For investment giant Blackstone, Harrington Re the start-up total-return focused reinsurance firm launched by itself and AXIS Capital recently provides a source of permanent leveraged capital, helps it distribute its funds and ultimately will end in an IPO exit, according to the firms President & COO.
It’s no surprise to hear that Blackstone is targeting an IPO for Harrington Re and that the idea of spinning off the reinsurance start-up in years to come is already being discussed.
But for the investment manager, being part of the total return reinsurance start-up is about more than just the potential exit multiples, there are clear benefits to partnering with an established underwriting shop like AXIS and the business model helps Blackstone in a number of ways.
AXIS and Blackstone partnered on Harrington Re, as the pairs entry into the space that follows the hedge fund reinsurance business model in order to achieve a total return across both the underwriting and investment sides of the balance sheet. The start-up raised $600m of capital, with $550m raised through equity and $50m through a debt issuance.
AXIS Capital Holdings contributed $100m to the equity investment in Harrington Re, while affiliates of Blackstone contributed another $50m, as the pair of founding companies demonstrated their alignment with the investors.
Harrington Re brings AXIS into the alternative investment oriented reinsurance space, seeking to optimise returns across both the underwriting and asset management side of the business, while Blackstone gets to do what it does best and manage a portfolio of alternative investments for the reinsurer.
And that’s where the benefits begin for Blackstone, as the premium float generated by Harrington Re from its reinsurance underwriting will all flow through into Blackstone funds, providing it with a source of long-term capital.
Speaking during Blackstone’s second quarter 2016 earnings conference call this week, President and COO of the investment management group Tony James explained how he feels about the new Harrington Re venture.
“I love Harrington Re,” James explained, going on to say that he would have liked to have taken a bigger slice of the vehicle, but adding that there were rules about how much of the equity the insiders could take.
Harrington Re helps Blackstone to broaden the distribution reach of some of its funds, which otherwise might only be available to qualified investors, after a lengthy application process. The reinsurer also enables Blackstone to tap into more retail types of investors, which again might be out of reach for some of its investment funds, James explained.
“I love this. So this allows retail investors and institutional, but think about smaller retail investors, to get access to full Blackstone products in one set,” James said.
For the investors it’s an easier way to access the returns Blackstone can generate, with the added bonus of any underwriting return that Harrington Re creates as well.
James continued; “You don’t have to go through a lot of brain damage and filling out of papers and invest big minimums and all that to get into all these different funds. So first of all you put money up, you get Blackstone returns across the portfolio and diversification, which is very steady. It’s high return but when you get that kind of diversification, it’s very steady.”
For Blackstone this means greater distribution reach for its alternative investment funds, while at the same time accessing capital that could potentially be much longer-term as well.
“For Blackstone its permanent capital,” James said. “We invest in the float from the reinsurance. We get free leverage, so we get the returns on $1.50 for every dollar we put up. The Blackstone returns on a $1.50 for every $1 that we put up.”
James then explained that there are also tax advantages for Blackstone, as the returns accumulate tax free because it is an equity investment in a reinsurance company and so tax on investment gains does not apply like an investment into a fund.
So the next benefit for Blackstone would be when it can cash in on the accumulation of returns and any underwriting return, which ultimately increases the value of its investment in Harrington Re. James made it very clear that an IPO is the likely goal with Harrington, seeing it as an opportunity to realise the profits efficiently.
“We will IPO this thing and we expect to get a premium to book value,” James explained, “So then you get a markup on all that accumulated earnings and accumulated tax free and guess what, when you sell it’s capital gains.”
“It’s just a great product,” James continued “And for us, so that’s from the investor standpoint.”
“We actually hope to make money on the insurance underwriting side of it as well. So obviously I like the product a lot ,for both Blackstone and for the investors. It’s a win-win, like so many products are, but it’s good for us and it’s good for our LP’s (limited partners) as well,” James stated.
A significant amount of the float generated by Harrington Re will flow through to Blackstone’s GSO Capital Partners, which is its credit oriented alternative investments arm, which perhaps gives more of an insight into how the assets will be invested.
James and Blackstone are clearly excited by the prospect of having got Harrington Re off the ground after the successful capital raise.
His comments make clear exactly why large alternative asset managers still like reinsurance, with the idea of accessing more permanent capital, from a broader distribution base, with leverage, an underwriting return as well and the prospects of an exit through an initial public offering which is very tax efficient for them.
It’s no wonder other asset managers continue to look at the reinsurance space, despite the perhaps negative press that is often generated about the two most high-profile proponents of the hedge fund backed reinsurer strategy, other asset managers can see the clear benefits that James lays out.
The total return reinsurance strategy is really only just beginning. In the currently softened reinsurance climate and low investment yield world, reinsurers are likely to increasingly look to how they can maximise the return on their premium float, so gradually moving to a more total-return reinsurance model in time.
When the underwriting returns are depressed having the flexibility to make more income from the asset side of the balance-sheet is likely to become increasingly important in years to come and in some ways allows traditional reinsurers to make the most of their leverage twice.
Blackstone has seized the opportunity to enter the total return reinsurance space, with an experienced underwriting partner in AXIS. It will be interesting to see who else attempts to launch one of these start-ups in the years to come.