Is bigger better?

The sudden burst of M&A activity has dominated the discussions on earnings calls over the last few weeks. Veteran insurance investor, Nick Martin, looks at whether increased scale will be enough for reinsurers to succeed in a challenging market.

Nick MartinNick Martin is the Co-Manager of the Polar Capital Global Insurance Fund which currently invests in excess of USD 500m in insurance equities.

The 2014 year end earnings season in the US is now behind us and in most cases companies produced good results. Book values typically grew c.12% for the year, a creditable performance given continued low interest rates but in part helped by another light catastrophe year. Although company conference calls contained the usual discussion of the 1 January renewals, investors were more interested in what management teams had to say about the accelerating pace of M&A activity in the sector. Reinsurance market conditions, especially in catastrophe, appear now to be sufficiently poor that some of the social issues that often prevent corporate activity are now being overcome. Management teams and investors alike are asking themselves what does it take to be “relevant” in today’s market and what do they need to do to be successful in an arguably permanently changed world.

Being bigger clearly has advantages in terms of ratings, line size and credibility with clients and brokers. John Charman commented last year during Endurance’s approach to Aspen that he thought a company needed $5-8bn of premium to be relevant. His view today is that the “new market norm” is “much closer to $10bn” and the XL/Catlin and AXIS/PartnerRe deals seem to support this view. Munich Re’s comments suggest they see a limit to the advantages of size. Management stated on an analyst call that they see themselves as too big to be an acquirer of another reinsurer as they already have big line sizes and clients would likely not want them to have a higher share post an acquisition and therefore Munich would “lose business for which we have paid money”. RenaissanceRe after their acquisition of Platinum will have close to $5 billion of shareholders’ equity.  Management think they are sufficiently relevant in their markets given their deep experience and best in class reputation.  I believe there is certainly room for relatively smaller high quality players like RenaissanceRe but there is little doubt that the bar has being raised.

For most companies, being bigger might now be necessary but is not sufficient. For many years, the industry’s top performers were those companies that were consistent outperformers on underwriting but also importantly did not make mistakes in their investment portfolio.   The best companies right size their balance sheets relative to the market opportunity and are always mindful of shareholder returns. Looking ahead, the crucial importance of underwriting excellence will not diminish but management teams will need to be more thoughtful in using other tools in their toolbox. These could include tightly controlling expenses, the superior use of data analytics and adding alternative income streams such as from third party capital management.

2014 started with Endurance's attempt at Aspen and finished with RenaissanceRe/Platinum and XL/Catlin. 2015 has started with a bang with AXIS/PartnerRe and Fairfax/Brit in quick succession. I think more deals are likely as this year develops. Also interesting to watch will be the progress of new initiatives such as Arch’s Watford Re and ACE’s partnership with Blackrock. Consistent underwriting results provide companies like Arch and ACE with valuable “content” and these companies should continue to do well in the new world.        

For me, success in running a (re)insurer, will always be defined by growth in tangible book value per share and dividends over time. As management teams try and navigate through these choppier waters, whether independently or as part of a larger entity, that needs to be the metric they always keep at the forefront of their minds.


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All opinions and estimates in this report constitute the best judgement of Polar Capital as of the date hereof, but are subject to change without notice and should not be relied upon.  The views represented herein do not necessarily represent the views of Polar Capital. Shares in the fund should only be purchased by professional investors and investors should consult the fund’s offer documents before making a decision to invest.

See also

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Posted: Monday, February 23rd, 2015