Over the years, private equity firms have been quite adept at finding opportunities amid chaos and calamity. Recently, they’ve been paying close attention to the insurance business.
The tragic events of Sept. 11 have put a major strain on the insurance industry, to the tune of an estimated $30 billion to $70 billion loss. Faced with a shortage of capacity and soaring premium rates from reinsurance companies, insurance companies say they’re able to cover the claims associated with the attacks out of surplus capital, but are lobbying the government for aid in the event of future attacks. In fact, Congress is working on legislation to aid insurance companies, with the goal to pass an aid package before it convenes this session.
With insurance companies in a desperate state, reinsurance companies are in a favorable position to call the shots. And private equity firms have taken notice.
While recent events have certainly intensified the situation with insurance companies, it’s still fair to say that GPs had been looking for ways to put their abundance of dry powder to work in the industry for some time. Insurance companies’ capital bases have slowly been depleted over the years, especially since Hurricane Andrew hit in 1992, costing the industry about $16 billion. Until the terrorist attacks, the hurricane was the biggest insurance catastrophe of all time.
And the problems don’t stop there. The insurance industry is further aggravated by the current low-interest environment, which has an adverse effect on the industry’s bottom line. All of this makes insurance companies more dependent on the reinsurers.
Firms taking notice of reinsurance companies include Hellman & Friedman, Warburg Pincus, Kohlberg, Kravis, Roberts & Co., MMC Capital and Capital Z.
“The industry has had a pretty difficult time over the last three or four years,” says Jack Bunce, a managing director at Hellman & Friedman. “When Sept. 11 happened, we knew a lot of the capital was going to be wiped out, and we thought that might create an opportunity for us.”
And he was correct.
Hellman & Friedman, along with Warburg Pincus, this month agreed to pump a total of $750 million into a new underwriting initiative, Arch Reinsurance, on behalf of Arch Capital Group Ltd., a Bermuda-based insurance and financial services company. Warburg Pincus and Hellman & Friedman will invest $500 million and $250 million, respectively, to purchase Series A convertible preferred shares and Class A warrants of Arch Capital. The financing will raise the company’s capitalization to more than $1 billion.
“Arch Capital’s existing licenses, infrastructure and operations enabled us to get into business immediately,” says Kewsong Lee, a managing director at Warburg Pincus. Lee notes that it was important for Arch Reinsurance to be up and going by Jan. 1, 2002, because January is when most of the volume in the insurance business is written. “So for us to be on the ground running is extremely advantageous to everybody,” he says.
This is Warburg’s second dip into the reinsurance industry. It formed RennaisanceRe in 1993. Hellman & Friedman’s first venture into the reinsurance industry dates back to November 1992 with the formation of MidOcean Ltd., the first Bermuda-based dedicated property catastrophe reinsurer.
MMC Capital Inc., a major player in the reinsurance industry, is making headlines of its own. Through its Trident II LP fund, which was formed in 1999 to seek investments in the global insurance, reinsurance and financial services industries, the firm in September formed Axis Specialty Limited, an insurance and reinsurance company. The fund will commit $200 million to the venture, which is expected to be capitalized at $1 billion.
Teryce James, chief communications officer at MMC Capital, said, “The WTC disaster is likely to be the largest insured loss in history. The losses have created a shortage in capacity in the industry and resulted in increased premiums. This provides Axis with an opportunity to provide capacity at attractive rates.”
In addition, MMC Capital recently agreed to a venture with the Enstar Group Inc. to form Castlewood Holdings Ltd. – a vehicle set up to acquire reinsurance companies. Enstar and Trident will make equal capital commitments totaling $79 million in exchange for their majority stake in Castlewood Holdings. Upon closing, Castlewood Holdings will have total capital available in excess of $100 million.
Another industry old hand, Capital Z, the private equity affiliate of Zurich Financial Services, this month announced a $400 million co-sponsorship with Aon Corp. and Zurich Financial in Bermuda-based Endurance Specialty Insurance, which will provide underwriting for the commercial property and casualty insurance markets. Endurance Specialty is expected to be capitalized at $1.2 billion.
Bob Spass, a partner at Capital Z, says he has seen rates increase in the property and casualty sector, but he has also noticed liability lines increase over the last 12 months as a result of a prolonged down cycle in pricing. This wasn’t true after Hurricane Andrew, as only property casualty rates increased. And in 1986, the pricing turn in the industry affected only the liability side of the business. “This time around, all segments of the business are increasing in price, and there are capacity issues with respect to all lines of business,” Spass says.
Not to be left out, KKR this month injected an additional $100 million into Alea Group Holdings AG, a global reinsurance enterprise. Alea was started in December 1997 when an affiliate of KKR and management acquired Rhine Reinsurance Co. from the Baloise Insurance Co. In May 2000, KKR invested $150 million in the company.
Perry Golkin, an executive at KKR, said in a statement, “Over the ensuing months, we will better understand the degree to which fundamentals of the insurance/reinsurance marketplace have improved, and we are prepared to ensure that the group has sufficient capital to meet the needs of its clients.”
Strategic players are also taking up the opportunity to make reinsurance plays. For example, White Mountain Insurance Group Ltd. is reportedly looking to build a Bermuda-based reinsurer with $1 billion in capital. The company is expected to invest $200 million and seek to fund the balance from outside investors including private equity shops.
Read Between the Lines
The many reinsurance initiatives sponsored by both financial and strategic players is seemingly flooding the industry with a lot of private equity capital. But a closer look reveals a distinction between raising capital and successfully putting it to work, sources say. “The fact that you’re announcing a plan is not the same as declaring victory,” says Robert Clements, chairman of Arch Capital. “Many of these announcements are crafted in such a way that it is easy to draw the conclusion that there is capital committed to the market. But upon closer inspection, you discover that there are many a slip between cup and lip.”
Clements adds that his venture with Warburg Pincus and Hellman & Friedman has a distinct advantage over its competitors because of Arch Capital’s existing infrastructure and its public listing. “All of these objectives are in the business plan of most people who are looking to start business in this kind of environment, and some of these things can take years to build,” Clements says.
In addition to the task of building out an infrastructure for new entrants, sources also warn against the different accounting and regulatory issues involved in the reinsurance industry. “Clearly, the industry is an animal unto itself,” says Spass. “It is not an easy thing to diligence and is incredibly complicated if you’re not spending a lot of time on it.”