As new entity forms emerge and the lines between policyholders, agencies, and carriers blur, stakeholders will benefit more. This will need for a broader range of expertise from advisors.
The insurance sector has accepted structural change.
As businesses specialise more, the insurance value chain continues to change. From MGAs to fronting operations to reciprocal exchanges in the US, new types of businesses and new structures are thriving.
The change in the connection between risk and capital, which is being pushed by a shifting risk environment and altered expectations from ultimate investors, includes all of these entities and institutions, even if they all assume different shapes and have different functions. We feel that the business operations and capital structure of our sector are just getting started on a path that will result in considerable reorganisation.
A valuation arbitrage between insurance services and insurance risk-bearing vehicles underpins these developments. The arbitrage is evident in the valuations of both publicly traded companies and private M&A deals, where companies that provide insurance services trade at long-term premiums while balance sheet companies trade close to cycle averages.
Because balance sheet risk, which is subject to underwriting volatility, is less desirable than steady fee-based, low-volatility earnings, there is a significant opportunity for further dividing the roles of managing and absorbing risk.
Growing use of the reciprocal exchange paradigm
One of these novel structures is the reciprocal trade model, which is gaining popularity in the US. Two entities make up the reciprocal model. Let's start with the reciprocal exchange, a risk-bearing balance sheet company that is owned by its policyholders.
In addition to premium payments, members also make surplus contributions, which are advantageous from a tax perspective. Since policyholders are searching for adequate insurance coverage rather than comparable capital returns as normal shareholders, the cost of capital is significantly lower than in the conventional model.
"The insurance industry is experiencing considerable innovation in capital structures at this time."
The attorney-in-fact is the second entity. This is the management role and the fee-earning enterprise, which is separate from the trade of goods and services and is often a highly valued enterprise. In more modern formations, it may be owned by distinct third-party investors or by the reciprocal exchange in earlier vintage versions.
We at TigerRisk Capital Markets & Advisory (TCMA) have contributed greatly to the development of reciprocals. Currently, there are about 70 similar buildings in the US. In the last five years, eight of them have been founded, and TigerRisk has been a prominent player in structure, consulting, capital raising, and reinsurance brokerage for seven of those formations.
The reciprocal model is based on US legal standards, but we think the ideas apply to other regions as well. The TCMA has discussed the possibility of creating a similar model in those markets with insurance players in London and Europe.
A full skill set is necessary for innovation.
While reciprocals are one of the newest structures with the quickest growth, many other models and transactions are emerging in response to the changing market.
For instance, the US presently has about 15 specialised fronting firms that offer licences and balance sheet capital but transfer the fundamental capital risk to other reinsurers and capital market investors.
Utilizing affiliate-owned balance sheets, Lloyd's capital providers, and other third-party financial vehicles were used in other recent transactions.
The optimum structure, in our opinion, incorporates a number of different capital sources and balance sheet solutions, such as reciprocals, fronting carriers, Lloyd's vehicles, additional primary and reinsurance capacity providers, and more.
But it's important to remember that structuring by itself won't result in lucrative underwriting, and that any of these structures must have a successful underwriting model in order to work.
Dynamic interaction between balance sheet and fee-based organisations,
There are many variations in this dynamic interaction between balance sheet and fee-based organisations, and additional variations will undoubtedly emerge as market leaders keep innovating.
As the market changes, those of us shaping these strategies require a set of talents to match, and as the top strategic advisor on risk to capital, TigerRisk has incorporated these competencies from the beginning.
The skill set includes expertise in creating new companies, providing strategic and M&A advice, raising money, working with rating agencies, and providing reinsurance and capacity solutions.
The insurance industry is currently going through a significant period of innovation with regard to capital structures. To keep up and seize the chances, consulting services will need to be creative.
