Mutuals turn to surplus notes as a replacement for reinsurance

The insurance industry looks set to bring more business to investment bankers in 2024 and beyond as mergers and acquisitions (M&A) activity reheats, the initial public offering (IPO) market increasingly opens for business, and new ventures may raise funds.

So say top leaders at Stonybrook Capital, an investment banking strategic advisory dedicated to the re/insurance industry. Managing directors Paul Kneuer and Paul Dzielinski are riding that rising tide and seeking possible deals at APCIA in Chicago. They see business brewing, they told APCIA Today.

“Insurer financial activity has ticked up and is expected to continue to rise,” Kneuer said. “Driving the need for capital are growth, generational shifts in ownership and more,” he said of his primarily SME clientele. 

“Buyers have stepped forward with greater appetite.”

The M&A pipeline is “definitely growing” following a cooler period where deal flow had been stymied by a number of factors including the war in Ukraine, inflation, oil prices, and tensions in the Middle East. 

“Things have picked up a bit,” Kneuer said of what he calls a “record year” for M&A at Stonybrook. “The pipeline is very solid.”

Buyers have stepped forward with greater appetite for deals that in some cases have been in the pipeline for some time. “An expectation of an improved cost of finance and, directly or indirectly, the opening of the IPO market opens exit opportunities for private equity (PE) investors,” Kneuer said of drivers on the buyers’ side. 

Sellers had long been ready to do deals. The desire for growth or to rebuild some balance sheets have been long-standing needs. Stonybrook is currently working with a major player hiving off a non-core portion of its portfolio. “There’s no particular evolution in seller needs; they just haven’t been able to execute,” he said.

The opening of the IPO market could allow exits by PE but it may also bring debuts from brokers and primary carriers, Stonybrook adds.

Using the niche

Stonybrook’s specialty has been in the niche financing market which mutuals have been leveraging at an increasing rate, including to ease the pain around an ever-costlier reinsurance market, Dzielinski added.

Surplus notes, a debt instrument that can offer a solvency boost if the duration is long enough, is a Stonybrook specialty. Its usage has grown among smaller mutual insurers, including as a replacement for pricey quota share reinsurance.

Stonybrook calls itself “one of the biggest bankers in the surplus notes space”. It claims its buyer database is the largest on the market.

“Demand for surplus notes has been increasing over the last two years, largely storm-driven,” Dzielinski added, citing “quite a bit of dislocation in the small mutual market” in Midwestern states. Much of this has been because of losses stemming from severe convective storm perils including tornados, hail and more. 

Stonybrook calls the product “a potential substitute for quota share reinsurance”. Kneuer cites one recent deal and one underway where the mutual insurer presented its stance as a “conscious choice” between surplus notes and quota share. “The insurer choose surplus notes.”

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