While the alternative capital entering reinsurance markets has spurred transactions in accordance with the anti-correlation theory, other investors that have entered the market via acquisition of businesses have certainly blurred the theory’s parameter of the required level of underwriting margin.
Exor’s offer to acquire Partner Re is an example of a knowledgeable investor identifying reinsurance market returns as an attractive opportunity relative to the yields available elsewhere, despite current market conditions. In its early approach, Exor cited an objective of returns exceeding the MSCI World Index (Euros) over the cycle, which it interpreted as an 8 percent hurdle. This is materially below the traditional view of the cost of equity capital for specialty insurance and reinsurance markets.
Similarly, the use of investment float has been a long-term feature of the market. However, the introduction of Fosun as an acquirer, Fairfax’s acquisition of Brit and the proliferation of the new hedge fund reinsurance model has emphasized a model with a much greater focus on generating returns from the investment float than the market mean. Given the ratio of investment float to equity within specialty insurance markets, an additional 1 percent investment return can equate to approximately 2.5 percent of combined ratio.
Both of these sets of acquirers exhibit a lower requirement for underwriting return than normally assumed in markets. They are therefore able to effectively compete in soft markets for merger & acquisition transactions with traditional market consolidators - which require higher underwriting margins - despite not accessing the benefit of underwriting synergies.