PartnerRe and AXIS Capital said today that they expect third-party reinsurance capital management at the combined reinsurance firm, if the merger succeeds, will bring in annual fee income of $60m by 2017, while also providing capital relief.
In the latest push by the two reinsurance firms to persuade shareholders that by merging the firm’s emerge stronger, more diverse and with greater opportunity than would result from EXOR’s bid to acquire PartnerRe for cash.
A presentation published by the reinsurers lays out a number of areas of opportunity and where they believe the merger will take them to. One of the areas discussed is third-party reinsurance capital management.
Current reinsurance market dynamics have resulted in an increased supply of alternative capital coming into the market, the presentation explains, creating opportunities to provide a “broader range of cost-effective solutions to clients.”
For the combined PartnerRe-AXIS Capital, there will be a “greater opportunity to leverage alternative capital.” This would enable the combined firm to reduce its cost of capital by “matching risk to different forms of capital” while also providing the re/insurer with an “enhanced product offering for clients,” the presentation continues.
The increased availability of alternative capital “creates meaningful opportunities to leverage franchise, offer broader range of cost-effective solutions to clients and brokers, generate attractive fee revenue and release capital.”
The presentation explains that the two firms already have a long history of managing third-party reinsurance capital, with both increasingly leveraging relationships with third-party capital providers in recent years.
Both firms already place multiple lines of business and risks with third-party capital providers, the presentation explains, with the combination of the two firms increasing the potential “across a broad range of third party capital opportunities to optimize flexibility in allocating risks to best form of risk funding.”
Ultimately the combined PartnerRe – AXIS Capital would leverage the combined firms franchise position to manage and use third-party reinsurance capital in order to generate fee income and reduce the reinsurers capital requirements.
The presentation gives an estimate of the potential impact to the combined firm’s bottom line. They expect to generate over $60m in additional fee revenue as well as around $150m of capital relief from the future third-party capital management activities at the post-merger firm.
The expectation would be that this would add around 0.7% in return on equity, alongside providing a way to free up more funding for capital management activities.
Impressive numbers indeed and while large, definitely feasible, if the combined PartnerRe – AXIS decided to go all guns blazing into ILS and third-party capital.
In order to generate that kind of fee income the combined firm would need to significantly increase the amount of third-party capital under management, we would envisage, but the greater scale of the should provide the opportunities for deployment.
Now that sounds like an attractive proposition indeed, however it should be noted that the firm’s are proposing this against a background of flat net written premium growth in reinsurance. Hence premiums would effectively be turned over to third-party capital, likely to maintain competitiveness, which as a result would reduce the amount written on the firm’s balance sheet.
That raises the question of where underwriting is most profitable, on an equity balance sheet or a third-party capital backed balance sheet. Of course in the current climate of lower rates, some returns are inefficient on the equity balance sheet and only possible using third-party capital.
One thing is certain, the combined PartnerRe – AXIS will be significantly more attractive to third-party capital investors, who would prefer to partner with larger players, with greater market reach. So the fact that the firm’s are considering upsizing their use of third-party capital will be seen as a positive by the type of investors who may choose to back that.
The PartnerRe shareholders get their chance to vote on whether to combine the two firm’s or to opt for the EXOR all-cash offer in the coming weeks. Until that vote is completed, or unless EXOR pulls back, the future remains uncertain for both firms.
One thing is certain though, with the reinsurance market increasingly embracing alternative capital and ILS, third-party investors are likely to play an ongoing role in the companies underwriting whatever direction they head in.
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