS, to be replaced by New Mountain Capital, which valued the US wholesaler at around $1.3bn.

The transaction, he explained, also demonstrated how PE's enthusiasm for insurance distributors was driving valuations for brokers to a typical 9-10x price to Ebitda multiple - significantly higher than in recent years.

In many cases, acquirers are also assisted by greater financial leverage, especially for businesses that are less capital intensive, such as broking. Typically the loans being offered - such as 6.5x debt to Ebitda for 5 percent interest - are the best that has been available since 2008, Ursano said.

Click to enlarge