There are a number of theories as to why we didn’t see a group of new reinsurers start-up after the record natural catastrophe losses suffered by the industry in 2011. Some say reinsurance capacity was sufficient, others say that the losses were not sufficiently impactful to push rates to the point where profitable opportunities emerged. Of course, both of these statements are true, but rating agency Standard & Poor’s would add that investors were just not interested in backing a reinsurance ‘Class of 2011’.
In a report published recently S&P explain why they feel that the class of 2011 reinsurers didn’t show up and say that it was largely down to a lack of interest in backing reinsurance equity ventures from investors. Doug Ostermiller, Director of Insurance Ratings at S&P, gave a number of reasons for the lack of interest.
While the 2011 catastrophes were undoubtably huge events and resulted in massive insured losses, they were confined to specific regions meaning that they didn’t result in a broad market hardening. Rate increases were seen in loss hit regions and lines of business, but other regions and lines have only seen very low single digit rate increases, not what investors were looking for.
Equity market valuations of re/insurers were too low at the time, and continue to be very low today. The economic climate has reduced the book value of many existing reinsurers and this will have caused any investors looking at the space to be put off by the low potential returns. It’s also worth noting that reinsurance capital positions were strong, particularly in the non-life market. Interestingly, S&P said that the investment performance of the class of 2005 was well below the requirements of your average private equity investor, this will have made reinsurance and insurance equity less attractive for some.
So what would equity investors have been looking for in the market for them to be interested in backing a class of new reinsurers? Ostermillar explained that private equity investors in reinsurance would typically be looking for opportunities to achieve a 20%+ return on their investment over the term. When deciding who to invest in they would look at managers track records, market conditions, equity market valuations of reinsurers and their investment horizon.
On the market itself, Ostermillar said that conditions need to be right in order for private equity to see a sufficiently attractive opportunity to deploy large amounts of capital into the reinsurance sector. They’d be looking for a significant deterioration of capital in the space, likely from a single large catastrophe event or series of catastrophe events. They would also want to see broad market hardening and rate increases almost across the board. Equity valuations would also need to be much higher, he added.
“We believe that financial investors are not likely to support a new class of off-shore (re)insurance franchises until the capital position of the market diminishes materially, there is a broad market hardening, and equity valuation return to historic levels,” commented Doug Ostermiller.
So the aftermath of 2011 did not meet private equity investors expectations and therefore capital was not deployed into the space on mass triggering a reinsurance Class of 2011.
However, S&P note that they observed capital flowing into the non-traditional reinsurance arena, with instruments like catastrophe bonds and sidecar vehicles – typically self-liquidating, special-purpose balance-sheet companies, attracting investors interest.
Given some of the thinking around how capital from non-traditional sources impacts the reinsurance space, it is to be debated whether we will ever see a mass launching of large private equity backed reinsurers again. With capital now being deployed into reinsurance in a multitude of forms from the capital markets, and growing interest in the non-traditional reinsurance space from investors, will the traditional reinsurer model ever seem quite as attractive to investors as it did in 2005?