RenRe + Validus Re: Marrying another version of yourself
Opposites attract; likes repel. This statement might make sense when reviewing Coulomb’s law of electric force or watching another generic comedy on Netflix. Insurance companies can be another example, where deals are often done to fill in the missing holes in a book of business - though this can often result in insurers stepping out of their comfort zones and finding uncovered reserving minefields.
However, we are seeing a “likes attract” phenomenon in the case of Renaissance Re’s acquisition of Validus Re, where, rather than stepping out of its lane, RenRe is buying a book that fits squarely into its own, allowing them to scale and take additional advantage of the hard market.
Following the recent news of the Everest Re capital raise, one of the questions on everyone’s mind had been if and how RenRe would respond. Would it follow suit, or miss out on this generational hard market?
In 2021, RenRe had tried to capture the post-Covid market opportunity and even raised capital. But that strategy did not pan out, as a gap emerged between expectation and reality in pricing. The result was that the company had to ramp up its buyback and get rid of some of that capital.
Fast forward to January 1 and April 1, 2023, and it did seem like the stars were aligning for one of the hardest reinsurance markets. However, with RenRe’s underwriting leverage (a measure of capital deployment, see appendix) nearly tripling to 1.3x in 2022 from 2017, it was logical to assume that the company might have to sit out of many of the current opportunities.
And then came Monday evening, with RenRe announcing its deal to acquire Validus Re from AIG for close to $3bn. (Adam McNestrie has analyzed the AIG side of this deal here)
If one were to step back, the obvious question would be: what took so long?! Although we will discuss the deal multiple later in this note, let’s call this deal what it is. It’s a quasi renewal rights deal for a book very similar to RenRe’s existing book, and it allows the company to capture the current market momentum.
Since the early 2010s, the reinsurance industry has witnessed a degree of upheaval, from competition from alternative capacity to an uptick in natural catastrophe losses coinciding with poor risk selection. This has resulted in many reinsurers being consolidated away (willing or forced).
The remaining class has attempted to pivot away and develop a hybrid model in an attempt to tamp down the volatility. “Jack of all trades, master of none” is a common refrain when evaluating the results of some of these carriers.
Amid these winds of change, RenRe has remained steadfast in its focus on reinsurance. Yes, it has also pivoted away from the property-cat-predominant strategy to casualty reinsurance, and has avoided transitioning to the hybrid model as other Bermudians have done.
This strategy has presented near-term challenges, and RenRe’s value creation has slowed down as it awaited better market conditions. It has, however, chosen periodic acquisitions which have helped it along the value creation path.
The chart shown below compares total value creation for various carriers in this space with different paths chosen over time leading to different outcomes, with the global rate-on-line growth for context. There is a clear stratification, with little movement outside of each trajectory.
RenRe’s deal with Validus essentially allows it to significantly gain scale, increasing its benefit from the market conditions. This puts it in an excellent position to execute on its playbook while also continuing to leverage its third-party capital providers.
This leads us to three takeaways:
Firstly, on a proforma basis, RenRe’s approximate top-line goes up from $9bn to $12bn and moves it to the fifth largest spot among global reinsurers. On a standalone basis, in its Q1 2023 results RenRe had to pull back from other segments while growing close to 40% in property-catastrophe. But with this deal, it won’t have to contend with capital gymnastics among various subsegments in order to grow.
Secondly, on a financial basis, the deal translates into 18% accretion to earnings on a proforma basis, as well as book value accretion. Keep in mind that RenRe raising capital at 1.75x times its own tangible book value but paying 1.4x to AIG is a positive financial arbitrage.
Thirdly, is industry consolidation back on the table? Insurance stocks have been resilient, and (re)insurance market conditions have been stellar with respect to pricing over the past 12-18 months. If we do have a quieter hurricane season, we could see additional consolidation discussions due to a better capital position. We also expect additional consolidation in the specialty space, as part of the continued pivot to a hybrid model for reinsurers.
We discuss these points in more detail below.
Firstly, for RenRe this deal is marrying another version of itself
The chart below shows the proforma business mix for RenRe + Validus, which looks much like putting the same pies on top of one another.
In our prior industry discussions, we have tended to maintain a cautious tone on acquisitions, due to the challenge of asymmetric information. However, Validus is quite similar to RenRe in its underwriting style and risk selection capabilities.
This essentially enables RenRe to flip the switch once the acquisition is completed and move it seamlessly onto its own platform.
On the topic of top line, another consideration to keep in mind is the shift in RenRe’s leverage, which is a measure of business written over its capital base. Over time, RenRe’s leverage has nearly tripled (see appendix), presenting a challenge to its growth aspirations.
Instead, it had to pick and choose, and move capital around, a topic which came up on its Q1 earnings conference call. We can see this in the net premiums number where property catastrophe grew by 36% but other property fell by 29%.
Taking a step-back, this acquisition allows it to stick to its knitting and focus on what it does best.
Secondly, financially this deal is accretive on an earnings basis by 18%, with ROE at 24%
In terms of deal metrics, RenRe is paying close to $3bn for a $2.1bn equity base at Validus and approximately $2.7bn top-line going forward.
The deal is being funded through a mix of cash on balance sheet, the already concluded share-offering of 6.3 million shares, and debt. The table below shows our estimate of the capital structure to fund this deal.
We have also broken down Validus’s book into casualty/specialty, property XOL, and QS, and applied our estimate of underwriting profitability. Our estimates for investment income, fee income, integration costs, and synergies are shown below. Putting this all together our analysis shows 2023 EPS accretion to be close to 18% with the combined entity generating a 24% return on equity. Note that these numbers are preliminary and could change materially over time, including changes due to interest rates.
Too often, companies overpay for franchises, face meaningful dilution upfront, and are under immense pressure to make the numbers work. In several cases, when making “change the narrative” acquisitions, buyers find new problems which negate the original premise for doing the deal.
But here, the earnings accretion with no book value dilution shows the favorable financial aspects of this deal.
Thirdly, consolidation discussions are back on the table for this industry
In our aptly titled note from 2021, “Where have all the reinsurers gone?” we looked at how much the industry landscape had changed. Over the past 11 years or so, and prior to the Validus announcement, 17 reinsurers have been consolidated away. Many of them were forced to the deal table, while others realized that being a non-specialized, mono-line entity trying to diversify away was not going to cut it.
Over the past year or so, insurance stocks have been resilient, and market conditions in insurance and now reinsurance have been stellar at least on the pricing discussion front. If we do have a quieter hurricane season, we could see additional consolidation discussions, particularly in the specialty space. Excess capital, slowing pricing, reversal in mark to market losses and fewer opportunities in E&S could all contribute to this shift.
The table below shows the level of consolidation that has occurred in this industry in the past few years. We would not be surprised to see specialty and hybrid franchises continuing to contemplate various pairings once the peak of the hurricane season has passed.
In summary, RenRe’ s acquisition of Validus Re is essentially buying another version of itself and is accretive with no book value dilution. A win-win strategy for AIG and RenRe will also entail both of them continuing to focus on their core classes of business. Further, the current hard market and related opportunities could even translate into a reacceleration of value creation, allowing RenRe to leapfrog its peer group.