Dearth of reinsurance startups to persist, its different this time: Shea, Gallagher Re

The hard market in reinsurance is different this time around, with no evident lack of capital or capacity and this is just one factor that has meant we aren’t seeing a wave of new reinsurance startups, something broker Gallagher Re’s Brian Shea says is likely to persist, except perhaps in the casualty space.

Gallagher Re’s Shea gives four reasons for why the hard reinsurance market has not stimulated a wave of interest from investors in backing new equity balance-sheet reinsurance startups.

First and most obvious is the fact the reinsurance industry is not lacking supply of capacity. While demand has been rising, it is not significantly outpacing the industry’s ability to satisfy that demand.

“The bottom line is that the reinsurance market has ample and well-diversified supply, and reinsurance buyers have the ability to flex nimbly across different sources of capital,” Gallagher Re’s Brian Shea, Chairman of Global Strategic Advisory explained.

At the same time, the surge in catastrophe bond market activity in 2023 and 2024 has helped to augment the reinsurance industry’s capital base, while there is growing interest in collateralized reinsurance structures such as sidecars from certain investor-types as well.

Investor sentiment has remained positive on incumbent reinsurers, with capital raises successfully seen and strong growth achieved by leading industry companies.

But most incumbents have not even needed to raise capital, given the demand side has not risen sufficiently to warrant that and there has not been a capacity gap for startups to fill, Gallagher Re’s Shea said.

A second factor is investor skepticism on “structural profitability” of the reinsurance sector, Shea believes, which goes hand-in-hand in what could be the most significant issue for some investor types that have typically backed reinsurance startups in the past, concerns around the market duration.

We’ve reported numerous times that in our discussions with investors, the types that would typically back company startups in the reinsurance space, there is concern over profit, the lack of progress being made to increase profitability through market efficiency, but also this concern over how long a hard market opportunity may actually last.

In the past, new reinsurance startups have been treated to a number of years of harder rates, but that has shorted in the more recent startup waves and this time investors, such as private equity players, are skeptical whether the reinsurance sector can sustain pricing and remain disciplined.

The problem is that, while the industry itself tried to blame alternative capital for the softening of rates through the 2010’s, shrewd investors know that actually some of the largest reinsurance companies chased rates down and bent to the loosening of terms, which drove the very soft market we saw by 2016.

That has not been forgotten and shrewd investors are not listening when reinsurers try to blame the insurance-linked securities (ILS) market for that soft market period, especially for the significant term loosening that was seen.

You only have to look at statements from major reinsurers about their growing premiums in the US through the early 2010’s, and speak to industry participants, to know they were competing heavily and with far more firepower than the ILS market had, so were likely the leaders of that downward trend.

That period has resulted in concerns among investors that allocating to a balance-sheet startup reinsurer, with all the complexity that comes with that, may not be appropriate for a market in which the cycle can move so fast and so far, if discipline slips (or competitiveness rises).

In addition, Shea of Gallagher Re believes private equity investors are keeping their powder dry and this has been seen broadly across funding sectors in most markets, given the lack of IPO’s and other major transactions of late.

We’d add another factor that has deterred private equity investors, the fact that when a new reinsurance startup does emerge, they often tend to be the same faces (or cohort), with the same business models, with just a shiny new set of brand values sprinkled on top.

Investors are looking for something different this time as well, seeking more efficient business models and more aggressive industry transformation plans. That just isn’t being seen in most proposed startups today.

However, investors are finding ways to back reinsurance that avoid a lot of these hazards and concerns and enable investors to be tactical and strategic, when it comes to sourcing the returns from the currently still hard market.

Shea explains, “One way that investors can back the hard market cycle, without making such a commitment to duration, is to invest in insurance-linked securities (ILS) — rather than fund a start-up with permanent equity capital.”

The catastrophe bond market is a prime example, Shea notes, with forecasts suggesting another record year is ahead, something Artemis’ data supports.

“This growth in cat bonds resulted from mark-to-market gains, coupons comprised of risk premium and elevated collateral yields, lower loss activity, and net inflows largely but not exclusively from additional pension allocations to ILS managers,” Shea said.

Adding, “Beyond cat bonds, we have also seen hedge funds and private equity money returning to the sidecar market, and this might be soaking away some funds that in other years would have gone into start-ups.”

One factor that could change all of this and stimulate investors to want to back reinsurance startups in more traditional forms, is “if reserving issues in casualty lines become more widespread,” Shea points out.

“Arguably, investors would sense a longer-lasting opportunity, and one where it is less easy to participate in alternative forms, such as ILS (notwithstanding some progress on casualty ILS innovation in recent years),” he continued.

Adding, “Possibly also, the environment for PE to invest would be easier. If the focus is casualty, new entrants would also be able to play to investors the ‘clean balance sheet’ story versus incumbents. On the other hand, a new entrant would need to present strong security to the cedant, given the long-tail nature of casualty claim payments.”