Raising capital in the post-Covid world
Capital raising activity last year was driven by hardening market conditions and the need to bolster balance sheets. Insider Engage explores the pros and cons of different capital sources and likely future trends
Funding and financial backing for (re)insurers is more important than ever and in recent times many organisations have looked to the capital markets for support.
Last year, a range of sources including private equity, industry capital and public placements contributed to the capital inflow. Beazley, Hiscox and Renaissance Re used the public equity and debt markets, while Conduit Re, a start-up reinsurer, listed on the London Stock Exchange.
In total, capital raising in the global reinsurance sector is estimated to have totalled $22bn in 2020, according to Willis Re’s Strategic & Financial Analytics’ December update.
(Re)insurers look to raise capital for a number of reasons – from the initial creation or expansion of a business, to capitalising on hard market conditions when rates are favourable.
According to Catherine Thomas, senior director of analytics at AM Best, in her assessment of capital raising activity in 2020: “Existing companies have raised capital both to bolster balance sheets in response to uncertainty as to the potential scale of the impact of Covid-19-related losses, and to take advantage of favourable market conditions.”
“Capital supporting new entrants has also been attracted by a broad hardening in market conditions,” she adds.
Companies also seek capital to support opportunistic acquisition or growth opportunities, or to further position the business for investment, according to Danny Maleary, CEO of Pro MGA Solutions.
“A capital raise can help a business move to take a bigger slice of the market sector that they operate in, and also give them the scope to enter new markets. Maximising short, medium and long-term returns and increasing overall profitability is also a strong strategic driver,” he explains.
Pros and cons of capital sources
The main sources of investment are to raise equity capital through share sales or initial public offerings (IPOs), private equity, corporate debt, and short-term financing such as bank loans.
“Institutional investors also play a role, as do pension funds and family offices, and then of course alternative capital is a growing force in this space,” says Maleary.
There are pros and cons to each option but before deciding which route to go down, (re)insurers should look at their long-term business strategy and the requirement for funding.
“Essentially, choosing the right investor should be based upon the strategy of the individual business to support its vision, whether that is maximising the returns, profitability, hard market condition and/or positioning the business for growth and a greater capital event,” Maleary explains. “The different capital providers bring different strengths to each scenario, so getting the right advice, insight and support when choosing to raise capital is critical.”
Companies can quickly raise capital by going down the public equity route and gather the support of new and existing shareholders in a very quick manner. It can also provide an evergreen pool of capital if companies wish to raise more money in the future.
“Depending on the timing, it may be a cheap method of sourcing capital, and equity holders have the lowest level of security to repay debtors if the [(re)insurer] is wound up. On the other hand, transaction costs may be high,” says Andrew McNulty, insurance and financials analyst at ALG, a close partner of investment research and advisory company Edison Group.
Once listed on the public market, companies are much more visible, and it is often more expensive than being a private company. Public companies face meet stricter regulations, oversight and reporting requirements, including trading updates.
Conversely, in private equity, there is usually just one player involved, which may then choose to flip the company to another private equity firm. Because reinsurance is a niche sector, investors that are typically interested may be more interested in private equity funding as it gives them more structural comfort or flexibility or cater to their investment horizons.
For corporate debt, depending on the timing, the interest serving costs may be attractive and fixed interest structures may allow stable financial planning, says McNulty. However, he adds, the disadvantage is that, depending on the debt servicing costs or debt levels already in place, the interest charge may be expensive.
The benefits of short-term liquidity financing are being able to take advantage of low short-term financing costs, as well as its flexibility, he says, but there is a risk of a “sudden increase in interest rates resulting in an unattractive long term funding source”.
Financial reinsurance is of course another route to raise capital. “An insurer may ‘realise’ profits early from the underlying insurer business thereby ceding risk to the reinsurer. The disadvantage is that this form of raising capital passes profit to the reinsurer,” says McNulty.
Trends in 2021 and beyond
AM Best’s Thomas says this year, rates in a number of business lines are “set to continue to harden” as the market responds with increased underwriting discipline to adverse claims experience driven by social inflation in the US, Covid-19 related losses and, in recent years, an elevated catastrophe experience.
She explains: “We may see reinsurers raising capital if they either need to strengthen their balance sheets, for example if capital is depleted due to outsized catastrophe losses, higher than anticipated Covid-19-related losses or adverse prior-year development, and/or to take advantage of perceived opportunities presented by a hardening market.”
Recent improvement in rates and terms has been led by the insurance market, while rate increases in the reinsurance sector have lagged those in the primary market, she notes.
“A prolonged period of weak market conditions, coupled with catastrophe losses and adverse claims inflation trends in casualty, has meant that (re)insurers have reported lacklustre results over the past five years,” she says. “We think this need to improve underwriting margins should help sustain underwriting discipline and rate improvements, particularly when the very low investment returns available are taken into account.”
However, there is uncertainty over whether this will be a sustained and broad hard market.
“With retro market capacity constrained, cat reinsurance was more expensive to place at 1/1 renewal, but actual increases appear to have been at the lower end of expectations going into the renewal season,” notes Thomas.
The introduction of the accounting standard IFRS17 which comes into effect from 2023 could make financial reinsurance less attractive as insurers “will no longer enjoy the funding immediately boosting the equity of the business by recognition of the financing in the profit and loss account”, says McNulty.
Going forward, Maleary predicts more strategic alignment between businesses and investors, and an appetite for longer-term relationships between parties. He thinks there will be fewer three-to-five-year relationships and more that are seven-to-ten-years and beyond before investors exit.
He also predicts that new investment capital structures will emerge, together with the continued growth of options around alternative capital investment opportunities.