Share repurchases, start of a change in reinsurer capital structure?

by Artemis on September 18, 2013

One of the issues traditional reinsurance firms are currently wrestling with, in this well-capitalised reinsurance marketplace, is what to do with excess capital when they cannot find enough attractive opportunities to deploy underwriting capacity at a reasonable rate of return.

This was one of the topics of discussion at the recent reinsurance Rendez-vous in Monte Carlo, with speculation mounting as to just how traditional reinsurers will react to further rate declines across property catastrophe reinsurance business at the upcoming January renewals, as well as the spectre of declining rates spreading out to other areas of the market.

Share repurchases, where firms utilise their excess capital to buy back shares from investors at an attractive price, is one way that reinsurers can deal with capital left behind after renewals if they cannot find enough attractive deployment opportunities. This enables investors to profit, as share repurchases are typically at a small premium, and reinsurers to own more of their firms as they effectively take equity back in-house.

The share repurchase may be the first step in a broader change in the capital structure of reinsurers, if the forecasts for more alternative capital to flow into the market are accurate, which we believe they are likely to be. As the reinsurance market becomes increasingly well-capitalised, with more of the capital coming from direct, third-party investors in the space and alternative capital sources, reinsurers are facing tough decisions about the best way to react.

Some reinsurers, the larger global players and the more specialty lines focused, may choose to buy-back shares to reduce excess capital while at the same time becoming more involved in the management and deployment of third-party capital. Share repurchases will allow these reinsurers to optimise their capital structures to the best mix of equity and third-party capital to suit their business models.

Other reinsurers may choose to go down a much more drastic route, perhaps buying back much more of their shares and moving to a largely third-party or alternative capital backed underwriting structure, while remaining shareholders own equity in the underwriting services company that emerges at the end of this transition.

Share repurchases may occur as part of industry mergers and acquisition, which are expected to increase, because two reinsurers want to merge, to create a larger reinsurance entity with more market opportunities and reach. Shareholders would likely be offered the chance to have their shares bought back as part of many mergers in the future in the reinsurance market.

We will certainly see more consolidation, but we may see more in the way of changing business models and managing capital through share repurchases is just one way that reinsurance firms will prepare themselves for a structural shift. The management of capital is increasingly important to reinsurers and not just in terms of managing third-party inflows. Managing equity capital and excess capital, balancing the right mix across all capital sources, is going to see increasing focus placed on the reinsurer CFO’s.

Reinsurance broker Willis Re said recently that it expects some equity capital will get pushed out of the reinsurance market, as reinsurers deal with over-capitalisation and a continuing influx of alternative capital into the space from investors. Some of this shifting of equity capital, which may largely end up being redeployed back into the space as alternative capital (as the investors like reinsurance as an asset class), will likely occur through share repurchases.

Reinsurer PartnerRe is one prime example of a reinsurance firm reacting to a lack of attractive capital deployment opportunities and choosing instead to repurchase shares. The firm announced a share repurchase programme amounting to up to 6 million shares just the other day.

As managing capital becomes every more important, in a reinsurance industry which is now dealing with new and alternative capital sources, the share repurchase is an increasingly useful tool in the reinsurers kit to deal with excess capital and any further decline in rates.

BestWire quotes Bill Babcock, CFO of PartnerRe, at a recent event on the 9th September as saying; “Our first objective is to put capital to work taking risk and supporting clients, but if we can’t get adequate return, we’ll return capital, and that’s what we did. We’ve really been doing it the past two-and-a-half to three years in a big way.”

Babcock cited a decline in reinsurance pricing, PartnerRe saw pricing down by double-digit percentages at June and July 1 renewals, as well as excess capacity caused by inflows of alternative capital into the reinsurance market. He also said that international property casualty reinsurance pricing is now “Under almost constant pressure”. That makes the outlook for reinsurers less than rosy, Babcock commented.

Herein lies a conundrum for reinsurers. Too much capital already, not enough deployment opportunities at the rates they are used to, more capital coming in from alternative sources creating more competition and almost every reinsurance firm has a desire to tap into alternative reinsurance capacity in order to have the ability to underwrite with a lower cost-of-capital. These are competing forces in many ways and as pressure builds this might not end well for some firms who fail to adapt.

How best to optimise the capital structure and reinsurance business model, to be able to lower overall cost-of-capital while maintaining some equity investor support, without having so much capital on hand that you can’t deploy it all is an interesting, and difficult, situation to be in.

This conundrum will force reinsurers to think laterally, be innovative in terms of product design, business focus and also capital and corporate structure. What will emerge at the other side of this transitional phase in the reinsurance market may not be all that different from today, but business models are likely to be modified, the capital providers may change and the amount of equity in the space could differ dramatically.

The main change, or evolution, we hope for is in terms of innovation in products, risk transfer structures and lines of business. Firms who can innovate will position themselves as leaders in the reinsurance market, creating new opportunities for themselves and others to follow, and as we all know the leaders do tend to be followed by the capital.

More reading:

There are so many reports and commentaries on alternative reinsurance capital and ILS thanks to the recent Monte Carlo Rendezvous event that we felt it worth highlighting some other reading on the topic, all from the last two weeks, which you can find below (most recent first):

Next $100 billion of alternative capital will transform reinsurance: Aon Benfield

Big reinsurers: Demand, diverse business to fend off alternative capital

Are reinsurers facing consolidation or changing business models?

As reinsurers react in Monte Carlo ILS managers keep cool and carry on

Alternative capital growth driven by collateralised reinsurance: Swiss Re

Alternative capital may squeeze out equity capital in reinsurance: Willis Re

Lloyd’s Nelson: Alternative capital can help insurance grow to $2tn by 2025

Insurance-linked securities market calling for innovators: PwC

Catastrophe bond market may hit $23 billion by end of 2016: GC Securities

Alternative capital as significant to reinsurance as emergence of Bermuda: S&P

Demand for alternative reinsurance instruments and ILS to continue: Fitch

Alternative capital the biggest challenge for traditional reinsurers: Moody’s

Lloyd’s Nelson warns on ‘systemic’ risk of alternative reinsurance capital

Broker facilities an opportunity for third-party capital to expand reach?

Opportunity for reinsurers to learn from ILS: Aon Benfield CEO

Capital markets investors boost global reinsurer capital to $510 billion (including a useful list of links to many alternative reinsurance capital initiatives that we have covered previously)

Strong capital inflows bring ILS & cat bond market to new high: Aon Benfield

Alternative capital a disruptive force in reinsurance: Goldman Sachs

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