Will reputation, deep pockets provide advantage?
By Adam Cancryn and Mohsin Azamreprinted with permission from SNL Financial
Investment firms continued their push into insurance in the third quarter, backing a trio of IPOs aimed at serving narrow parts of the industry. The offerings represent the latest step in hedge funds’ and private equity firms’ migration into the sector in search of new, profitable opportunities. Funds have poured cash into the reinsurance industry during the past couple years, setting up and investing in alternative vehicles that promise better returns than their typical investments. Private equity firms elbowed their way into the primary insurance business by snapping up brokerages and accumulating cheap blocks of annuities business.
Now, major firms are spinning off companies of their own, entering parts of the industry where they think their reputations and deep pockets might give them an advantage. Perhaps the highest-profile public offering in the third quarter was the August debut of Third Point Reinsurance Ltd. Developed by Daniel Loeb and his firm, Third Point LLC, the company follows the path of similar hedge fund-backed reinsurers such as Greenlight Capital Re Ltd. and S.A.C. Re Ltd. That class of reinsurers has helped reshape the sector in recent years, as investment firms crowd into the business in search of broader sources of capital.
Although the influx of participants and lack of major catastrophe losses have driven prices down, analysts see opportunities for Third Point Reinsurance to thrive through shrewd underwriting and its investment portfolio connections to Third Point. The reinsurer courts quota share agreements within underserved areas of the market, leaning on Loeb’s reputation and strong relationships with brokers to win business.
An Established Rolodex
“This is somebody with an established Rolodex, and that means that he can compete for business without saying, ‘I have to sacrifice pricing,'” Keefe Bruyette & Woods analyst Meyer Shields told SNL. “He just knows people, and he knows how to underwrite and knows what to accept, so it’s entering at what’s clearly not a great point but having skills that will at least allow the company to maneuver through that.”
Supplementing Third Point Reinsurance’s underwriting income are the investment returns generated by Third Point. That combination has proven attractive to investors so far in its short public life. The company’s stock gained 10.95% through the end of the third quarter, compared with a 3.46% rise in the SNL U.S. Reinsurance Index and a 1.22% increase for the S&P 500 during that period.
“Third Point’s hedge fund returns are the key swing factor for [Third Point Reinsurance] earnings/ROE and thus the key stock driver,” Morgan Stanley analyst Gregory Locraft said in a Sept. 9 report initiating coverage of the company with an “overweight” rating. “This makes [Third Point Reinsurance] the ideal investment for investors seeking hedge fund returns.”
J.P. Morgan Securities LLC, Credit Suisse Securities (USA) LLC and Morgan Stanley & Co. LLC were among the underwriters for the reinsurer’s IPO. While Third Point Reinsurance is competing with a broad field, two other soon-to-be-public insurers are targeting niches within the industry. An investment group including Goldman Sachs Group Inc. is funding mortgage insurer Essent Group Ltd., in a bet that it can grow its value as the real estate market rebounds. The company announced its IPO plans Sept. 16, withGoldman Sachs & Co. and J.P. Morgan Securities among the underwriters.
As a private mortgage insurer, Essent has already grabbed market share. The Bermuda-based firm reportedly made up 9.2% of all coverage sales in the first six months of 2013, up from 5.2% from the same period in 2012. Fidelity & Guaranty Life is also looking to gobble up share in the coming years, but it operates mainly within the fixed annuities business. The Harbinger Capital Partners LLC-owned company is an extension of investment firms’ aggressive move into the annuities sector as traditional insurers shed their exposure to the volatile products. Rather than cobbling together various blocks of business through acquisitions, Harbinger will gain direct access to the market as a major investor in Fidelity & Guaranty.
Credit Suisse Securities (USA) is acting as the sole book manager for the upcoming IPO.
However, the string of public offerings is likely to invite more scrutiny of investment firms’ involvement in insurance. Harbinger filed for Fidelity & Guaranty’s IPO around the same time it settled market manipulation lawsuits with the SEC. State regulators at the same time havequestioned the inherent conflict between the insurance industry’s emphasis on long-term liabilities and hedge funds’ shorter investment windows.
The Issue With Hedge Funds
“One issue with hedge funds is the lack of transparency, specifically with respect to the investment vehicle and the type of transaction itself,” Nelson Levine de Luca & Hamilton Partner Matthew Vuolo told SNL. “Whether that, in and of itself, creates more risk, I think it’s too early to tell.”
The New York Department of Financial Services in May subpoenaed Harbinger and other investment firms involved in the insurance industry, asking questions about their investment strategies. It also recently extracted concessions from Athene Holding Ltd. in exchange for approving its acquisition of Aviva USA Corp. As more nontraditional players enter the insurance market, regulators will likely push for greater transparency around their operations.
“The chance of new regulations governing these transactions, I think, is very good,” Vuolo said. “I would think that regulators will look to achieve increased regulatory control over these transactions and really with an eye toward increasing transparency and also vetting the actuarial models they use to assess risk.”
Throughout the rest of the insurance industry, companies in the third quarter remained focused on taking advantage of low interest rates to refinance their debt. Insurers completed 26 debt offerings in the third quarter, double the amount seen in the 2013 second quarter but down from the 34 completed in the prior-year quarter’s refinancing frenzy.
As Always, QE Looms Nearby
The activity occurred in spite of rampant speculation over whether the Federal Reserve would back off of the stimulus program that has kept interest rates at super-low levels. Insurance companies during the past several quarters have refinanced their upcoming debt maturities to lock in the attractive rates. But some companies backed off as the 10-year Treasury yield rose on expectations the Fed would taper off their bond buying. When the central bank decided against doing that, the 10-year Treasury yield dropped, and the refinancing continued.
“The summertime had a couple of bumpy periods,” Robert Riegel, Moody’s Investors Service U.S. life and P&C insurance managing director, told SNL. “But once the Fed backed away from easing their foot off the gas pedal on quantitative easing, you had [Reinsurance Group of America Inc.] issue … [and] Marsh & McLennan [Cos. Inc.] issue.” He added that insurers have continued to refinance debt as far as 18 months ahead of the maturity date, much further out than normal.
J.P. Morgan Securities, Merrill Lynch Pierce Fenner & Smith Inc., UBS Securities LLC andDeutsche Bank Securities Inc. were among the underwriters on RGA’s issuance of $400 million of 4.700% senior unsecured notes due Sept. 15, 2023. A group of firms including Goldman Sachs & Co. and HSBC Securities (USA) Inc. underwrote Marsh & McLennan’s sale of $250 million each of 2.550% senior notes and 4.050% senior notes.
As busy as the debt markets have been, equity issuance has remained nearly nonexistent. The industry completed just three common or preferred equity offerings in the quarter, a consequence of the enormous cash stockpiles many insurers hold after a few years of lower catastrophe losses. Rather than issue stock, insurers are more likely to buy it back as a way to spend some of their cash and boost valuations in the process.
“It’s not likely that they’re going to raise equity just to warehouse additional resources that they really don’t need to support growth in their business,” Riegel said.
Wells Fargo Securities LLC and Goldman Sachs were among those underwriting Allstate Corp.’s public offering of $350 million of depositary shares, which ranked as the largest equity sale during the quarter.