Rating agencies skeptical on PartnerRe’s standalone reinsurance future

by Artemis on August 4, 2015

Reinsurance firm PartnerRe has been downgraded by A.M. Best, who cites a lack of diversification in its business without the AXIS deal. It has also been given a negative outlook by S&P, who said the reinsurer has been distracted by the prolonged back and forth of M&A activity.

Despite the fact that PartnerRe now has more certainty in its future, after Italian investment holding group EXOR S.p.A.’s offer to acquire the reinsurance firm was agreed to earlier this week, rating agency Standard & Poor’s said that this leaves PartnerRe with a degree of uncertainty about its future.

Standard & Poor’s credit analyst Taoufik Gharib highlighted “uncertainty regarding how PRE will operate under the new ownership,” as a key reason for revising its rating outlook on the reinsurer to negative from stable.

S&P highlights a number of key issues and uncertainties, including who the future management team at PartnerRe will be, how the reinsurer will manage its capital, what its investment strategy will be, what strategies for growth it may have, how its dividends will flow through, what will happen to the board of directors and how the reinsurer will manage its risks, including tolerances and aggregation.

Rating agency A.M. Best goes considerably further, downgrading PartnerRe and citing “concerns regarding PartnerRe’s concentration in reinsurance and lack of a diversified product platform, in particular, the ability to provide both primary and reinsurance solutions.”

The downgrade takes PartnerRe from a financial strength rating (FSR) of A+ (Superior) down to A (Excellent) and its issuer credit ratings drop to (ICR) to “a+” from “aa-.

A.M. Best is clearly not as confident as EXOR in the ability of a reinsurance platform to remain standalone in the current challenging market environment.

That seems perhaps a little harsh, given that PartnerRe’s results have been ok to date and other standalone reinsurers have not been downgraded. Perhaps A.M. Best’s reaction to the AXIS deal falling apart hints at action coming for other standalone reinsurance firms?

“The proposed merger with AXIS would have begun to address these issues and with that transaction terminated these concerns are brought back to the forefront,” A.M. Best explains.

The rating agency said that it is also cites the distraction of the M&A process, saying it is concerned that “any such diversification initiatives at PartnerRe have been delayed because of the now terminated merger agreement with AXIS.”

A.M. Best adds that “These concerns are magnified given the current challenging reinsurance market conditions.”

On the distraction, S&P said; “We believe that PRE’s management has been distracted since the announcement of PRE’s initial acquisition by AXIS Capital Holdings Ltd. in January 2015.”

And that; “The back and forth between the two outstanding offers during the past several months (i.e., AXIS and EXOR) in a challenging soft reinsurance market has also been a distraction.”

S&P also highlights the go-shop agreement, allowing PartnerRe to seek out better offers before the 14th September, as an additional distraction for the reinsurer, saying that this will “further accentuate the future operational and execution risk.”

S&P concludes; “The negative outlook reflects our uncertainty about whether PRE will maintain its overall strategy. The change in ownership could weaken PRE’s business or financial risk profiles during the next 12 months.”

Is the standalone reinsurance business model viable in a market that has faced structural and fundamental change in recent years? The answer to this has to be in the cost-of-capital and efficiency that a reinsurer can perform its business activities with, you would think.

In the case of PartnerRe, EXOR will be aiming to reduce the overall cost-of-capital at the reinsurer, letting it benefit from the overall diversification within its investment holding portfolio. Conceptually that should allow PartnerRe to operate at lower returns, as EXOR applies a level of diversification benefit to its operations.

In practice just how much benefit will there be for EXOR? Will EXOR look to embrace a more alternative investment strategy on the asset side, which could allow it to reduce the reinsurers capital costs even further perhaps? Impossible to say at this stage.

The fact remains though that reinsurance as a standalone operation can be profitable at certain levels of efficiency, cost-of-capital and also scale or operations. Has PartnerRe passed the size where it can maintain a profitable future in a structurally changed reinsurance marketplace?

With zero information on the future strategy of PartnerRe, aside from EXOR’s original statements that it will be business as usual (which we find hard to believe without at least some changes and additional efficiencies), it’s very hard to make any conclusions from this.

Perhaps EXOR will look to swiftly add insurance operations to PartnerRe, or maybe it will embrace alternative capital and turn PartnerRe into an underwriting service provider, writing business on behalf of its own and other investors capital, flipping the model entirely.

The rating agencies clearly aren’t convinced, but Moody’s and A.M. Best have affirmed AXIS Capital’s ratings, suggesting that they much prefer the diversified insurance and reinsurance business model to the standalone reinsurer model that PartnerRe presents itself as currently.

Time will tell. Until we better understand EXOR’s strategy, and that acquisition is completed, it’s extremely hard to forecast just how PartnerRe will perform in years to come.

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