The Class of 2020: Capital Raising for Existing Firms or Insurance Startups?

By | July 16, 2020

Capital is coming into the industry “leading to questions about the emergence of a Class of 2020,” the rating agency said in a report published yesterday. In the report, the rating agency addressed rumors that market dislocations are exposing potential opportunities in specialty, U.S. excess and surplus lines, and reinsurance markets and drawing potential investors looking to put capital into new company formations—not just reloading existing companies.

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The report titled “Insurance Capital Raising—Bolstering Existing Firms or Funding Start-Ups?” makes the point that many startups evaluated by AM Best analysts in prior classes of startups over the years have not “met requirements to achieve what is considered the necessary rating commercially.” Noting that some companies had to revise initial business plans in order to achieve such ratings, the report lists a dozen companies that initially or eventually got startup ratings from AM Best since 2014—11 with ratings of “A-” or better—along with the requirements for initial rating assignments.

The report refers to “increased speculation that capital is looking to support new company formations—keen to benefit from hardening rates and terms and conditions” in 2020, but does not mention any specific newbie ventures or potential leaders by name.

The report does note that existing companies, including Beazley, Fidelis, Hiscox, Lancashire, QBE and Renaissance Re, have announced capital-raising initiatives in recent weeks, with capital raises aimed at shoring up balance sheets that might be dented from the uncertain impacts of COVID-19 losses and to take advantage of an expected hardening market.

Another factor—the low interest rate environment—is making a hardening insurance market look attractive to yield-seeking investors, both new and existing ones, Best said, highlighting the $600 million-plus recapitalization of Starstone, a specialty insurance subsidiary of runoff consolidator Enstar in June to illustrate the point.

Starstone isn’t an entirely new venture but a restructuring of an existing entity putting experienced leaders Jeff Consolino and Ed Noonan at the helm as CEO and executive chairman. Consolino and Noonan previously worked together at Validus, a member of the “Class of 2005″—one of several classes of Bermuda startups that emerged in the wake of market-changing catastrophes.

Class of 2005

The “Class of 2005,” which sprouted up in the wake of Hurricanes Katrina, Rita and Wilma, included Validus, Ariel Re, Flagstone, Harbor Point and Lancashire. Prior classes included: the “Class of 2001,” born during the hard market following the 9/11 attacks, including the likes of Arch Capital, AXIS Capital, Aspen Insurance Holdings, Montpelier, Allied World and Platinum Underwriters; the post-Andrew class of 1992, including RenaissanceRe, Partner Re and IPC Re, among others. Even ACE (now Chubb) and XL (now part of AXA XL) are considered part of a class of startups, formed in the mid-1980s hard casualty insurance market when high-excess underwriting capacity was difficult to come by. (See 2015 Carrier Management, “P/C Insurer Mergers: Reaching the Tipping Point,” for more on the history of these classes and what happened to the companies in each of them.)

AM Best explains the lack of any more “Class of 20XX” cohorts since 2005, noting the popularity of collateralized reinsurance vehicles (or sidecars) and insurance-linked securities that gave third-party capital means of entering the market without the hassle of new company formations. In 2020, the appetite for those types of vehicles has been tempered by a spate of high-severity losses, issues regarding collateral release and longer-then-expected settlement from some catastrophe losses.

Should a “Class of 2020” emerge during the hardening market that is gaining more momentum as claims experience from COVID adds to prior late-2019 and early-2020 pressures from social inflation, AM Best will be looking for one of the ingredients in Starstone’s recipe—experienced management teams—among its requirements to assigning initial ratings. The rating agency will also want to see a “clearly-defined five-year business plan” together with “stress-tested capitalization that conservatively supports the business plan,” as well as staffing and infrastructure adequate to get activities off the ground and to meet regulatory and rating agency scrutiny. Analysts will also want access to management board members, strategic investors and investment bankers, actuaries and advisors.

As for the group of 12 startups that have AM Best financial strength ratings, only one—Fidelis Insurance Holdings—has been changed since getting its initial “A-” rating in June 2015. On June 3 this year, AM Best moved the rating up to “A,” noting that the writer of specialty insurance, reinsurance and retrocession products has a very strong balance sheet strength, adequate operating performance, appropriate enterprise risk management and manageable exposure to COVID-19 claims. “Fidelis’ disciplined underwriting, experienced management team, and its acceptance and recognition by the market have allowed for solid underwriting performance over the past three years,” Best said, announcing the upgrade, also making note of the benefits of a diversified business platform, including its establishment of managing general agencies and a sponsorship of a special-purpose insurer and of the group’s solid investment returns.

While no other ratings of startups have changed since initially assigned, AM Best did put the “A-” financial strength rating of hedge-fund reinsurer Watford Re under review with negative implications in May, following an announcement from Watford on April 23, 2020 that its first-quarter earnings included a net investment loss of roughly $300 million as volatile investment markets reacted to the economic consequences of COVID-19.

More generally, across the universe of rated insurers and reinsurers, AM Best said in yesterday’s report that initial stress testing it has conducted to gauge the preliminary impact from COVID-19 has revealed that “capital levels provide an adequate buffer against a potential shock to their balance sheets.”

Noting that COVID impacts are likely to hit earnings in 2020 but are unlikely to prompt a material decline in risk-adjusted capitalization, the report states that “companies could still face credit rating pressure if market conditions deteriorate beyond prescribed scenarios.”

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