David Priebe, Chairman of Global Client Development
A year ago, (re)insurers’ access to capital markets was in doubt. A worldwide financial crisis decimated balance sheets, sent equity values tumbling and caused credit markets to come to a standstill. Today, however, the situation has changed completely. Catastrophe bond issuances have resumed, and the mergers and acquisitions (M&A) market is gaining momentum. (Re)insurers are turning to capital markets to address a wide range of strategic and tactical needs. It is clear that this source of capital remains both viable and reliable.
In the third quarter of 2009, two transactions were completed and risk capital was up 28.8 percent year-over-year, with USD412 million1 of issuance. Both transactions completed in this quarter closed in late July, with Parkton Re Ltd, on which GC Securities* acted as co-lead manager and joint bookrunner, being one of the few transactions to be upsized this year. The initial target placement of USD125 million ultimately led to a USD200 million issuance.
For the first three quarters of 2009, 11 catastrophe bonds were issued, for USD1.79 billion in risk capital. Total risk capital outstanding grew from the second quarter of 2009 to the third quarter, reaching USD11.3 billion - up from USD11.19 billion and a net increase of USD112 million (1 percent). And, it looks as though the fourth quarter will be strong, bringing a year of salient recovery to a close. The fourth quarter is usually the second most active quarter as measured by risk capital issued, accounting for 28 percent of total issuance since the market’s inception. If issuances reach the consensus estimate of USD3 to USD4 billion for 2009, though, the fourth quarter would be the most active of this year. A total of USD1.2 to USD2.2 billion in catastrophe bonds would have to be issued, which would comprise 40 percent to 55 percent of 2009’s issuance activity. Though this seems aggressive, several factors could make this threshold reachable.
The two catastrophe bonds placed in the third quarter were placed within or below spread guidance and well inside the spread levels associated with transactions completed in the first two quarters of 2009. Additionally, the fundamentals of the insurance-linked securities (ILS) market also point to a strong fourth quarter. The USD660 million scheduled to mature this quarter will be followed by another USD518 million in January 2010, and these maturities may lead to an increase in demand for new issuances. Further, consistent positive movements in existing bond prices in the secondary market should exert downward pressure on required clearing spreads on fourth quarter primary issuances. In particular, 2009 vintage transactions, which use “next generation” or clean collateral solutions, are in high demand.
Improvements in general financial stability around the world and the positive perceptions of ILS as an important asset class for more traditional capital providers (e.g., pension funds, endowments and sovereign wealth funds) in the wake of the recent credit crisis may support elevated demand for the direct investment in insurance risks, as well. A benign 2009 wind season so far in terms of insured losses (though the season has been roughly average in terms of storm formation) is also making catastrophe bonds more attractive to both issuers and investors.
The opening of financial markets following last year’s financial crisis has thus led to new sources of capital for risk transfer. This is also the case for other forms of capital, particularly as (re)insurers seek to take advantage of depressed valuations to acquire companies as a way to accelerate growth in a mature market.
After a record year of M&A in 2003, the (re)insurance industry nearly fell silent in 2004. The number of transactions completed dropped from 42 (at a value of USD18 billion) in 2003 to 17 in 2004, with a total value of USD449 million. From 2005 through last year, the M&A market grew steadily, ultimately reaching 59 transactions at an aggregate value of USD16.6 billion in 2008. Carriers have been busy this year, too: 40 deals have closed, with a total value of USD7.1 billion, at the end of the third quarter of 2009. And, the trend is likely to continue upward.
The flow of capital back into the (re)insurance industry provides fuel for the prevailing trend. At the halfway point of 2009, the Guy Carpenter Global Reinsurance Composite showed an 8.2 percent increase in aggregate shareholders’ equity, mostly through investment and underwriting earnings. Further, the group’s cash position increased substantially - up 316 percent to USD7.9 billion. Capital and cash translate to strategic alternatives, and (re)insurers consequently have plenty of choices. In navigating the options available, many will respond to the clear competitive conditions that have arisen.
In 2010, we expect to see an increased level of both tactical and strategic M&A activity. Tactical M&A activity provides an opportunity to accelerate growth, as companies can add to their top line by acquiring companies where expense synergies exist. Strategic M&A, on the other hand, provides acquirers with access to new lines of business that they might not be able to enter otherwise, as the cost to establish a sufficient operation would be disproportionately high. Excess and surplus, specialty managing general agents and other specialty lines companies are seen as quite attractive, because they fill voids in product suites or platforms — and they tend to have lower loss ratio products than standard alternatives.
Much has changed in the past 12 months. The industry has turned from coping with capital constraints and weathering the fierce conditions of the financial crisis to seeking new routes to growth. Over the next 24 months, M&A activity is likely to be robust. Opportunities abound, and as some (re)insurers are taking advantage of them, others will follow.
The renewed accessibility of capital markets has already impacted the (re)insurance industry, and the effects will be expanded in 2010. Catastrophe bond issuances and M&A activity indicate that options unavailable a year ago are once again ready to be integrated into a company’s suite of risk and capital management tools. Uncertainty has receded, with carriers now turning their attention to expansion, though with a sense of caution. (Re)insurers are again pursuing aggressive ROE targets, but they are doing so with the memory of September 2008 fresh in their minds.
- This includes the Eurus II Ltd. EUR150 million transaction converted to US Dollars at an exchange rate of USD1.41:EUR1. For Euro denominated issues, amounts are converted to US Dollars according to the prevailing exchange rate on the closing date of each transaction.
* Securities or investments, as applicable, are offered in the United States through GC Securities, a division of MMC Securities Corp., a US registered broker-dealer and member FINRA/SIPC. Main Office: 1166 Avenue of the Americas, New York, NY 10036. Phone: (212) 345-5000. Securities or investments, as applicable, are offered in the European Union by GC Securities, a division of MMC Securities (Europe) Ltd., which is authorized and regulated by the Financial Services Authority. Reinsurance products are placed through qualified affiliates of Guy Carpenter & Company, LLC. MMC Securities Corp., MMC Securities (Europe) Ltd. and Guy Carpenter & Company, LLC are affiliates owned by Marsh & McLennan Companies, Inc. This communication is not intended as an offer to sell or a solicitation of any offer to buy any security, financial instrument, reinsurance or insurance product.