PE’s scepticism about the duration of the market opportunity has lengthened the odds on greenfield start-ups

In late spring a pervasive sense of the crisis gripped the sector with stock markets down 30%-35% at their nadir, investments crashing to unprecedented levels and fears that a wave of property BI losses could turn a multi-class earnings hit to the largest insured loss in history.   

Coming on top of a set of pre-existing dynamics that were already driving a P&C market turn, including years of soft pricing, mounting loss cost inflation in long-tail lines and major remediation drives (e.g. AIG, Lloyd’s), the crisis looked set to create real dislocation – and, with it, opportunity.

Private equity houses started an intense round of discussions with senior sector figures, looking to gauge the likely magnitude and duration of the firming pricing. Available leadership talent also set about the same task, and began work on scoping out the Class of 2020 and pitching their projects to capital.  

The challenges faced by the Class of 2005 – the last round of event-driven dislocation – meant that there was always a bias against a whole swathe of de novo start-ups.   

Market expectations instead pointed towards an expectation that the rough $5bn-$10bn range of PE money in play would flow to a mix of a) scale-ups of quality existing franchises; b) buy-ins to inexpensive platforms; and c) de novo launches.

As set out previously, there is a complex set of trade-offs that has faced capital/management teams looking at the market.

Injecting capital into an existing business brings with it exposure to years of under-priced underwriting, as well as uncertainty around the ultimate quantum of losses relating to Covid-19.

De novo start-ups neutralise this issue, but suffer from a speed-to-market problem, which handicaps a business looking to capitalise on rate hardening that is of uncertain duration.

Meanwhile, management buy-ins largely address the speed-to-market problem, but resurrect the exposure to prior years and the in-force book, as well as adding the need to fix a typically broken legacy platform.

In the spring and early summer, it looked like all these different permutations would be used by different capital providers.

Increasingly that now looks unlikely, with chances receding that we will see a true de novo start-up. 

With the absence of Mitch Blaser’s Lloyd’s start-up – which is more of a niche specialty casualty insurance play – all the major start-up teams that we have written about now seem intent on seeking a starter acquisition.

This extends to management teams that earlier in the crisis were attracted to the idea of starting with tabula rasa given the additional control this offered and the chance to build things differently.

While the biggest share of the private equity money could now come in via scale-ups (Convex, Fidelis, Ark).

The change seems to reflect the crystallising PE view of the balance sheet play in insurance, which emphasises diminished claims expectations from Covid-19 and the impact of the remarkable recovery of financial markets.

The upshot of this view is that the degree of available market capital and the expectation of normalisation in terms of risk appetite as we transition to a post-vaccine period will cut short the hardening cycle. The perspective has also made fundraising more challenging generally.

Against this backdrop, speed-to-market becomes the pre-eminent concern. Legacy liabilities relating to Covid-19 and the long soft market are seen as relatively manageable, particularly with a hungry market of legacy acquirers, while operational or cultural legacy issues can either be fixed or lived with.  

Seen through this lens, a scale-up and a management buy-in have the same quality of offering access to an existing portfolio and a quick start. One just offers an incumbent management team and a quality business, while the other provides new leadership and a business that needs work. 

But this is, of course, reflected in the prices of these different courses – with PE able to buy into acquisition vehicles at book value and having to enter scale-ups at meaningful premiums.

Whichever way the PE money opts to go between scale-ups and buy-ins, as the clock runs short on start-up efforts, it seems increasingly likely that in this hardening cycle, there we will be no de novo 2020 start-ups.

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