Who will be the winners and losers?

As the COVID-19 pandemic stress test continues, re/insurers are preparing for what comes next, including expectations of a hardening market. This is driving a growing trend for equity raises. Intelligent Insurer reports.

The number of equity raises is increasing. Analysts at Peel Hunt report that there have been 67 COVID-19-related equity raises of at least £5 million in the UK since mid-March. This activity has raised £9.6 billion. In the last week of May and the first week of June alone, 12 UK companies raised £1.9 billion “for COVID-19 reasons”, according to the firm.

The specific reasons behind this trend are many with a broad range of implications for market players and their credit ratings down the line.

Non-COVID-19 raises and block trades have also increased, reaching £1.5 billion in the UK since mid-March, with around £0.45 billion raised/block traded in the two weeks before June 8, 2020.

Major insurance industry firms are in the thick of this overall trend.

Hiscox began its £375 million raise in early May, Beazley’s £247 million raise was announced in mid-May and insurtech Blue Prism started its raise of £100 million in mid-April.

Continental equity raises and block trades have also “jumped sharply”, with a further £4.4 billion raised and traded in the two weeks prior to June 8, 2020, reaching a total of about £12.6 billion since mid-March.

“A lot of these equity raises are going to be liquidity-related,” says Clyde Lewis, deputy head of research at Peel Hunt.

“Where businesses are going to be breaking covenants if their income streams are frozen, then clearly there are going to be pressures on it.”

Stuart Shipperlee, managing director at Litmus Analysis, tells Intelligent Insurer that for some firms the equity raises will be about building up a “war chest” for what lies ahead.

“You’ll want to have cash, coming out of this pandemic—not just enough to survive but enough to invest.”
Clyde Lewis, Peel Hunt

“With reinsurance and specialty there is a strong expectation of significant price-hardening,” Shipperlee says.

“Whether that will fully play out as people hope and expect over the cycle of the renewal seasons all the way through to January 1, 2021, I don’t know. But there’s certainly a strong expectation that this price-firming will persist.

“Any organisation that plays in those markets will be looking to add to its war chest with equity as those well-priced opportunities come along. If they can then it’s sensible to do so.

“The increase in activity may be driven by organisations who feel they have shareholder support now, so they want to get in quickly, in case the investment community appetite diminishes,” he adds.

COVID-19 triggers

The pricing environment has been, in part, triggered by COVID-19, says Shipperlee, commenting that pricing has been inadequate for reinsurance for a long time as there has been too much capital available.

“On both the asset and liability sides of the balance sheet, COVID-19 reduces the capital available, increasing the price,” he says.

“The reinsurance industry has needed a very severe reason collectively to force through price increases. There’s an emotional as well as a financial component, and an ‘if not this then what?’ element to the extent that equity raising is reacting to current or expected pricing increases that is partly a COVID-19-related event.”

“As is often the case under a severe stress scenario, the strong appear to get stronger and the weak appear to get weaker.”
Stuart Shipperlee, Litmus Analysis

Looking at COVID-19 itself, there are all sorts of forecasts about what the re/insured loss might be and they are usually extremely big numbers. The current balance sheets have to absorb that loss, so some of the equity raising might be earmarked for that, says Shipperlee.

Ratings impact

Moves to raise equity have implications for credit ratings. Peel Hunt’s Lewis says that what is changing is that these businesses are raising fresh equity which gives them a stronger balance sheet.

“In theory all these moves should be positive for any debt-based ratings and financial health tests.

“The market was worried about businesses that were undercapitalised, now they should be better capitalised and in healthier shape. There’s a shift from a debt to an equity-based finance structure and that is pretty helpful.”

However, Shipperlee adds, the environment has become more challenging from a credit rating point of view if you focus on reinsurance and specialty.

S&P’s global reinsurance sector outlook moved to negative from stable in May.

Shipperlee says this is because while pricing was unattractive in reinsurance for some time, S&P considered that the very high degree of capital adequacy in the reinsurance industry meant that the credit rating environment was stable.

“In theory all these moves should be positive for any debt-based ratings and financial health tests.”

"Now the agency has moved to negative; it is expecting negative ratings actions in the reinsurance sector over the 12-month period.”

Reinforcing the capital position is inevitably a positive with the rating agencies. However, he adds, it’s not clear that the rating agencies have seen reinsurance sector capital put under pressure yet. “But it is also true that they, along with everybody else, don’t really have a firm handle on that yet. Time will tell,” he says.

Two other key questions around COVID-19 and credit rating impacts focus on re/insurers’ enterprise risk management (ERM) systems and risk appetite.

“To what extent does this scenario highlight strengths and weaknesses in rated re/insurers ERM systems?” asks Shipperlee.

In recent years, S&P and AM Best have both been very positive about ERM in reinsurance, he says, indicating that the systems, measures and reporting processes around ERM are well defined and managed.

“If we come through the COVID-19 scenario with that having been proved to be true, and the systems around expecting, managing and measuring loss are robust, it will reinforce the strength of the ERM in the eyes of the agencies.”

Risk appetite is another element to consider as reinsurers raise equity in a hardening market. Shipperlee says individual rated insurers will need to explain whether they are “changing” and in doing so whether they are increasing their risk appetite.

“Risk appetite is another element to consider as reinsurers raise equity in a hardening market.”

“Most reinsurers have a defined range of risk appetite for higher risk areas of business and many of them will not have been using that fully because prices have been unattractive,” he says.

“Just because people might become more active in riskier areas of reinsurance doesn’t mean their risk appetite has changed, it just means they are moving within their risk appetite.”

But if they are materially increasing their risk appetite in response to an attractive pricing environment, then that would be a factor to be considered in their credit rating.

“Well-priced risk is a sensible thing to write if you have that appetite but increasing your risk appetite per se is part of your credit rating profile. The credit rating agencies will be very interested in what you are going to do with this money.”

Reserve gap

Another issue could still hamper efforts to mitigate the COVID-19 fallout: adverse reserve development. The pre-COVID-19 period was characterised by quite a lot of concern about adverse reserve development, particularly in the US.

“Stephen Catlin, chairman and CEO of Convex, was on record talking about a vast potential hole in reserving in February. There were some straws in the wind around that issue, a notable part of that due to social inflation. That obviously hasn’t gone away,” says Shipperlee.

In this kind of bullish business environment of rate-hardening, he says, from a credit rating point of view, people should remember “there may yet be some pretty unpleasant surprises” coming through for some companies around the reserve position on a long tail business.

“There may yet be some pretty unpleasant surprises coming through for some companies.”

A continuing trend?

The trend for raising equity is clearly a response to the pandemic, but as lockdowns worldwide begin to ease, will this financial activity continue?

That will depend on the businesses and industries, says Peel Hunt’s Lewis.

“A lot of companies have gone early. The bigger more complicated equity raises obviously take longer to organise and put together, and there will be a lot of pre-marketing.

“It’s a lot harder to raise a billion than it is to raise 10 million—there are a lot more investors and institutions you have to line up.”

Lewis says that there’s still a lot of uncertainty around how quickly cash and profits will come back into businesses, depending on your business model, and ultimately what government policies will do.

For example, in the UK there is still a question mark over whether the UK’s furlough scheme will be extended beyond October and what other possible tax cuts or incentives the UK government might provide.

Shipperlee expects to see more equity raising, although he says “it will come in different flavours”. Some of this activity will be from listed companies raising more, some will be new ventures. He adds that there has been a lot of talk about new Lloyd’s syndicates, or a larger Lloyd’s syndicate, which could present opportunities.

“There may be a degree of winners and losers coming out of this, whereby the companies with profiles and track records that are the strongest are able to do this more than some others.

“As was the case post-9/11, there’ll be new entrants to the market, looking to take advantage of pricing increases.”
Daniel Topping, BP Marsh

“As is often the case under a severe stress scenario, the strong appear to get stronger and the weak appear to get weaker, there may be an element of that: who can and can’t raise capital.”

Commenting on where people “will place their bets with this new money”, Shipperlee says “the thinking is probably in flux at the moment”. There is a general sense of pricing improving in a number of areas but it will take some time for a clearer pattern to emerge.

Daniel Topping, chief investment officer at BP Marsh, which published its annual results on June 9, says he expects to see more equity raising driven by the pandemic. He would separate it into two potentially distinct sections.

“Some raises will be done purely to stabilise and solidify balance sheets in anticipation of incoming claims, therefore ensuring that their capital base is sturdy enough to take that on. It’s more the pre-existing players in the market that are doing that sensibly, and partly to take advantage of an uptick in pricing.

“On the other hand, as was the case post-9/11, there’ll be new entrants to the market, looking to take advantage of pricing increases. I know that new entrants in the market such as Convex and Fidelis are very actively writing new business,” Topping explains.

As recently as June 10, Fidelis announced it had raised $800 million as it targets new lines and uplift from harder market rates. For some, the opportunities at hand are too good to miss.

“For certain businesses if revenue starts to grow you’re going to need capital to deliver that revenue growth.”

After COVID-19

With so much uncertainty it can be difficult to imagine what a post-COVID-19 world will look like. But preparations are already under way for a multitude of scenarios.

Lewis says: “For certain businesses if revenue starts to grow you’re going to need capital to deliver that revenue growth. You’ll have pressures on your working capital.

“You’ll want to have cash, coming out of this pandemic—not just enough to survive but enough to invest. And we’ve had a few raises that would sit in that box.”

There’s a big picture issue here as well, he says, focusing on return on bonds and fixed income versus equities.

“If you look back, debt was seen as being cheap—certainly compared to the cost of equity. When interest rates are so low you’d think ‘why would you ever bother with equity?’.

“You bother with equity because there’s a big hidden cost that sometimes comes along, like COVID-19, which bites you pretty hard.”

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