Three Fundamental Questions
1. Join the party or watch the parade go by ?
2. Buy or build ?
3. Standalone or join the Multi-Strat Re platform ?
Join or Watch ?
If you are a value investor or an investor, fund of funds, or a family office that normally allocates to a portfolio of alternative investments, and if you deeply care about better returns, improved liquidity, and tax efficiency, then you should actively look for asset manager backed insurers, reinsurers, and banks and weigh each prospect against its sponsors’ fund or managed account offerings and the offerings of other asset managers with similar investment strategies where your are currently invested or are thinking of investing.
If you are an asset manager who wants to: (1) improve performance without incurring a proportionate increase in risk; (2) secure permanent capital; (3) increase assets from sources that would otherwise be unavailable; (4) maximize future after-tax fee income per unit of invested capital; and/or (5) optimally monetize the value of your asset management business, then you owe it to yourself to look further.
Buy or Build ?
If you decide that you want to join, then you must decide whether or not to buy an existing insurer, reinsurer, or bank or start one from scratch. In general, we do not like acquisitions, because we do not trust most balance sheets, due diligence is often a time consuming and expensive exercise in futility, and the price might include a premium to book value. For many acquisitions, any premium to book value would likely exceed the total amount of signing bonuses necessary to poach the key executives that could allow one to replicate the business as a startup and use the difference as equity capital.
A startup has no legacy issues and no premium to book value. A reinsurer can be launched in 90 to 120 days, at relatively minimal cost, with relatively little overhead, and with relatively few restrictions on its investment strategy. Furthermore, startup reinsurers can access the capital markets through a 144A offering or an IPO within one year of launch (9 Bermuda reinsurers have raised more than $4 billion in startup capital via a 144A or IPO. The smallest was $175 million and the last was in November of 2013).
By comparison, launching a startup life insurer, P&C insurer, or bank takes far longer, costs far more, has more moving parts, and will likely have significant limitations on its investment strategy.
Standalone or the Multi-Strat Re Platform ?
While we believe that we have advised on more successful acquisitions and launches than the combination of all other successful acquisitions and launches that we did not advise, we also believe that the number of acquisitions and startups where we were engaged but did not succeed also exceeds the combination of all other successful acquisitions and launches that we did not advise.
Furthermore, we also believe that the failure rates when we did not advise far exceed the failure rates when we did advise. Acquisitions and startups of standalone insurers, reinsurers, or banks are really, really, really difficult.
We have learned that failure rates are highest for acquisitions followed by large standalone startups. Some of these failures were due to exogenous events such as Long-Term Capital, 9/11, Katrina, Wilma, and Rita in 2005, and the Financial Crisis of 2008. Acquisitions and large standalone startups consume significant internal resources for 18 months to 2 years (six years in the case of one of our successes) and the length of the calendar increases the likelihood that an exogenous event can sideline success.
Other failures occurred when the manager went out of business before completion (Pequot and Fairfield Greenwich Group), when expenses spiraled out of control (often topping $5 million), when capital targets were set too high and could not be reached, when buyers and sellers could not agree, when the executives demanded guarantees that were excessive, and when investment banks targeted traditional insurance, reinsurance, and banking investors for a private placement, because that is what they know, rather than alternative asset investors, who understand the investment strategies that drive returns, but are largely unknown to the investment banks.
When the startup outsources as much as possible, starts small, learns by doing, grows gradually, and raises enough capital before hiring full time staff, success rates are far higher. This is the premise of the Multi-Strat Re platform.
Multi-Strat Re is a shared resource for multiple reinsurers, each of which has been sponsored by an asset manager that manages all of its reinsurer’s assets. Each Participating Reinsurer is independent of the others (if a manager’s investment strategy blows up, the others are immune), but proportionately shares in the float and the risks generated by Multi-Strat Re, which specializes in high frequency low severity risks (no hurricanes, earthquakes, or other catastrophic risks).
A Participating Reinsurer on the Multi-Strat Re platform can launch in 90 to 120 days after we are engaged (vs. 18 months to 2 years or more for a standalone) with as little as $2 million in capital (vs. $500+ million for a standalone) for $100,000 in startup costs (vs. $1 million to $5 million, not counting compensation guarantees in excess of $25 million for a standalone) and annual fixed costs of less than $150,000 for the first year (vs $3 million + compensation guarantees for a standalone).
For more information on the Multi-Strat Re platform, link to its web site www.multi-strat.com and/or an Opalesque TV video. In addition, you might be able to attend one of the seminars described elsewhere on this website.
Our role with respect to the Multi-Strat Re platform is to manage the process of licensing and launching a Participating Reinsurer for a fixed fee. Once the Participating Reinsurer is initially capitalized with $1.1 million, Middlebury Securities (www.middsec.com) helps it raise capital from the clients of the Sponsor and new investors in a Reg ‘D’ offering and it becomes operational. Middlebury’s compensation is tied to the capital it raises.
Multi-Strat Re then manages the reinsurance process and other service providers perform the remaining operational and administrative tasks of operating a reinsurer. Each of our recommended service providers has agreed to preferential pricing for the first year of a standard launch.
The costs of reinsurance underwriting, monitoring risks, and claims administration are variable with the amount of float generated for each Participating Reinsurer. The underwriters earn long-term success fees for better than average results and these success fees are subject to high water marks.
Once the Participating Reinsurer reaches $10 million to $100 million in equity capital, is comfortable with the reinsurance business, and is willing to risk the costs of a busted offering, investment banks of varying degrees of capability will be willing to undertake a 144A offering or an IPO if the capital markets are receptive. It is highly likely that this could take place within a year of launching.
As each Participating Reinsurer grows it may take certain outsourced functions in-house and gradually wean itself from Multi-Strat Re in order to ultimately become a standalone reinsurer.
The Multi-Strat Re underwriting team, Middlebury Securities, our executive resources, some of the service providers, and we share in warrants issued by each Participating Reinsurer. We expect these to become quite valuable, but only if the investors in a given Participating Reinsurer have profited first.