Private equity market increasingly bullish on insurance and E&S

Historically, the insurance sector has not been high on the list of preferred investments for private equity markets, but since 2001 interest in insurance and reinsurance has been on the rise, not only with private equity firms, but also with other forms of alternative capital investments.

By mid-November more than $500 billion in private equity transactions had occurred in 2006, with $100 billion in October alone, according to Andrew Rosen, a partner with private equity firm HM Capital Partners. Dallas, Texas-based HM Capital has a controlling interest in national wholesale broker Swett & Crawford.

The terrorist events of 2001, followed by New York Attorney General Eliot Spitzer’s investigations, and the hurricanes of 2004 and 2005 created investment opportunities, said Rosen at a meeting of the Texas Surplus Lines Association. “Private equity falls into an investment class that is considered alternative assets,” Rosen said. “Within that class, private equity, at least the way we look at it, is considered controlled investing in established businesses with the use of leverage — leverage meaning debt.” Other forms of alternative investments include venture capital and hedge funds.

The private equity industry has seen “tremendous growth” over the past 20-plus years and the market has both evolved and matured during that time, he said. After a bit of a “Wild West” ride in the 1980s, investors figured out during the 1990s that in order to use the capital wisely, they needed to understand businesses, rather than just be financial investors. “A lot of firms, if they survived the early ’90s period came out very strong. You started seeing a rise in the number of firms but also in the size of firms,” Rosen said. The equity market today is at an all-time high in terms of “deal-flow” and equity capital raised. There are more than 100 firms that control more than $100 billion in capital, according to Rosen.

A lack of interest
There are a few reasons for the historical lack of interest in the insurance sector. One is that it is a highly regulated industry and trying to create change in a regulated environment can be difficult. In addition, underwriting firms are difficult to evaluate; without knowing what the long tail costs are, determinng profitability is a challenge. Different accounting standards and complex reserving requirements add to the confusion, and it can be a difficult business to leverage, he said.

Now, however, there is a lot of interest, particularly in the excess and surplus insurance market, where there has been much growth. “[W]hen you see fundamentals that are positive over a growing market, that will be interesting to private equity investors,” he said.

HM Capital has shied away from the risk side of the business but it likes the wholesale brokerage business because in addition to tremendous growth, the market has good fundamentals. “Overall we’re very bullish about this industry because of the role that it fills. The expertise, placing risks that are generally not suitable for the standard markets … long term growth in this business is positive. And we like the fact that it is not as cyclical. We all recognize that this is a cyclical business, the private equity business is a cyclical business, but we like the fact that it’s not as cyclical [as] the risk bearing businesses.”

Wholesale brokers, he said, have the expertise and access to markets that their retail clients need, therefore they have business value. “This is not a capital intensive business,” Rosen said. “So when you think about private equity and the fact that we do use leverage, high cash flow is important to us … high cash flow, low capital requiring businesses is a huge positive.”

With increased specialization in insurance, the knowledge and relationships wholesalers have is “of tremendous value to retailers. … We’re seeing more and more specialization by carriers and it makes it even more and more difficult for retailers to figure out how to place business. It makes the role of the wholesale broker extremely important.”

Private equity can play the role of consolidator. “This industry is still relatively fragmented — the top 10 wholesale brokers still represent only about one-third of the premiums … there are just a lot of firms out in this marketplace. We do think there will be increasing consolidation of this business over time. On the retail front it will continue, on the wholesale front it will continue.”

Rosen said HM Capital spent several years investigating the E&S sector before it acquired Swett and Crawford from Aon. “We didn’t originally think there was anything for us in the wholesale sector. We didn’t see anything of that size, of that scale. … All of that changed because of Mr. Spitzer.” Spitzer’s investigations led big brokers, including Aon, to divest their wholesale operations.

He said HM Capital views its relationship with Swett as a partnership, rather than “just us acquiring a company.” More than 20 percent of the company is owned by employees; there are more than 160 employee shareholders.

Swett has reorganized its management structure to focus on how the company interacts with its retail partners and its carriers. “We created practice groups and practice group leaders,” Rosen said, “so that when we actually go and address the market, or the markets need to find a way to address us, it’s very easy. … We don’t want to bring the resources of an office to solve a client’s problem. We want to bring the entire resources of Swett, to have all of our offices interact together through these practice group leaders.”

Topics Trends Agencies Excess Surplus