Show me the money!!! - how (re)insurance businesses are raising capital during COVID-19

Since most advanced economies went into lockdown earlier this year, the specialty (re)insurance industry has raised close to $10bn in fresh capital to take advantage of opportunities now presenting themselves.

In this week's article, I discuss & unpack some of the interesting & innovative capital plays out there, what tools & techniques are being used and how they might impact the industry in the future.

1. The ‘Large’ Private Equity-backed (re)insurance startup

What is it?

Starting a global (re)insurance carrier from scratch (startup) requires a significant amount of capital. It’s why new entrants to the insurance underwriting business often opt for the capital-light managing general agency (MGA) model, by ‘renting’ the balance sheet of a large incumbent in order to take on risk.

The startup route requires investors with deep pockets to fund the initial setup and growth phase. Private Equity (that is capital from professional private investment firms) usually provides a sound way to access large pools of startup capital.

How does it work?

Private Equity investors will look for management teams to back which have a strong track record of performance and experience in growing large-scale (re)insurance businesses. The benefit of backing a startup is that there are no legacy drawbacks to contend with (e.g. legacy IT platforms and legacy capital reserves set aside to pay claims on policies written historically).

It literally is ‘build a business up’ from a blank sheet of paper. The startup will need a significant amount of capital in place to satisfy regulators of its solvency to pay claims. This will also help establish a strong financial rating from the rating agencies, in order to reassure other stakeholders (e.g. brokers and clients) that the new startup is secure enough to pay losses when they arise.

Private equity investors typically look to invest for between 3-7 years before they push for a sale, partial-sale or public flotation of the business in order to take some money off the table.

Recent notable examples

One of highest-profile examples of the large PE-backed (re)insurance startup over the last 12 months is Stephen Catlin & Paul Brand’s Convex Group. Both were instrumental in building up the eponymous Catlin Group from a small Lloyd’s managing agency into a publicly-listed business writing over $4bn of premium income and employing some 2,500 people across the globe before being sold to XL Group in 2015.

Their new venture is backed by Canadian private-equity house Onex Group with a reported $1.8bn of committed capital (I said 'large' pools of capital!) for a 10-year term, and has been hiring a number of people across its different functions through 2019 and 2020.

2. The ‘Hybrid Capital’ InsurTech startup

What is it?

Insurance Technology (‘InsurTech’) companies are typically fast-growth and therefore well-suited to venture capital investors that are prepared to take on a high-degree of risk of failure (in return for potential high-growth and scale).

However, for those InsurTechs which are looking to attack a multitude of markets, products & opportunities, the ability to structure as ‘hybrid capital’ entities offer an interesting approach.

How does it work?

Hybrid capital structures are typically formed when the management/founding team of the business requires funding to take opportunities across differing products and markets.

The typical structure is that of a holding company at the top. This holding company owns a number of subsidiary companies which are setup to carry out different operations. For example, one subsidiary might purely exist to build out the scope & scale of a digital platform that the overall group is pursuing, whilst another subsidiary might exist to perform acquisitions of other existing businesses in the market.

Some investors backing the founding team may only support one approach (e.g. digital scale up) but not another (e.g. acquisitions). Hence the need to split the group into subsidiaries and have different investor types backing the different businesses all under one group structure.

Recent notable examples

Pie Insurance, a US-based workers’ compensation-focused insurtech raised $127m from a consortium of private equity and venture capital investors back in May 2020.

$27m of the total was earmarked to support the 'continued growth and expansion' of Pie Insurance’s automated offering to small business owners. The remaining $100m equity capital commitment will go toward the creation of a new holding company that will purchase licensed insurance companies.

Whilst the Investor Relations team for the holding company will certainly not be short of work! - it’s an innovative funding structure which allows an Insurance/InsurTech business to pursue multiple growth opportunities simultaneously, whilst managing the risk/reward profiles of their various new & existing investors.

3. The Public Equity &/or Debt raise

What is it?

Publicly-listed companies have a big advantage when it comes to raising capital compared to their private company peers. It is (relatively) easy to raise capital via either a public equity raise (‘rights issue’) or a public debt raise.

How does it work?

In the (re)insurance space, having access to capital is of paramount importance. As an insurance company/carrier you need capital to be able to support your underwriting activities and claims payment services, whilst staying solvent & producing an acceptable return to your shareholders.

‘Hard’ underwriting markets (where insurance prices are rising overall) provide profitable opportunities for insurance companies to grow. However, taking advantage of the hard market requires access to sufficient capital in order to underwrite. That’s where being a public company has a big advantage. Go back out to the public markets, raise capital either via debt or equity (or both) and use the increased capital to grow in profitable product lines. The downside (of equity raises) is the dilution of existing shareholders’ equity stakes, and for debt raises it increases the borrowings/debt against the business resulting in higher loan repayments and interest.

Recent notable examples

Since Q1 2020, the Covid-19 lockdown period has seen a number of high-profile publicly-listed specialty (re)insurance businesses take to the public markets to raise equity for future growth opportunities. These incl. RenRe ($1bn+), Hiscox (￡375m), Beazley (￡247m), Lancashire ($365m) and QBE ($750m). On the InsurTech side, Lemonade successfully IPO’d to raise $319m in fresh equity for growth.

4. The (re)insurance ‘sidecar’

What is it?

A (re)insurance sidecar, sometimes referred to as a ‘reinsurance sidecar vehicle’ or simply a ‘sidecar’, is a financial structure established to allow investors (often external or third-party) to take on the risk and benefit from the return of specific books of insurance or reinsurance business.

How does it work?

Typically, sidecars are set up by existing (re)insurers who are looking to either partner with another source of capital or set up an entity to enable them to accept capital from third-party investors (usually private equity & hedge fund investors). It is a convenient way of temporarily expanding the balance sheet of a sponsoring (re)insurance company to write/take on more risk & hence earn more premium income.

Reinsurance sidecars are often joint-ventures between two existing insurance or reinsurance businesses. Increasingly though, sidecars are simply a convenient structure allowing third-party capital to be deployed within reinsurance underwriting business.

Reinsurance sidecars are normally ‘fully-collateralized’, meaning that the funds are always available to pay claims in the event of losses. The ceding insurer or reinsurer, who cedes risk to the sidecar, will typically pay its premiums for the coverage up-front allowing investors to profit from the premium return but then leaving their collateral exposed for the duration of the underlying reinsurance contracts.

Reinsurance sidecars can either be limited duration, so sometimes simply 1-year, or more permanent structures which underwrite new business at each renewal season depending on how much available capacity they have or managed to raise from external investors.

Sidecars became very popular in the aftermath of large catastrophe events such as the 2005 mega-catastrophes (Hurricane Katrina, Rita & Wilma) as the structure for a reinsurance sidecar can be established quickly, allowing investors and underwriters to profit from changes to the reinsurance rate environment.

Recent notable examples

My own employer, Liberty Mutual Insurance, setup its own sidecar arrangement (Limestone Re) a number of years back and has raised hundreds of millions of dollars to date . Others in the market (with sponsoring reinsurers) include: Alturas Re (Axis Capital) and Fibonacci Re (RenRe).

5. The ‘Management Buy-In’ (MBI)

What is it?

Management Buy-Ins (‘MBIs’) are a technique used to provide fresh capital and a high-calibre management team to an existing business. MBIs differ from MBOs (‘Management Buy-Outs’) in that the management team is new and being recruited externally. MBOs on the other hand, use fresh capital from new investors to support some members of existing management to buy out the other management staff & existing investors, whilst allowing the remaining management to continue to run the business.

How does it work?

MBIs usually work well when a high-profile and highly capable management team is put together by the individuals who intend to take on the key roles of Chairman and CEO. Given MBIs tend to require a large amount of capital, the new management team usually look to private equity houses to raise the large sums required to do the deal. The private equity investors can then benefit from putting capital to work and backing a top-drawer management team.

MBIs allow high-calibre management to ‘buy into’ an existing business /platform and make changes that they believe will increase shareholder value over time. In theory, it more closely aligns shareholders and management as the latter usually has a sizeable stake in the business.

Recent notable examples

In the (re)insurance sector, Ed Noonan (formerly CEO of Validus Holdings which was sold to AIG in 2019) and Jeff Consolino (formerly of American Financial Group) partnered with several private equity investors to raise $610m and perform a MBI of StarStone US Holdings, a specialty P&C franchise. Noonan and Consolino will take over the role of Chairman and CEO of the StarStone business respectively.

6. The Special Purpose Acquisition Company (‘SPACs’)

What is it?

Special Purpose Acquisition Companies (‘SPACs’) have become all the rage over the last 12 months, despite being around for decades. SPACs or ‘blank cheque’ companies as they are more colloquially known are a vehicle used to take private companies of a sufficient size & scale to the public markets, without going through the traditional & long-winded initial public offering (IPO) process.

How does it work?

SPACs are formed by ‘sponsors’, usually hedge fund or private equity companies with sufficient clout and experience with large scale investors. The SPACs are formed and then investors place funds (usually hundreds of millions or billions of $$) within the SPAC which is listed as a shell company on the public market. Much like a stock of a regular public company, the SPAC is a tradeable security on the markets with a trading price that can be bought and sold.

The SPAC usually has a 2-year shelf life with which to merge with an existing private company. The effect of the merger is to take the private company ‘public’ without the need to initiate an IPO. IPOs are commonly seen to be fraught with danger with management time spent preparing for the IPO rather than focusing on the business & risk the target price not being achieved given volatility. The SPAC takes control back from the public investors into the hands of the sponsor and original investors. If the SPAC cannot find an acquisition target within the 2-year timeframe, then it is unwound, de-listed and the funds are returned to investors.

Recent notable examples

Whilst the insurance industry is yet to see any noticeable SPAC movements, other industries have seen a number of blockbuster, headline-grabbing deals. Richard Branson’s private commercial spaceflight company, Virgin Galactic, merged with Social Capital’s SPAC (‘Hedosophia Holdings II’) led by ex-Facebook executive and prominent Silicon Valley investor, Chamath Palihapitiya in summer 2019. Virgin Galactic’s public valuation at time of writing was $5.1bn.

A number of others have recently launched including by famed hedge fund manager, Bill Ackman, amongst others.

I wouldn’t rule out some smart players in the (re)insurance arena using SPACs to similar effect.