The Sirius board managed to secure a sale and cash exit at a premium for some of its investors, while under pretty urgent threat of being downgraded into run-off by the ratings agencies and despite having to deal with a challenging and unpredictable Chinese owner. In doing so it has ensured that a decades-old underwriting franchise did not collapse ignominiously, and as we said Friday, it deserves credit for saving Sirius even as it sold the business.
Meanwhile Third Point Re managed to find a transaction that accelerates its pivot into a specialty (re)insurer despite limited available cash and its 0.7x price to book multiple, along with its own status as a reinsurer with an A-/negative rating and a track record of underperformance.
The complex formula which included the use of contingent value components, warrants, preference shares and upside share instruments is also a testament to investment banking tradecraft being put to hard work – although it makes examining the valuation highly challenging. (A back of the envelope analysis suggests a ~0.7x multiple for a pure cash deal but up to ~0.8x valuation for the second option including contingent value rights, applying a 10% cost of capital to present value the contingent payments.)
Although, sister title Insurance Insider had revealed that the two sides were in exclusive sales talks in early June, the above challenges marked out the path to a deal as something of a tightrope walk – an exercise which was then made more complicated still by a simultaneous CEO change at the acquirer.
Stepping back from the mechanics of the deal-making, the combination itself goes some way towards solving crucial and near-term business problems, but does not in itself point a sure path to a successful future for SiriusPoint, with execution challenges ahead, and questions still to answer around its investment strategy.
Sirius' pressing problem was around ownership, with CMIG – a distressed Chinese investment group that has defaulted multiple times – an unsuitable owner of a global reinsurance business.
Its parent's financial status has proven a challenge for Sirius for some time, but the situation became acute in March when the company revealed CMIG had blocked an attempted rights issue designed to dilute its stake – immediately prompting an AM Best downgrade to A- and a negative watch.
Third Point Re's business model has come under pressure following a change of stance from AM Best last spring on the total return reinsurers. This followed sustained underperformance on underwriting from the cohort of reinsurers, as well as highly volatile investment performance that also fell short of expectations in terms of total returns.
With the status quo not an option, Third Point Re has looked to transition towards a more traditional model, scaling back its exposure to Dan Loeb's hedge fund and seeking to reconstruct its underwriting portfolio which had initially focused on areas like non-standard auto, structured deals and retroactive reinsurance that were designed to generate float at modestly negative margins with relatively little volatility.
The business has been adding new underwriting staff and has entered cat reinsurance and specialty lines reinsurance, but faces adverse selection as a small Bermudian reinsurer with A-/negative that writes only $600mn of business and still comes with the total return reinsurer label even though it has disavowed it.
By increasing its premium base by 4x and adding almost 200 underwriters (it has just 10 now), as well as a series of new underwriting platforms, Third Point Re in one move becomes a "near-normal" reinsurer from an underwriting perspective - and has scope to scale back its legacy reinsurance book still further post-deal.
The business will be on the radar of the major reinsurance brokers and cedants. It can now lay claim to decades of claims-paying heritage. There is no longer any chance that it could fall foul of any plausible version of the PFIC rules.
But although it does address these fundamental business challenges, the creation of SiriusPoint is not a silver bullet for the problems of the predecessor entities.
And for the new company to be a success, the new management teams need a series of conditions to be satisfied – most of them dependent upon execution.
First, Sirius must turn out to be a sound underwriting business that has “lost its way a little bit” (Sid Sankaran) rather than a reinsurer that has gone into long-term decline.
Sirius has a long track record of successful underwriting, including generating at least 10 points of underwriting margin in each year from 2012-15, as well as a break-even underwriting result in the 2011 “Year of Cats”.
The business, founded in Sweden, has a history that tracks back to 1945, making it one of the oldest reinsurers in the world, and market veterans talk about it as a business that has historically been seen as a credible leader in the international markets, particularly in continental Europe.
However, the reinsurer’s underwriting performance has markedly deteriorated under the ownership of CMIG, which acquired it from White Mountains in 2015, with the reinsurer underperforming Aon’s reinsurance aggregate’s combined ratio narrowly in 2017 and by 4 percentage points in 2018 and 10 points in 2019.
It is difficult to diagnose the causes of the worsening results, but it is hard to believe given the course things have taken that CMIG was a thoughtful and savvy owner of the enterprise - something which is crucial in reinsurance where cycle management is key.
Management incentives were set up to encourage growth in assets and in the perennially underperforming Asian markets, and ill-timed growth (13% in 2017; 27% in 2018) must have played a part in hurting results.
Management distraction may also have been an issue for the reinsurer, with a series of M&A moves undertaken including the 2017 acquisitions of MGUs Armada Global and International Medical Group at high prices ($600mn of goodwill combined), and an abortive effort the next year to buy Israeli insurer Phoenix.
Following a management transition on the retirement of Allan Waters to Kip Oberting, the leadership team has had the additional of distraction of seeking a resolution to its shareholder challenge. This has necessitated multiple attempted M&A deals, a SPAC IPO, a pulled rights issue and finally a full sale process.
How much long-term damage this has done to Sirius’ portfolio and underwriting capabilities is difficult to tell from the outside and will be a critical determinant of the new reinsurer’s prospects.
Sirius Group underwriting margin (%)
Source: Company reports, Inside P&C
Second, a newly appointed first-time CEO needs to successfully execute a reverse merger of a far larger and more complex organization.
Third Point Re non-executive director Sid Sankaran has taken over from Dan Malloy as CEO of the reinsurer, and will become chairman and CEO of SiriusPoint on closing.
Sankaran, who has been CFO of health insurer Oscar since March last year, becomes a CEO for the first time in his career while still in his early 40s. He is better known in the P&C sector as a former CFO of AIG, who was appointed to the role by Peter Hancock in 2016 and held the position during the fight with activist Carl Icahn around the potential breakup of the firm.
He left AIG at the end of December 2018 as part of the almost complete turnover of senior management at the global insurer following Brian Duperreault’s succession to the CEO role in 2017.
Sankaran may be familiar with complexity from his time at AIG, but he will be faced with a major operational challenge in successfully integrating the two entities.
Third Point Re is a tiny organisation with only 36 staff, including only 10 underwriters, with just three offices - one of them a marketing outpost.
Sirius, by contrast, has 1100 staff including almost 200 underwriters, spread across almost 20 offices, including footprint in Europe, Asia and Australia.
It is a substantially more complex company that includes not just a Bermuda reinsurance company, but a European reinsurance company, a Lloyd’s managing agency/syndicate, a US insurance company, a run-off acquirer, a major medical/travel MGA and a sizeable healthcare MGA.
Bringing the two entities together will be complex, and an early task is likely to be a clear-headed assessment of whether it makes sense to streamline the group through closures (eg Lloyd’s) and divestitures (the MGAs).
Sankaran has also identified the need to take expense out of the combined business by modernising the infrastructure and IT of the organisation. “Technology is a passion of mine,” he told investors.
Headcount: Third Point Re vs Sirius
Source: Company reports, Inside P&C
Third, SiriusPoint management will have to find a way to create a culture that is conducive to the retention of the senior underwriting staff at Sirius.
Talk about complementary cultures on the conclusion of a deal has become de rigueur, and both outgoing Third Point Re chairman Josh Targoff and Dan Malloy, who is moving back to a role as underwriting executive, talked about what they saw as shared values.
Nevertheless, it seems likely that there is a significant cultural gap to bridge given the different scale and history of the companies, as well as Third Point Re’s history as a float generating rather than a true underwriting business.
Sankaran will need to work hard to win the hearts and minds of an incredibly long-serving Sirius management team, which is already likely to be highly bruised by the soap opera of the last 12-18 months.
Critical members of the team include Monica Cramer Manhem, president of global reinsurance, and Warren Trace who leads Sirius Bermuda and heads up North American reinsurance.
Crucial in this respect is likely to be a little noticed appointment flagged with the deal announcement.
Steve Fass has been named vice chairman of SiriusPoint. Fass is a former non-exec on the Third Point Re board, but also led the acquisition of Sirius while at White Mountains and has long-standing relationships with the target’s key executives.
He has been named vice chairman rather than a non-executive director to create greater scope for involvement in the firm.
Fourth, the company needs to successfully tell a story about its investment strategy to investors and ratings agencies, as well as to deliver a period of sustained returns from the asset side of the balance sheet.
Outgoing CEO Malloy has been stressing for months that Third Point Re is evolving from its roots as a total return reinsurer, and on the investor call chairman Targoff said that “this transaction will allow us to completely turn the page from the hedge fund re moniker”.
Third Point Re has scaled back its asset allocation to the Third Point LLC funds from 70% in Q1 2019 to 30% at the end of Q2 2020 (albeit with the investments levered around 1.4:1). Based on its presentation, this equates to ~$750mn of assets.
SiriusPoint has said its asset allocation to Third Point LLC “and alternatives” will be 26% of $6.1bn of pro forma assets, equivalent to ~$1.6bn. It is not clear what proportion of this will be directly managed by Third Point LLC.
Despite the almost flat allocation (30% vs 26%) to alternatives, Third Point Re said that it expected the new investment arrangements – which will include the use of third-party managers for the 74% “traditional investments” - to result in a reduction in volatility. It said that this would give it “a portfolio mix more in line with pure property casualty reinsurers”.
Note that Third Point’s funds leverage means the exposure to the funds is effectively larger than the headline allocation.
This allocation looks outsized, with peer companies in Bermuda typically allocating around ~90% of assets to fixed income strategies.
Ultimately, Third Point Re will be rated by investors like a total return reinsurer until it is able to convince the market that it is not a total return reinsurer.
To do, it may have to reduce the allocation to Third Point LLC further.
Price-to-book vs peers
Source: Company reports, Inside P&C
Fifth, investors will need to be comfortable that the “irony factories” keep production levels tightly under control.
We have called the total return reinsurers “irony factories” because they have struggled to convince external observers that they are businesses run fully in the interests of all shareholders, given the scope for conflicts of interest created by the service agreements for investing/underwriting with founding minority investors.
And it is just these kinds of potential conflicts of interest – perhaps most clearly dramatized by the investor response to Greenlight Re’s sale process – that investors like Loeb and Greenlight Re’s David Einhorn will often go after in their own activist campaigns. Hence the irony.
Through year-end 2019, management fees paid to Third Point LLC are broadly equal to net income, although for 2019 the latter was 10x the former. And despite a strong response post-deal (+7%), the stock remains well short of its 2013 IPO price of $12.50 at $8.82.
Third Point management and performance fees against Net income
Source: Company reports, Inside P&C
These factors will remain under close scrutiny from investors going forward.
In this regard, the decision of Third Point LLC COO Targoff to step down as non-executive chairman – although he will remain on the board – lessons the influence of the hedge fund, and comes after the positive signal of the prior scale back in asset allocation to the hedge fund.
However, set against this is the company’s decision not to use the deal as an opportunity to heavily dilute the proportion of assets allocated to Third Point LLC, with the modest proportional reduction coming alongside a significant increase in absolute allocation – which will boost fees that have come down sharply.
Investors may still be wary of the company’s shares owing to concerns (right or wrong) around the informal influence exercised by Loeb, something which still creates scope for the ultimate irony of an activist coming in to attack the potential conflicts of interest.
The presence of the founding minority investor could also act as an inhibiting influence on a sale of the combined business, a key lever for value creation for smaller Bermuda specialty players that has been pulled by a range of peers over the last 5-10 years.
Third Point Re Underwriting Margin (%)
Source: SNL, Inside P&C
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