the insurance value chain: key investment themes john kraska september 2, 2015

THE INSURANCE VALUE CHAIN: KEY INVESTMENT THEMES

John KraskaSeptember 2, 2015

The Insurance Value Chain Is “In Play”: Key Investment Themes | 2

Peak Market Cap Of $755B In May 2007

Peak Market Cap Of $755B In May 2007

AIG

Berkshire

U.S. & BERMUDA P&C U/W MARKET CAP “ONLY” $354B

AIG Market Cap ~45% Of P/C Industry Market Cap In Late 2000. Berkshire Hathaway ~42% Now

Currently $869BCurrently $869B


SMALL MARKET CAP LACK OF INVESTOR INTEREST FOR U.S. P&C INDUSTRY

Property Casualty Underwriters (Ex. AIG, BRK)

Only $354B

Property Casualty Underwriters (Ex. AIG, BRK)

Only $354B


25 YEARS OF DECLINING PEAK VALUATIONS

Source: FactSet, Dowling & Partners Analysis


TOP WORLDWIDE GROUPS BY MARKET CAP … ASIA SHOWING INCREASED M&A APPETITE ABROAD

* Berkshire Hathaway Bubble Not Shown ($350B), Includes Fairfax (Canada); ** Includes QBE (Australia); Source: FactSet

v2.0


CYCLICAL CHANGES SUPPRESSING RETURNS: LOWER INTEREST RATES & LEVERAGE

Source: A.M. Best Aggregates & Averages, D&P Estimates, U.S. Department of Treasury, Company Reports

“New Money Rate”

“Imbedded Yield”


New Money Pre-tax Investment Yield

P:S 1.5% 2.0% 2.5% 3.0% 3.5% 4.0% 5.0% 6.0% 7.0% 8.0% 9.0%

70% 80.7% 81.9% 83.2% 84.4% 85.7% 86.9% 89.5% 92.2% 94.9% 97.6% 100.5%

80% 83.4% 84.5% 85.7% 86.8% 88.0% 89.2% 91.6% 94.1% 96.7% 99.3% 101.9%

90% 85.5% 86.5% 87.6% 88.7% 89.9% 91.0% 93.3% 95.7% 98.1% 100.5% 103.0%

100% 87.1% 88.1% 89.2% 90.3% 91.3% 92.4% 94.6% 96.9% 99.2% 101.6% 104.0%

110% 88.5% 89.5% 90.5% 91.5% 92.5% 93.6% 95.7% 97.9% 100.1% 102.4% 104.7%

120% 89.6% 90.6% 91.5% 92.5% 93.6% 94.6% 96.6% 98.7% 100.9% 103.1% 105.3%

130% 90.5% 91.5% 92.4% 93.4% 94.4% 95.4% 97.4% 99.5% 101.5% 103.7% 105.8%

140% 91.3% 92.3% 93.2% 94.2% 95.1% 96.1% 98.1% 100.1% 102.1% 104.2% 106.3%

150% 92.1% 93.0% 93.9% 94.8% 95.8% 96.7% 98.6% 100.6% 102.6% 104.6% 106.7%

160% 92.7% 93.6% 94.5% 95.4% 96.3% 97.2% 99.1% 101.0% 103.0% 105.0% 107.0%

170% 93.2% 94.1% 95.0% 95.9% 96.8% 97.7% 99.6% 101.5% 103.4% 105.3% 107.3%

180% 93.7% 94.6% 95.5% 96.3% 97.2% 98.1% 100.0% 101.8% 103.7% 105.6% 107.6%

190% 94.1% 95.0% 95.9% 96.7% 97.6% 98.5% 100.3% 102.1% 104.0% 105.9% 107.8%

200% 94.5% 95.4% 96.2% 97.1% 98.0% 98.8% 100.6% 102.4% 104.3% 106.1% 108.0%

81%86%

ECONOMICS OF 12% AY ROE

Assumptions:Duration: 1.8 yearsExpense Ratio: 28%Surplus p/t Yield: 250bps over new money

2001

1985

Source: D&P Analysis

98%101%

106%108%

20-25 pts of Improvement Needed


DIFFERENT RETURN EXPECTATIONS OVER TIME

15% ROE ERA

ESTIMATED ULTIMATE

AY CR

CR NEEDED FOR 15% ROE

CR NEEDED FOR 10 YR TRS + 700BPS

CR NEEDED FOR 12% ROE

12% ROE ERA

SINGLE DIGIT?

Source: A.M. Best Aggregates & Averages; D&P Estimates


SECULAR CHANGES ARE PERMANENTLY ALTERING THE (RE)INSURANCE INDUSTRY


CAT BONDS TOOK 15+ YEARS TO DISRUPT PRICING (2012)

June 1996

First Cat Bond

Issued In Dec-96 By St. Paul Re


THE PENSION FUND “MARTINI”

Source: Guy Carpenter

Pension Fund Capital Under Management$30 trillion

Global property cat limit $341 billion

Global retro capital <$30 billion

Global insurance sector capital (including life) $2.5 - $3 trillion


Guy Carpenter estimates non-traditional capacity at ~18% of total world wide cat limits. Ultimately, GC predicts alternative capacity could reach $115-150 by 2018.

“ALTERNATIVE CAPACITY” GAINS MARKET SHARE

Doubles In 5 Years


PENSION FUNDS DRIVE GROWTHNEPHILA ALONE HAS ADDED ~$7B SINCE 2009

“Nephila Gorilla”

Founded in ‘98 as part of

Willis;Sells in ‘03

Invested in Jun-08


PROPERTY CAT PREMIUMS = ~ 10% OF GLOBAL NON-LIFE REINSURANCE

Source: Guy Carpenter estimates (as of 3/1/15)

$144.9B$12.3B

$21.5B$0.8B

$84.4B$3.5B

$28.3B$1.9B

$47.1B$2.0B

2015 Global Cat Market:$341B Limit; $21B Premium

~$25B+~$4B+

Florida Remains The Global Cat Market “Peak Zone”


JUNE 1ST 2012: PRICE TAKER BECOMES PRICE MAKER = 3 RENEWALS IN FLORIDA

Note: “Expected” c. ratio assumes a loss and G&A expenses are held constant. 2011 base c. ratio considers a 45% loss ratio, 10% commission ratio and 5% G&A. ratio. Source: D&P Analysis

Assumes Rates Off 5-10% At Jun-15


Lloyd's

Bermuda102%83% 80%

97%

155%

223% 231%

D&P Reinsurers

60%

100%

140%

180%

220%

260%

Q2-09 Q2-10 Q2-11 Q2-12 Q2-13 Q2-14 CURRENT

Pric

e to

Tan

gibl

e B

ook

Valu

e

Florida Public Insurance Company Composite5 Year Price To Tangible Book Value

Lloyd's Bermuda Florida Public Composite D&P (Re)Insurance Composite

Source: Factset, Company Reports, D&P Analysis

Wind Season

D&P "TippingPoint"

FL Rates Down Another15-25% At 6/1/14

FL Rates Down 10-20% At 6/1/13FL Rates

Increase ModestlyAt 6/1/12

Wind Season

D&P "TippingPoint"




Wind Season

D&P "TippingPoint"




Wind Season

D&P "TippingPoint"




FL PUBLIC COMPOSITE #1 SHORT-TERM BENEFICIARY


THE P/C (RE)INSURANCE VALUE CHAIN IS IN PLAY

Moving Further From The “Customer” = More Pressure On Returns

The (Re)Insurance Value Chain


CONSOLIDATION CHANGES THE BUSINESS

2014 2014 Top 20

Rank Broker Ownership ($, B) Mkt. Sh.

1 Marsh & McLennan Public (NYSE) $13.0 27%

2 Aon Public (NYSE) $12.0 25%

3 Arthur J. Gallagher Public (NYSE) $4.6 10%

4 Willis Group Holdings Public (NYSE) $3.8 8%

5 BB&T Insurance Bank / Public $1.8 4%6 JLT Public (LONDON) $1.7 4%7 Brown & Brown Public (NYSE) $1.6 3%8 Wells Fargo Insurance Bank / Public $1.6 3%9 Hub International Private Equity $1.3 3%10 Lockton Private $1.2 3%

TOP 10 $42.6 90%

11 USI Private Equity $0.9 2%12 Gras Savoye S.A. Private $0.8 2%13 Alliant Insurance Services Private Equity $0.6 1%14 Towers Watson & Co. Public (NYSE) $0.5 1%15 AssuredPartners Private Equity $0.5 1%16 Verspieren Private $0.4 1%17 BroadStreet Partners Private Equity $0.2 1%18 Leavitt Group Private $0.2 0%19 CBIZ Benefits Private $0.2 0%

20 Integro USA Private Equity $0.2 0%Top 20 $47.3 100%

Source: AM Best, Business Insurance, D&P Analy sis

Rec

ent T

rans

actio

ns→ PE

→ PE

→ PE

Relative

1989 1989* Top 20

Rank Broker ($, B) Mkt. Sh.

1 Marsh McLennan $2.5 27%2 Alexander & Alexander $1.2 14%3 Sedgwick Group $1.0 12%4 Johnson & Higgins $0.8 9%5 Corroon & Black $0.5 5%6 Willis Faber $0.5 5%7 Frank B. Hall $0.4 4%8 Rollins Burdick Hunter $0.3 4%9 Minet $0.3 3%10 Jardine Insurance Brokers $0.2 3%

TOP 10 $7.7 86%

11 C.E. Heath $0.2 2%12 Arthur J. Gallagher $0.2 2%13 Bain Clarkson PLC $0.2 2%14 Hogg Group PLC $0.2 2%15 Faugere & Jutheau $0.1 1%16 Jauch & Hubener $0.1 1%

17 Hudig-Langeveldt Group $0.1 1%18 Gras Savoye SA $0.1 1%19 Sodarcan $0.1 1%

20 Hilb, Rogal & Hamilton $0.1 1%TOP 20 $9.0 100%

Source: A.M. Best Review; *Brokerage Revenue

Independent

→ PE

→ PE


CHANGE IN OWNERSHIP OF TOP 100 BROKERS

Source: Dowling Hales

PublicManagementInsurance Co / OtherBankPrivate Equity 8

63

4

13

127

76

5 84

67%18%

3%5% 7%

2000

9

77

11

3

66%14%

2%

7% 12%

2013

By Revenue:

By Count:

62%24%

13%

1984

More Institutionalized Ownership

More Competitive Landscape

PE-backed Brokers Continue To Be Exceedingly Active On The M&A Front


PRIVATE EQUITY’S INFLUENCE ON M&A

Source: Dowling Hales, D&P Analysis

Broker Deals by Buyer Industry 2014 Broker Deals by Count

“Wave” 2 Buyers Will Be Aggressive Consolidators For Next 5-7 Years


M&A PIPELINE REMAINS STRONG

Brokers In Play = ~4.1K Firms And $20B of Revenue

Note: (1) Estimated using midpoint of each revenue category except for Extra Large and Jumbo Source: Independent Insurance Agents and Brokers of America, Business Insurance and Dowling Hales estimates.

Distribution by Number of Firms

Distribution by Revenue(1)

Target Market for Consolidators

~$20B of Revenue /

Target Market for

Consolidators

~4,088 Firms


• Heightened competition is driving “average” multiples for deals into upper single digits (approaching/exceeding 10x for larger deals) but does not tell the entire story

• Guaranteed purchase multiples have also moved higher (rather than a meaningful portion of the purchase price being held as an “earn out”) and the “price of entry” has increased (as shown by the minimum EBITDA multiples moving higher in recent periods)

• Valuation is also very much in the eye of the beholder as buyers are increasingly prospective looking and at times will even give credit to synergies / revenues that are much further down in the business plan (i.e. “transactional EBITDA”)

• This, lower interest rates / flexible lending and increased competition is the reason why multiples have moved up ~1-2x vs. long term averages

DEAL MULTIPLES, COMPETITION AND VALUATIONS

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

0.0 x

2.0 x

4.0 x

6.0 x

8.0 x

10.0 x

12.0 x

14.0 x

16.0 x

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Guaranteed Multiple EBITDA

Minimum Maximum Libor

PE Deals

Price ofEntry

Source: Dowling Hales, Intercontinental Exchange (“ICE”)


Power Pendulum Continues Shift To Intermediaries

P/E Owners Continue To Drive Consolidation (Buying Revenue)

Number of Primary Insurance Markets Utilized Will Decline

Increased Compensation to Intermediaries In Form Of:

• Supplemental / Contingent Commissions to Middle Market

• Broker Managed / Controlled Facilities With Larger Brokers

Pricing Pressure For Both Primary Carriers & Reinsurers

Intellectual Capital & Modeling Tools Advantage Buyer Over Seller

INTERMEDIARY CONSOLIDATION IMPLICATIONS

He Who Controls The Customer Wins


“HEDGE FUND RE” = IT’S ALL ABOUT TAXES

“And probably from the structural point of view, the most disturbing one is hedge funds that offer tax benefits to the high income individuals that invest with them and, at the same time, go big time into asset risk, can afford, for that reason, higher combine ratios. And this, of course, is a deja vu for many of us, because we used to call that cash flow underwriting. And it may end in tears sooner or later because others may follow suit, even though the hedge fund part of the business so far is of course relatively small.”

– Munich Re (August 7th 2014)


3 LEGS FOR A SUCCESSFUL TOTAL RETURN UNDERWRITER

Asset Manager Capital

Underwriter

Fees&

Tax Savings

Offensive •“Capital Lighter” Model = ↑ ROE•New Business At Lower Return

Defensive •Retain Business Under “Watfordization” Pressure

• Permanent Assets• Additional Fees / Product

• Raising Initial $750M+• Higher A/Tax Return


The “De Facto” Regulator

+New Business Penalty

SIMPLIFIED VIEW OF A.M. BEST’S BCAR FINANCIAL MODEL FOR STARTUP REINSURER…

= A.M. Best Requirements For The Needed

“A-” Rating

• Known Underwriter(s) W/ Long-Term Track Record

• Credible / Executable Business Plan = Where Does Premium Come From?

• Money Manager(s) Pass Strict Due Diligence

• Equity Is Knowledgeable About (Re)Insurance


HEDGE FUND REINSURANCE MODELS

$1.2B

$1.5B

$1.2B

$0.5B

$1.1B

Capital ($,B)(David Einhorn)

(Dan Loeb)

(Two Sigma)

(John Paulson)

(Highbridge Capital)

$0.8B*(Golub Capital)

* Press reports suggested target capital of $750M for Golub Capital and Pine River Re

Pine River Re(Pine River Capital)

$0.8B*

$1.0B(BlackRock)

“Content” Is King Model

Potential New Sponsors ?


WATFORD VS. ARCH RE: PRICING IMPACT

X

X

=

8pt Δ

78%?


IT’S NOT NEW…TOTAL RETURN (RE)INSURERS

Source: Company Reports, Dowling & Partners Analysis


LLOYD’S = 326 YEARS OF TOTAL RETURN UNDERWRITING


AJIT JAIN: KEEPS A LID ON PROSPECTIVE PRICING

Source: A.M. Best Aggregates & Averages; 2014 Projected


BURLINGTON NORTHERN RANKS AMONG THE LARGEST OF GLOBAL REINSURERS

Source: Company Reports, D&P Analysis

??


AJIT REACTS TO SECULAR INDUSTRY TRENDS

Ajit Reacts


TECHNOLOGY CHANGES THE COMPETITION

MULTI-LINE ERA

“SPECIALIST”START-UP

(RE)INSURERSDISRUPTIVE

DISTRIBUTION & NEW CAPITAL

SOURCES

TARIFF RATINGS

Minicomputer1965 - 1985

Micro P/C Era1985 - 2010

Cloud Computing, Big Data, Direct

Distribution, Sophisticated

Algorithms

Mainframe1950 - 1965

Pre-1950s

“Two Men, A Dog, A $1B & An A- Rating”

MGAs, Pension Funds, Hedge

Funds


GOOGLE … FRIEND OR FOE TO INSURERS?

Google Compare for Auto Insurance

Google Compare Up And Running In UK For 2+ Years

March 2015: Announces Launch Of Auto Insurance Comparison Site in CA

* Google Presentation May 2015

Google Compare isNOT

Becoming an Auto Insurer*


AUTONOMOUS CARS …THE FUTURE IS BECOMING CLEARER


PERSONAL AUTO: LARGEST INDIVIDUAL U.S. LINE

Per D&P Report “Path To Driverless Cars” (9/7/2013)


PROGRESSIVE THEN AND NOW

Founding CEO Peter Lewis Was The 1st To Point Out The Risk That Auto Insurance Might Ultimately Disappear.

“The biggest risk we face is the end of auto insurance…at some time in the future there will be so many fewer, less severe auto accidents that it will disappear.”

Founding CEO Peter Lewis (1998)

Progressive Puts “Homeowners” / ASI On The Balance Sheet

1998 2015

Future Progressive Year 20XX: Homeowners Premium > Auto Premium?


WE ENVISION A WORLD WHERE …

• Intermediaries Go Direct To Capital (Both Traditional & Non-Traditional). “Facilities” Grow To 25-30% Of Many Lines Of Business

• AmWINS Deal With Nephila = A Game Changer

• The Hartford’s Stealth Move With AARP• Ajit Jain Going Direct In Workers’ Comp

• Excess Traditional Reinsurance & Primary Capital• Hedge Fund & Pension Capital• Reinsurers Should Not Be Public Companies In New World


FOR U.S. COMMERCIAL UNDERWRITERS… WHERE DOES A DOLLAR GO?

* Composite of 127 Commercial Lines Predominating Groups Over Last 10 Years (2004-2013), Source: SNL Data, D&P Analysis

Pure Losses = 57¢Pure Losses = 57¢Loss Adj.Loss Adj.Expense Expense

14¢14¢

Commissions Commissions & Brokerage & Brokerage

10¢10¢

Profit Profit 1¢1¢

Salaries 9¢Salaries 9¢

Taxes = 3¢Taxes = 3¢

Other Other G&A 5¢G&A 5¢

i.e. Loss Ratio i.e. Expense Ratio


AMWINS: A GREAT EXAMPLE OF WHERE THE WORLD IS HEADED …

1) Partnered With Allianz Risk Transfer / Nephila… Exclusive “ETF” type arrangement between AmWINS and Allianz/Nephila for 10% of all “shared and layered” property business = should ~ $175M of premium.

2) Partnered With A Long-term Capital Provider… Completes strategic investment by Public Sector Pension (PSP) Investment Board = 20 year money.

3) Providing “Small Business” Flow… Two Sigma “rocket scientists” underwrite small business.

The largest U.S. wholesale broker with premium placements of $10B+ from 20K+ agents


(2011)

(2012) (2010) (2012)

(2015) (2010)

Year of Transaction

= Companies “Taken Out” / Merger of Equals

> $3B(2015)

SIZE MATTERS IN (RE)INSURANCE … 2010


SIZE MATTERS IN (RE)INSURANCE … 2015

< $3B

New Entrants

“New” Combinations


1) Lowest Number of Questions Asked Online

• Ability To Populate Data / Autofill = Reduces # of Qs

2) Largest # of Potential Customers / # of SIC Codes

3) Size of Account = Premium $s

4) Successful "Throughput" Of Underwriting W/O Human Intervention

5) Ability To Give Bindable vs. Indicative Quote

“DIRECT” BATTLE IN COMMERCIAL LINES WILL BE WAGED ON FIVE KEY METRICS ...


AARP: THE HARTFORD'S “TROJAN HORSE” INTO SMALL COMMERCIAL LINES?

“The Micro segment of Small Commercial is best served by a multichannel distribution strategy. We are aggressively moving in that direction with an AARP-endorsed offering and other initiatives that will bring increased simplicity and speed to small business owners and our distribution partners.

- Chris Swift CEO & Chairman The HartfordFebruary 3rd, 2015


AJIT GOES “DIRECT” IN COMMERCIAL LINES


A CASE STUDY: GEICO PREMIUM GROWTH

#2

#7

1993: Tony Nicely implemented a strategy to expand the customer base and increase advertising.

1996: Berkshire Hathaway purchased the remaining shares. Original purchase of ~1/3 of the co occurred in 1976-80, at a time when the company was recovering from near-bankruptcy.

Since then, the company has continued to successfullyexpand its advertising and its customer base.

Source: Dowling & Partners Analysis, Statutory Filings


AJIT GOES “DIRECT” IN COMMERCIAL LINES

Model With Least / Minimal Frictional Costs

Small Commercial Customer

Risk Assumed

Internet Based Platform

● Leverages Big Data● Pricing Algorithms● “Real Time” Bindable Quotes

Ajit’s Goals …● Fewer Than 20 Questions ● Save Customers An Average Discount of 20%● 80% “Throughput” Rate Of Customers


In The End … Content Is King & Capital Is A Commodity





the insurance value chain: key investment themes john kraska september 2, 2015

Documents

dowling partners analysis

draftthe insurance value

peak market cap

market cap asia

baig market cap

pc industry market cap

bermuda pc uw market

berkshire hathaway bubble