Will Markel’s big bet pay off?
Consolidation has transformed Bermuda’s corporate landscape in recent years with many of the Island’s biggest brands, although still Bermuda-domiciled, now owned by much larger global, oversees brands. PartnerRe is owned by Italian investment fund Exor; XL Catlin by French-based multinational AXA; and Validus by the world’s biggest insurer AIG, to name but a few.
On this basis, perhaps nothing should come as a surprise to risk transfer executives hardened to the constant rumours surrounding mergers and acquisitions—and many deals then becoming a reality, reshaping the landscape in the process.
Yet despite all this, the sudden news that Nephila Capital, the trailblazer and a dominant force within the insurance-linked securities (ILS) funds sector, was being taken over by Markel, came as a shock to many.
Markel stunned the market the week before the Monte Carlo Rendez-Vous when it revealed it would acquire Nephila Capital for an undisclosed sum, becoming the largest manager of funds in this sector in the process. Between Nephila and Markel CATCo, its assets under management will stand at approximately $19 billion, representing almost 20 percent of the ILS sector.
“The sheer audacity of Markel and the fact that the deal had been kept under wraps so well made it a big surprise to many,” said one market observer at the time. “Plus, everyone is wondering how much they paid.”
A new footprint
The logic of the deal soon started to make a great deal of sense. Nephila perfectly complements Markel’s other areas of expertise; it also gives the re/insurer access to a massive pool of alternative capacity, something that is already defining market dynamics and which will surely only become more influential in the future.
That is the company’s logic, admits Jed Rhoads, president and chief underwriting officer, Markel Global Reinsurance, who sat down to discuss the deal at the Monte Carlo Rendez-Vous.
On the one hand, he admits that Markel has “made a huge bet” in acquiring Nephila Capital. But this ‘bet’ based on an instinct of how the risk transfer landscape will change in the long term—and the company that emerges from the deal will be much greater than the sum of its parts, Rhoads says.
Rhoads adds that when considering the deal, Markel thought about the question of what the risk landscape would look like in 2025.
“We looked at what pieces of the puzzle we had and what we would need,” he says. “The market is changing; it is clear ILS and alternative capital are here to stay and they would be heavily integrated into any future model of risk. It was on that basis that we did this deal.”
He acknowledges that there will always be uncertainty in doing such a deal, but that it was an informed decision that feels right.
“We have made an enormous bet in the ILS space but I am proud of what we have done,” Rhoads says. “We did CATCo three years ago, so we were already in this space, but Nephila gives us a much bigger reach.
“Nephila was the original pioneer in this market and remains the pre-eminent company in it. Its founders created something unique, with a good reputation and of a remarkable size.
“Our view is that the industry has to learn to deliver capacity and capital in the most efficient fashion possible. This gives us yet another platform to ensure we can continue to do that for the long term.”
Richard Whitt, co-chief executive of Markel Corporation, adds: “We saw with CATCo and now with Nephila the opportunity to be a leader in that space and there are not many opportunities in the insurance and reinsurance business to pick up a leadership position as quickly as we have.
“We want to build out Markel’s capabilities across the insurance and reinsurance landscape.”
The missing piece
Nephila will complement its existing ILS offering from Markel CATCo, which it acquired in 2015; its extensive global insurance and reinsurance operations; its US carrier State National, which it acquired in 2017 and gives it a comprehensive fronting platform; and Markel Ventures, which invests in companies outside the re/insurance industry.
In addition to these core components of its portfolio, the company has also been investing in insurtech ventures in recent years. In 2017, it acquired SureTec Financial for approximately $250 million; more recently it partnered with FanShield, an insurance agency wholly owned by Protecht, which also founded insurtech TicketGuardian in 2016.
“The combination of all that is much greater than the sum of its parts,” Rhoads says. “We can deliver capacity in a much more efficient way and ensure we remain relevant right to 2025.”
He adds: “We want to make sure that we have the capabilities and the products that our customers need and, as much as possible, be a one-stop shop.”
He notes the deal is also significant against a backdrop of the ILS sector growing faster than the traditional reinsurance sector; Markel is now in a pre-eminent position to benefit from its potential. “This puts Markel in a really good position within the ILS market,” Rhoads says.
Whitt adds that the company expects this trend to continue. “We believe that the ILS growth trajectory will be higher than traditional for at least the next several years,” he says. “It is going to become a bigger part of the market.”
Pension funds and endowments are increasingly adding uncorrelated risk to their portfolios and are bringing new capital to insurance products, Whitt explains. “The interest is there on behalf of capital providers.”
Rhoads adds that on the customer side, ILS funds’ lower cost of capital enables a lower return profile for investors. Many stakeholders are interested in diversifying into other types of risk other than cat. “ILS funds are lean operators,” he says.
A year of change
Markel has made some structural changes to its leadership structure this year. It hired Robert Cox to the newly created position of president and chief operating officer (COO) to oversee all insurance operations.
Cox was previously executive vice president and COO for Chubb where he led worldwide operations of Chubb Specialty Insurance. During his career, he held several executive positions in all areas of specialty and commercial property and casualty insurance.
In his new role focusing on integrating Markel’s insurance operations, Cox will oversee all insurance divisions including Markel Assurance, Markel Specialty, and Markel International, in addition to sales and marketing. Cox will report to Richie Whitt, co-chief executive officer.
Markel also promoted Brad Kiscaden to president and chief administrative officer, and Bryan Sanders to president, US insurance.
As a team, Cox, Kiscaden, Sanders, and William Stovin, president of Markel International, will provide executive leadership and oversight of insurance operations.
A profitable base
Markel’s results have fared relatively well in the past 12 months in the run up to the Nephila deal, despite the heavy cat losses in 2017.
The company reported a comprehensive income to shareholders of $1.2 billion in 2017, a big increase on the $667 million it posted in 2016.
The improvement was due to an increase in net unrealised gains on investments, net of taxes, of $763 million in 2017 compared to $242.2 million in 2016. The increase in net unrealised gains on investments, net of taxes, in 2017 was attributable to growth in the fair value of Markel’s equity portfolio, the company said.
As a result of US tax changes, Markel also recorded a one-time tax benefit of $339.9 million in the fourth quarter of 2017.
“We finished 2017 with record comprehensive income of more than $1 billion which drove double-digit growth in book value over the past one-year and five-year periods,” said executive chairman Alan Kirshner.
“This was largely due to outstanding performance in our equity portfolio and reflects the benefit of our diversified operations. Our revenues also set a record, exceeding $6 billion, and reflect both organic growth and contributions from recent acquisitions.”
Markel recorded a combined ratio of 105 percent in 2017 compared to 92 percent in 2016, while its underwriting result in 2017 included $565.3 million, or 13 points, of underwriting loss from hurricanes Harvey, Irma, Maria and Nate as well as the earthquakes in Mexico and wildfires in California. The underwriting loss on the 2017 catastrophes comprised $585.4 million of estimated net losses and $20.1 million of net assumed reinstatement premiums.
The combined ratio for the reinsurance segment was 132 percent for 2017 compared to 87 percent for 2016. The increase in the 2017 combined ratio was driven by the impact of the 2017 catastrophes and adverse development on prior years’ loss reserves attributable to the decrease in the Ogden rate in 2017. Gross written premiums in the reinsurance segment grew slightly to $1.11 billion in 2017 compared to $1.04 billion in 2016.