Transatlantic Reminds Why Wall Street Likes Reinsurance
With cheap valuations and the potential for quick returns and lucrative fees, it is little wonder that Wall Street has always liked the reinsurance business.
From hubs in Bermuda, London, Switzerland and Germany, the largest reinsurers collectively write more than $100 billion a year in new premiums, and as long as major disasters don’t sap their capital, they hum along as steadily as anything else in the financial sector.
“Within the overall financial services sector you have one of the most attractive valuations, and you have a catalyst that is somewhat separate from some of the macro issues out there,” said Cathy Seifert, an insurance equity analyst at Standard & Poor’s who covers many of the Bermudan players. “The financial sector is sort of not an in-favor sector right now but in that sector these stocks look attractive.”
While shares in investment banks and brokers trade at a multiple of 1.34 times their book value, for example, reinsurers trade at closer to 0.74 times book in the current market, according to Thomson Reuters data.
That in and of itself makes the business attractive to the likes of Warren Buffett, whose Berkshire Hathaway entered the fray for Transatlantic last weekend with an offer that values the company at less than 0.8 times book.
As one financial services banker put it, Buffett could buy Transatlantic, shut it down and still make money on it as its already written book of business runs off over time.
If he succeeds, the Transatlantic deal could vault the Berkshire Hathaway Reinsurance Group into the No. 3 slot globally behind European titans Munich Re and Swiss Re.
“Predictability is difficult in this business, but at the end of the day Buffett likes insurance businesses because he gets to put float to work,” said Tom Lewandowski, financial services analyst at Edward Jones, referring to the cash pile insurers hold and invest while waiting to pay claims.
Whichever way Transatlantic answers, no one expects Berkshire to get into a three-way fight over price with the other two potential buyers.
“I don’t think Berkshire will be in a bidding war. I think they made an offer and that’ll be that,” said Steve Check, president of Check Capital Management in Costa Mesa, California, whose largest shareholding is in Berkshire.
Putting the float to work, as Buffett may aspire to do with Transatlantic, is one of the factors that has drawn Wall Street to the reinsurance business in past.
Transatlantic suitors Allied World and Validus Holdings were both co-founded by affiliates of Goldman Sachs Group, in 2001 and 2005, respectively.
Each is part of a disaster “class,” a group of reinsurers founded after a major capital-absorbing event like the 9/11 attacks or Hurricane Katrina. When a disaster like one of those events suddenly takes up tens of billions of dollars of reinsurance capital, companies rush in to take advantage of the subsequent increase in insurance pricing.
In fact, according to a 2008 economic analysis of the Bermudan insurance market by the Wharton School, at least four of the 11 insurers from the “class of 2005” had investment banks or top-tier private equity firms as lead investors. The same was true for at least three of the 10 firms from the 2001 class and four of the nine firms from the 1993 class.
In some cases, those Wall Street sponsors have started a company and then cashed out with an initial public offering or a trade sale as quickly as they could. In other cases, they have kept a significant stake in the business and maintained a banking relationship with the company.
Some of that has to do with what the insurance industry refers to as “long-tail risk” versus “short-tail risk” — in other words, how quickly the insurer is likely to see claims for coverage from insureds.
Long-tail risk, where claims may come in years after the fact, would include things like medical malpractice coverage and worker’s compensation policies. Short-tail risk, on the other hand, is the reinsurance people think of more typically, such as hurricane coverage.
The financial services banker said Wall Street firms like short-tail reinsurers for their ability to start them and sell them quickly, but they also like long-tail reinsurers because they can obtain deals to manage the float for those insurance companies and be paid fees as a result.
Given the attraction, there has been speculation in the industry that 2011 could eventually host its own disaster class. Insurers and reinsurers have lost more than $60 billion this year on natural disasters like the Japanese and New Zealand earthquakes and U.S. tornadoes.
That has not been enough to cause a so-called “hard market,” where insurers can raise prices across the board, but it has come close. Given that the worst of hurricane season is just starting, many believe a single U.S. landfall of a major hurricane would be enough to force that market turn.
If so, capital could rush in quickly; in 2005, for example, some of the new reinsurers were formed within two months or so of Katrina devastating New Orleans.
“It’s not 2001, and it’s not 2005 but slowly and gradually, it is a catalyst, and it is a catalyst that is bearing down on a group that is trading below their tangible book value,” S&P’s Seifert said.
(Reporting by Ben Berkowitz; editing by Gunna Dickson)