Challenges ahead for Aspen and Endurance
Now that Endurance has dropped its attempts to acquire Aspen, both companies have to come to terms with the future as standalone businesses and find a compelling story to tell investors.
Both have historically underperformed compared to their peers, with Aspen delivering an average return of equity between 2009 and 2013 of only 8.0 percent, versus a Bermudian average of 12.8 percent. Endurance delivered a 10.3 percent return on equity by the same measure.
In the course of its robust - and now successful - defence, Aspen has told its shareholders to expect an operating return on equity of 10 percent in 2014, 11 percent in 2015 and 11-12 percent in 2016. It has also committed itself to further growth in its US insurance business, with a target of $550mn of net earned premiums in 2015.
Aspen told its investors that it will achieve enhanced returns as an investment phase comes to an end. This will come via an increased investment allocation to equities and as increased operating leverage helps trim its expense ratio through reduced cessions.
There is some scepticism in the sector. Barclays Capital analyst Jay Gelb is forecasting an operating return on equity of 10 percent for Aspen in 2014, but expects this to drop to around 8 percent in 2015 and 2016 as soft market pressures take their toll.
Industry sources also argue that much of Aspen's growth in its insurance top line, which hit 23.7 percent in the second quarter, reflects a small number of programme deals rather than a broad-based expansion of the premium base.
Sources also highlight Aspen's relatively inflated expense ratio. In 2013, the company reported an expense ratio of 36.4 percent against a peer group average of 31.8 percent. These figures are based on The Insurance Insider's Bermuda composite rather than the range of companies typically dubbed "Bermudians".
Aspen was 400 basis points worse than the peer average in 2012 and 300 basis points behind in the year before that.
Aspen's decision to drop reinsurance and retrocession protection at a time when prices are falling fast has also prompted some sources to raise eyebrows.
The group said it expects a $25mn benefit to net income in 2014 and an additional benefit of $20mn in 2015. However, the corollary of a bigger net position is increased earnings volatility.
With total shareholder equity of only $3.5bn, the perception also persists that Aspen lacks the scale to compete in an increasingly tiered market, with signings and even pricing favouring the sector's heavyweights (a view that, of course, also holds true for Endurance).
Sources continue to argue that despite the hardcore defence orchestrated by Goldman Sachs, Aspen remains in play.
The list of potential suitors is relatively short, but given the expectation that specialty (re)insurers will suffer further margin compression as investors come to a fuller appreciation of the soft market, some still believe the company will be taken out.
Sources have told The Insurance Insider that during his hiatus from the (re)insurance industry, Endurance CEO John Charman looked carefully at the Bermuda market and identified a strategic tie-up between Endurance and Aspen as the great unexploited possibility.
There was nothing opportunistic about Charman's tilt at Aspen. It was the company that he wanted and it is understood that the former Axis CEO does not see another deal out there that he believes would offer Endurance a similarly complementary book of business or a comparable platform for growth.
Sources have said that Charman believes the Aspen board's refusal to deal has set his project to transform Endurance back by up to four years.
The failure of his takeover efforts will prompt a shift in focus to Endurance's efforts to remediate its underwriting performance and build out its specialty capabilities.
Much will depend on whether Charman can find a way to perform the alchemy of delivering major top-line growth in a soft market while driving a consistent improvement in underwriting returns.
The evidence of strong top-line growth and increased profitability was visible in the second quarter numbers. Gross written premium climbed by 20.4 percent to $689mn and operating earnings per share surged from $1.09 to $1.61.
However, the question is whether Endurance can find a way to grow its top line from $2.6bn to $3bn and then to $4bn or $5bn without the results unravelling.
Keefe Bruyette & Woods analyst Meyer Shields flagged up concerns about an ambitious growth path. "Despite Charman's impressive underwriting and management capabilities, we think the industry's history demonstrates the risks inherent in pursuing rapid premium growth during a period of deteriorating pricing, especially given our concerns over an eventual upward inflection in the loss cost trends," he wrote.
Sources speak highly of many of Charman's hires both in London and the US, and he clearly has the track record to attract heavyweight underwriters to Endurance. But with much of the industry commoditised, it is hard to attract business without offering a more competitive price.
As demonstrated by the investor response to the second quarter earnings (see page 1), the specialty (re)insurance market as a whole is facing major challenges. Those very challenges were a major part of the rationale for an Aspen-Endurance deal.
Without it, both parties probably find themselves less well adapted to survive what is looking set to be a long and harsh winter ahead...