Insurance hasn’t always been the most attractive option for wealthy individuals keen to splash their cash. But in this tough market, more and more real 'dragons' are expressing an interest. Michael Faulkner investigates. Illustration by Jonathan Edwards
Private investors had plenty of ways to spend their money while the markets were booming. But in our gloomy new economy, rich individuals – not to mention trade buyers, private equity and others – are eyeing up insurance, attracted by the potential for high returns and the lack of toxic debts (see box below).
“High net worth individuals are coming in for medium-scale deals – something that I can’t remember happening before,” says Tony Hulse, head of UK general insurance at KPMG.
“They take risks and they do deals that may not be attractive by traditional benchmarks.”
These risk-takers – dragons, if you will – include Towergate boss Peter Cullum and A-Plan founder Tom Duggan, the two private investors who backed last month’s £23m management buy-out of Hastings and Advantage.
The Lloyd’s market is also experiencing a surge in investment from individuals. Amlin recently raised £50m from private investors for a new syndicate and members’ agents are predicting that more money will pour in. Hampden, the largest member’s agency at Lloyd’s, is on the verge of securing private investment to help insurers struggling with the effects of the weakening pound (see page 13).
So what has made insurance more attractive?
Analysts point to the volatility of the wider market, where asset values and trade volumes have fallen. As insurance is a non-discretionary spend, it is better protected than other sectors.
Premium rates are also starting to rise in some lines of business. “Reinsurance rates have gone up, but how quickly this will follow to the retail market is difficult to predict,” says Hulse.
A recent survey of the financial services
sector by the CBI and PricewaterhouseCoopers reported that insurers were enjoying a rebound in confidence in anticipation of harder rates this year. The study also found insurers thought they were holding up relatively well against the present economic challenges.
For insurance companies, wealthy investors can make attractive suitors. They are likely to have a good understanding of the market and can take risks that other investors may not find tempting. The transactions can also be completed quickly.
On the downside, it may be difficult to find a suitable investor, the amount they invest is likely to be relatively small – and there may be concerns about links to criminal activity if the funds come from an overseas investor.
Edward Fitzmaurice, chief executive of Hastings Direct, looked at a range of options to raise the finance for the recent management buy-out, including banks, mezzanine finance (a form of debt and equity) and private equity.
“Private investors were easier. They understood the market and our recovery plan for the business,” he says. “Mezzanine finance or bank debt would have been more expensive, and the due diligence process would have been tougher with the banks or private equity backing. We also have more share of the upside with private investors.”
Private equity didn’t do the deal this time, but equity houses are still interested in the insurance sector – and they do have money to spend. Gresham, which owned 41% of Giles Insurance Brokers until it sold the stake to its rival Charterhouse last year, wants to invest again in the general insurance industry. 3i, meanwhile, retains a hefty stake in Jelf and in Hyperion Group. And the equity houses Charterhouse, Permira and CVC worked together to bring about the marriage of Saga and the AA at the end of 2007.
Simon Hemley, a partner at Gresham, says the firm is looking at investment opportunities within commercial broking and among outsourcing providers.
“We had success in the Giles transaction and we still think the broker space is ripe for consolidating,” he says.
Gresham is looking for a broker that could become a consolidator, or a regional broker that could expand into a national broker. A niche broker could also be attractive.
The economic downturn provides some benefits for Gresham, he adds. “The restriction in the debt market is an opportunity for us, as we have money in place.
“If we can find the right platform then a ‘buy and build’ strategy may be easier. It is not just about acquisition prices [which have fallen]; there may be more people willing to sell.”
Private equity houses are being more cautious about how they spend their money, however, and they have a reputation for being ruthless. “They have a large pool of capital for investment but are being very selective,” says KPMG’s Hulse.
“They are having difficulty achieving the gearing [debt funding], which made it cheaper [to do deals].” One example of this is BC Partners and Apollo Management’s bid for Royal Bank of Scotland Insurance, which is currently looking for funding.
Hulse says investors are changing their focus in response to the credit crunch. “Responsible investors are looking at just getting through the downturn. Before the focus was on growth, profit and cash flow, in that order. Now it has been reversed.
“It is about resilience. Investors are keen to ensure that balance sheets aren’t overstretched.”
One broker who sold a controlling stake of his business to a private equity house paints a compelling picture of the way these investors approach the market: “These guys are totally ruthless. There is little sentiment in the way they do business, they can see the market downturn but still want their return.”
The investment can be a double-edged sword, the broker adds. “On the one hand it’s amazing to get a massive investment, but now the economy is contracting there is a huge and constant scrutiny on the way the business is managed and a constant threat that the investment may be pulled and new or additional management expertise brought in.”
The banks are still lending money to the insurance industry, although the costs have increased and they have scaled back the sums available. Towergate, for one, was subjected to intense speculation about the way it was managing its debt financing last year, forcing Andy Homer, the consolidator’s chief executive, to issue a statement saying the group had not breached its banking covenants.
There has been scope for significant re-financing, however, despite the economic gloom. Swinton, the high-street broking giant, recently secured a £175m line of credit with Lloyds TSB. Last year Oval negotiated a £115m debt facility with a club of banks led by Barclays and Lloyds TSB.
“Borrowers need to show that the acquisition stacks up,” says Sebastian Kafetz, relationship manager at Lloyds TSB Corporate Markets.
The stock market is not an attractive option for raising capital at present, given the extent to which equities have plunged in the past 12 months. The FTSE 100 fell by more than 2,000 points during 2008, losing more than £480bn in value.
“It’s hazardous due to the volatility and it is expensive,” says Hulse. Yet there is some expectation of rights issues to raise capital, he adds.
Bermuda-based Omega Insurance, which owns a Lloyd’s syndicate, said in December that it was planning to raise £130m through the issue of new shares on the alternative investment market (AIM).
Fresh capital raising, via an initial public offering, is unlikely. “A broker has no chance of listing on the stock market at the moment,” says Alex Alway, chief executive of Jelf Group, which listed on the AIM in 2004. “We were fortunate to get on to the market then.”
Who’s investing in insurance?
- Lending is currently limited and costly
- A sound business case is needed
- But brokers have secured major funding in recent months
- Still interested in insurance
- More selective in picking deals
- May try to take control of the insurance business
- Coming into the market for medium-scale deals
- Can complete deals quickly and willing to take risks
- Investment can be difficult to manage and it can be hard to find the right investor
- Investment is generally smaller
- Market volatility makes this a hazardous option
- Rights issues could raise some capital
- Could undertake some major deals
- A number of insurers are still interested in buying stakes in brokers.