Opinion: Covea-PartnerRe – What could possibly go wrong?
This sector can sometimes throw up curious deals, the kind make that make you tilt your head to the side and squint as you try to make sense of them.
But Covea-PartnerRe is in a class all of its own.
Albert Einstein is believed to have said that insanity is doing the same thing over and over again and expecting different results. And it is hard to watch this story unfolding without feeling like some degree of insanity has taken hold.
Exor's decision to shake hands with Covea on a deal to sell PartnerRe after the French mutual reneged on exactly the same deal last year speaks to its desperation to sell – and the utter lack of other options to get out of reinsurance at a premium multiple.
Typically, we would write at this point as if the deal were certain to complete (given the frothy multiple and cash position of the buyer). But, given the history of the prior engagement and its spectacular collapse, we have to ask if Covea and PartnerRe will make it to the altar this time without misadventure.
There is no likely scenario that would torpedo the deal – but this is Covea.
What would happen if there were a magnitude 8 San Francisco earthquake? What if a lethal “epsilon” variant of Covid emerges and financial markets nosedive? Something unexpected could happen to make Covea feel the heat as it did in spring last year, and to repent of its big bet.
Alternatively, regulatory issues could emerge. Covea CEO Thierry Derez was found last November by a Paris commercial court to have made a serious breach of his legal and fiduciary duties to Scor in his attempt to acquire the company, resulting in EUR20mn ($23mn) of fines, of which almost EUR500,000 was levied personally on Derez. There is a scenario in which regulators take a very hard look at Covea’s suitability as an acquirer of PartnerRe.
If the deal does collapse, then Exor will face major embarrassment. After all, fool me once – shame on you, fool me twice – shame on me.
The pitfalls to come
The spectacle of Covea's hunt for a reinsurance platform since its first tilt at Scor in 2018 has been such that it has been easy to be distracted from the more prosaic reality of what would come next.
And if we do step back and think about Covea's prospects as the owner of a reinsurer – and the prospects of a reinsurer under its ownership – they are clearly not good.
There are a number of obvious road-blocks and potential issues.
First, reinsurance is a challenged business with a low-return, high-volatility profile.
In buying a major reinsurance platform, Covea is executing on a highly contrarian playbook. Right now, there are no other major insurance groups willing to look at buying a business with significant reinsurance exposure.
Axa is looking to go the other way and offload XL Re, the platform it incidentally picked up when it acquired Axa XL for its primary business in 2018. Tokio Marine has also exited the space, and AIG's decision to acquire Validus increasingly looks like a quixotic move given the exodus of staff.
Reinsurance brings significant volatility into the earnings profile of an insurance company. And although Covea as a mutual is theoretically well placed to absorb volatility, it has already demonstrated an aversion to it last year.
As the Inside P&C research team noted last year (see “Covea: Skydiving is not for you”), Covea's decision to walk away from an agreed deal based upon a financial shock is prima facie evidence for its unsuitability as an owner of a reinsurance business. Because the one thing that can be guaranteed in reinsurance is that there will be shocks and bad years to come.
If Covea wants into reinsurance it should be careful what it wishes for.
Second, large insurers have a bad track record buying reinsurers – the play typically doesn't work.
Getting M&A right requires a good understanding of the target business and its model, and a high degree of cultural affinity between the two sets of staff.
Whether or not there is anything truly different and special about reinsurance, people working in the reinsurance sector often believe there is – and often feel misunderstood and unappreciated as part of larger corporate structures where primary business is the major focus.
Axa – a sophisticated global financial services business – has struggled as an owner of XL Re, while AIG, which has a decades-long track record of underwriting a large complex client base, has also come unstuck with Validus Re.
There is scope for an even bigger cultural mismatch between Covea and PartnerRe than in these other recent cases.
He is a highly interested witness, but Denis Kessler notoriously compared the efforts of Covea to acquire Scor to a savings and loan association trying to buy Morgan Stanley.
This is (delicious) hyperbole. But there is some truth to the idea that the people who work in a mutual insurer with small commercial and personal clients come from a different tribe to those working in high finance. This is the difference between Main Street and Wall Street, to borrow an Americanism.
Layer on top of this the cultural distance between a French company and a Bermudian business (even if PartnerRe is the most European of its cohort), and you have scope for still more to be lost in translation.
This all comes after a period of instability at PartnerRe, when a period of underperformance was followed by an M&A saga, which gave way to a CEO succession, and now to the reanimated deal.
Third, it is not clear that a high degree of autonomy for PartnerRe will neutralise these challenges, particularly if underperformance continues.
The early messaging coming out of PartnerRe with trading partners is that the company will operate autonomously, with its management team under CEO Jacques Bonneau continuing to steer the ship.
Talk on day one of a transaction is not always matched by the reality of post-deal dynamics, and ultimately, if Covea buys PartnerRe, it will call the shots with the business.
Even if not explicitly interventionist, owners always matter because they give management teams their mandates and set their incentives.
But they also have a tendency to want to get involved, and true strategic and operational autonomy tends to depend upon flawless execution.
Tokio Marine has been happy to allow HCC a high degree of autonomy; Mitsui Sumitomo has taken close control of Amlin. PartnerRe will need to rehabilitate its performance and avoid missteps to avoid heavy control from its parent.
The nightmare scenario
Covea's past behaviour also raises the possibility of an absolute nightmare scenario here – one that should be contemplated at this point. After all, with Aon-Willis we have just passed through another M&A deal where not enough thought was given to the most severe downside scenario.
In this scenario, let's first say the deal closes, and Covea at last gets its reinsurance platform.
Elevated catastrophe losses establish themselves as an annual phenomenon. Higher inflation becomes endemic and results in adverse development on prior accident years and accelerating loss-cost inflation on the current year. PartnerRe continues its streak of underwriting losses. Reverting to type, the reinsurance market goes soft.
Staff turnover becomes a problem, with some senior staff leaving shortly after the deal, finding the environment uncongenial. Others are lured away by big offers in an increasingly competitive hiring market. Others still depart after two or three years when multi-year comp is paid.
Sizing up problems on multiple fronts, Covea decides it doesn't want to be in the reinsurance market anymore (as Exor did), and places PartnerRe up for sale.
Denuded of key staff, a depleted force – PartnerRe must find a buyer for a third time in 10 years. And it must find a buyer willing to trade with Covea for an asset focused on an unfavoured segment.
The deal announced yesterday opens up this depressing possibility.
Exor here may ultimately exit reinsurance with some kind of a return, satisfying its shareholders, but in doing so it is creating real risk to PartnerRe’s franchise, staff and clients.