Swiss Re Insurance-Linked Fund Management

PCS - Emerging Risks, New Opportunities

Walking a capital raising tightrope between glory & rate pressure


Capital top-ups, recapitalisation and fresh start-up capitalisation efforts are accelerating in insurance and reinsurance markets, as founders and investors look to make the most of the firming to hardening rate environment that is being seen widely across the sector.

tightrope-balancing-balanceIn some cases, these capital raising efforts are fully warranted, as there are re/insurers that require new capacity at this time, especially to deal with the impacts of the Covid-19 pandemic.

But, some other capital raising efforts may be destined to simply add to the sector’s capital base, at a time when we really do not know the full extent of capital lost due to the pandemic, risking elevating capital levels to such a degree that it ultimately prevents prices from rising as far as perhaps they could have.

It’s a balancing-act right now, between covering yourself in private equity backed glory and being reviled industry-wide for contributing to the dynamics that could make this one of the shortest hard market’s in history.

Of course, we’ve all seen this before, with the specialty insurance and reinsurance Classes of 2001 and 2005, as well as through the growth of the last decade and more recent 2017/2018 acceleration of the insurance-linked securities (ILS) market’s capitalisation.

All of these capital raising efforts meant that rates were not able to rise as much, or for as long as they could have.

In the case of the ILS market, there is also the fact that it is generally a lower-cost source of capital and often a more efficient business model to consider, hence rates should have declined as the capital market’s more direct participation in reinsurance accelerated.

But still, the accelerated growth of ILS did add to rate pressure, alongside the competition it raised among larger traditional reinsurers that drove rates down just as much as the capital market players.

In 2020 things are no different, except for that right now it appears to be traditional equity backed re/insurance carriers that are risking an over-capitalisation of the marketplace.

Fresh capital inflows into reinsurance are needed the most at times when there has been a destruction or loss of capital, driving recapitalisation needs and making specific room for new entrants in the market, or when there is heightened demand for capacity that can soak up new inflows as they come in.

Of course, there are significant losses from the Covid-19 pandemic to come, they will flow more rapidly through the coming quarters it seems. But many of these will fall to larger players, who will either be able to manage them or replace capital more easily where needed.

Right now we do see some specific pockets and players in the market where capital has been destroyed, but most of these are localised and come down to insurers or reinsurers recapitalising themselves to replace this and provide continuity to clients.

On the demand side, while we’re bullish that overall the pandemic will drive insurance and risk management uptake longer-term, this could take some years to manifest fully, meaning that right now there doesn’t seem an enormous amount of new demand emerging that needs to be filled.

This year, the majority of the capital raising is being undertaken for one reason, to make the most of the firming and hardening being seen across property and casualty insurance and reinsurance.

Rates are moving faster and in the most positive direction seen for a decade or more, so it’s no surprise that capital is knocking on many doors in the insurance and reinsurance sector.

This is another very good reason for raising capital, of course, but it helps if you have the franchise and expertise to get it deployed.

It also helps if you’re a nimble player, that is just as willing to reduce and return capital as it is to raise it. With these players perhaps best placed right now, given the cycles insurance and reinsurance tends to throw at them.

It also helps if you’re established.

Raising money means it needs to be put to work and in many cases private equity entrants come with high return expectations, sometimes multiples, that need to be serviced.

Established platforms stand best placed to achieve this in a meaningful and disciplined manner, although the returns may not be the multiples achievable by a full start-up launch.

But, even the start-ups with the highest-profile luminaries behind them may find themselves fighting the perception that they have to be the cheapest capacity in the market when they launch.

We’ve seen this repeatedly and even the highest profile specialty re/insurance launches of the last few years have almost all ended up writing ILW’s, or filling out cat programs at low rates just to get themselves started.

Which can mean there’s an element of luck to the success of a start-up, as their first-year portfolios can be rather exposed to peak perils as a result of this need to be lower-cost capacity.

Then, there are also economies of scale to consider.

Good examples here are Fidelis, launched by a luminary with $1.5 billion in 2015 and only just exceeding $2 billion of underwriting capital after its new $500m raise announced this week.

It takes time, no matter how high-profile a launch you are and even Richard Brindle will have had to negotiate the challenges of being the newest capacity in the market for a time, as his platform built out and created a position in the marketplace.

Convex is another good example from recent years, with a high-profile management team and $1.8 billion of capital at launch. But it has taken time for the company to gain traction, as it always does, even under the stewardship of leaders like Stephen Catlin and Paul Brand.

Creating new insurance and reinsurance companies is not a quick endeavour and again, you will have to get used to being expected to be cheap, no matter how high-quality you feel your capacity should be considered.

Both of these examples have very specific approaches and are trying to do some parts of the business differently, to achieve efficiencies that can make them more competitive.

But some of the start-ups coming through in 2020 are seemingly looking a little on the rushed side right now, coming through the investment process lacking a real story as to why they will be anything new, or different (we’ve seen a few of the decks), or more effective, or more efficient and often playing on a name rather than a strategy.

Which means they are bringing capital and capacity, yes with the backing of an industry luminary in most cases, but not always with anything that makes them a particularly compelling proposition in the market right now.

And that’s a shame.

Knowing some of the private equity teams looking to enter the market with capital right now and trying to identify the right platform with which to do so, there is some concern bubbling under the surface that all we’re seeing is the launch of a number of copycats, with nothing particularly new to offer, at a time when there’s perhaps not even a particularly great need for them in this number.

In terms of need, competition is always a good thing and perhaps what the Class of 2020 (or 2021, as that’s when they’ll really get going) will be able to do is push out some underperforming incumbents.

But to even get to that stage, they are going to have to fight to deploy their capacity and be extremely competitive, as a result of which there is every chance the weight of new capital entering the market makes the current hard market another that ends up being short-lived.

Of course, all of this is before we even begin to consider the insurance-linked securities (ILS) market and the start-ups likely to emerge from it.

There are at least two new ILS fund management groups in the works.

One as a new ILS manager that began its formative months promising a particularly intriguing strategy, with an innovative edge designed to meet the needs of anchor investors, but that has more recently become a much more mainstream proposition, we understand.

Another promises to bring together an interesting crew of industry people, but its chances of launching in time even for 2021 seemingly looks 50/50 right now.

That’s not to mention the reinsurance sidecar fund raising efforts, which continue (although remain challenging) and in most cases appear to be looking to target launches later in the year, with the mid-year having been missed by some of those targeting it.

Of course the existing ILS fund management groups are all likely to try and raise fresh capital as we move through the rest of this year as well. Some have even done so a little for the mid-year, a handful with much more success than others, we understand.

Add into this capital raising mix, or melee, the fact some of the largest reinsurers may also look to capital to support expansion of their underwriting as we move towards 2021 if rates are still looking buoyant.

With well-established franchises, the reach to guarantee capacity can be put to work meaningfully and the names to attract the biggest investors. We could see some capital bolstering by a number of the larger players as well, if the renewal market continues to promise this continued firming.

But how long will insurance and reinsurance rate firming continue, when the market is seemingly falling over itself to raise more capital?

Perhaps not as long as the private equity investors backing new start-ups might hope for, or have been informed it would.

The market is seemingly on a tightrope, between attaining glory through feted capital raise launches featuring rockstar names from the industry and private equity, and adding pressure onto rates in time for the next round of renewals.

Right now, everyone is playing the Covid-19 card. Telling investors that this time it’s different. That the pandemic has changed all the rules. That rate firming is here to stay and the market has elevated return requirements now the risk landscape is being perceived as much greater on both sides of the traditional balance-sheet.

Which may well be true, right now. But for how long?

Will it still be true after $10 billion (or more) of new equity capital flows into the market, which is likely to be met by some billions of new ILS capacity (if only to replace that which is trapped and to support catastrophe bond issuance, not to mention ILS start-ups that are forming)?

The industry may be backing itself into a corner where it is going to be testing the desire for deploying capacity, against the desire to sustain some of the recent rate increases.

At that stage it could all come down to discipline and whether a new floor on pricing can be established by the industry, rather than the current expectation for continued upward trajectory of pricing.

A new pricing floor is something we repeatedly hear as desirable among ILS markets, in particular when it comes to catastrophe bonds.

But when there is new capital, investor backed and in new start-up vehicles, it’s largely got to be deployed and sometimes at any cost (becoming the cheapest in the market).

Which means the established platforms that are prepared to hold onto capital or return it, if rates don’t look as attractive as currently hoped, may be the better (albeit less exciting) investment play at this time.

That or the ventures that truly have a lower-cost of capital they can wield effectively, making use of direct capacity from capital markets, alongside technology and tools to deploy it much more efficiently and in an optimised manner.

I hope I’m proved wrong though.

I hope the industry can stimulate new demand for risk transfer and that this makes room for the capital inflows and start-ups such that rates don’t come under as much pressure.

I hope the pandemic changes the perception of risk such that the corporate and sovereign entities of the world begin to take greater responsibility for the exposures they carry and that insurance is looked to as a tool to buffer against it.

I also hope that start-ups come with well-formulated business plans that aim to do something different, more efficiently, or better, so that we aren’t just going to see a number of copycat businesses built again.

Ultimately, I hope that rates can be sustained for longer this time around. But the tightrope may be particularly fine this time around, with little immediate wiggle room to prevent us falling into another period of softening.

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