The battle between the Agnelli controlled Exor investment firm and PartnerRe and Axis over the fate of the former continues. It certainly hasn't abated and if anything has increased in intensity.  

 

Exor lost a court case in Bermuda in which it was seeking access to the PartnerRe preferred shareholders. The Bermuda Supreme Court upheld Partner's argument that the reinsurer was not obligated to divulge the names of the owners of the preferred stock. 

 

Some observers saw this as a blow to Exor as the preferred shareholders compose about 41% of the voting stock that will be voting to approve or reject the merger with Axis on July 24.

 Last month, when we were assembling the May CATEX Reports, there had been no sighting of this preferred stock issue on the radar screen.  The issue popped up in public very quickly, and as news cycles permit these days, became what everyone was talking about for a few weeks.

 

We wondered about this. Preferred stock is a funny thing because in some ways it's really not like stock at all but more like a bond. The main interest of a purchaser of preferred stock is that the face value of the dividend rate on the stock continues to be paid. A preferred holder has little interest, we would think, in the business expansion plans related to a combined company which would increase common stock value. The more we thought about it we began to recall news stories concerning the sale of PartnerRe preferred from 2011 and 2013.  It had been the juicy dividend rates being offered back then that attracted our attention on page 139 of the PartnerRe annual report (7.25% and 5.875% respectively). 

 

From what we can tell the PartnerRe preferred stock is composed of three series of stock (Series D, E and F) which Partner sold in 2004 (6.5% dividend rate), 2011 (7.25% dividend rate) and 2013 (5.875% dividend rate) for a total of about $826 million. Each share of preferred has voting rights and the three series of preferred stock represent a little over 34 million voting shares.

 

According to page 174 of the PartnerRe prospectus filed with the SEC on June 1 there are over 47 million shares of PartnerRe common stock issued and a bit over 34 million shares of preferred issued.  The math works out so that the preferred represent about 42% of the stock that could vote in the July 24 proposal.

 

You can see why Exor wanted to be able to reach out to the 42% block directly. Their vote against the proposed Axis deal on July 24 will be critical to Exor. The Bermuda Supreme Court agreed with Partner that they were not obligated to release the names and contact details of so called "non-objecting beneficial owners".

 

We thought about this and remembered when GM and Chrysler went into bankruptcy in the US. The common shareholders had to get in line behind the creditors of the car-makers before they received any compensation. That's basic bankruptcy law --debtholders get paid first and secured debtholders get paid before anyone.

 

Even though the preferred stock issue was being discussed we wondered if there was other PartnerRe debt.  Debtholders usually can't vote, as can shareholders, that's one reason bankruptcy law protects them by putting them at the head of the line when corporate assets are divided after an insolvency. 

 

Were any PartnerRe creditors floating around and if so they would have a say in who was going to be paying the money owed to them in the future?  We would think that their only interest (like that of the preferred stockholders) would be to ensure that they were paid or that their dividend stream continues.

 

It turns out that there are approximately $750 million in "senior notes" that have been issued by wholly owned PartnerRe "special purpose vehicle" companies.  There are essentially no covenants attached to the debt, as to who it can be transferred to, and that the new responsible party only needs to sign a document assuming the guaranty which PartnerRe gave in the first place to backstop the debt.  So, officially, there would be no impediment to transferring that debt to any successor company --either an Axis or Exor entity.

 

What about voting? We found section 3.9 of the agreement between PartnerRe and Axis states that "There are no bonds, debentures, notes or other instruments of indebtedness of it or any of its Subsidiaries that have the right to vote, or that are convertible or exchangeable into or exercisable for securities having the right to vote, on any matters on which its shareholders may vote."

 

You can see why Exor really removed the restraints then after the Bermuda Supreme Court ruled they couldn't contact the preferred shareholders directly.  The purchasers of the $750 mm in debt have no voice in any merger, and can't block it even if they wanted to. But the 42% of those shareholders eligible to vote (the preferreds), can help block the merger but can't even be identified to be contacted by Exor. 

 

Worse, from Exor's perspective, PartnerRe was claiming that Exor's debt rating level would negatively affect both the debtholders and the preferred stock owners thus raising the spectre of them not continuing to receive the agreed to dividend stream.. S&P would later say that that claim was erroneous and that the Exor balance sheet would have no bearing on either. 

 

Nevertheless, in a hostile takeover like this what's an acquiring company to do?  (Ah, the dilemmas some of us face!) Well, after first blasting certain members of the PartnerRe board, accusing them of "engineering" the Axis deal as they stood to benefit "personally and financially" from it, Exor went on the attack. 

 

Because of the Internet, it's become easier for a company like Exor to reach out to the preferred stockholders even if Partner has successfully prohibited them from learning their identities and contact details. One has to assume that the "preferreds" are not disinterested parties and have been following the Partner-Axis-Exor discussion to some degree.

 

Exor seemingly calculated that an incendiary press release, accusing some of the PartnerRe board (including the interim CEO) of clear-cut conflicts of interest, would be enough to prompt any preferred shareholder to at least glance at it. Once anyone opens the press release there are several prominently displayed hyper-links inserted by Exor aimed specifically at the "preferreds" and also a FAQ document aimed exclusively at the preferred stock holders.

 

Exor's bottom line argument is that the Exor balance sheet, which will assume responsibilty for payment of the preferred debt obligations, is superior to the combined Axis-Partner balance sheet. Exor also argues that if the commitments that have been made publicly by Partner-Axis, to reward common shareholders with special dividends and stock buybacks, are carried out, then the newly merged company would actually be weaker than the current PartnerRe (and certainly weaker than an Exor-owned PartnerRe).

 

Keep in mind that Exor already owns 9.3% of PartnerRe common stock and has voting rights. The vote by PartnerRe shareholders on the Axis merger will require a simple majority of votes cast to defeat it. This means that Exor needs 40.8% of the common and preferred stock which casts votes on July 24 to defeat the merger bid. You can bet that Exor will be sure to vote its own stock.

 

The argument is laid out here.  It will be up to any preferred shareholder to read and then decide.  There is another little nugget buried away in the Exor argument to the preferreds and to the common stock holders. It's one Exor has noted from the start of its takeover effort but it's rarely been noted in the media except that Axis-Partner deny that it's an issue.

 

Exor has argued since PartnerRe is a so called "pure play" reinsurer, and has no insurer operations, that once merged with Axis (which has substantial insurer operations) PartnerRe would face backlash from other insurers who of course are now current purchasers of PartnerRe's reinsurance products.  We suppose the idea is that those cedents who are now reinsuring with Partner could stop if they see Partner as part of an amalgamated company that includes an insurance competitor to them like Arch.

 

Predicting human behavior is a dicey proposition and when you see predictions based on what one thinks a whole class of people might or might not do (the current PartnerRe client list) and the prediction is included in a formal financial presentation it seems a little out of place --or at least it did to us.  As a result we didn't pay much attention to it either.

 

That changed though when we read this story. The Insurance Insider reported that "the major relationship between Berkshire Hathaway and Suncorp looks set to be scaled back significantly as Berkshire's entry into the Australian primary market continues to create issues for its reinsurance business."

 

The article goes on to say that Suncorp "had been alienated" by Berkshire's decision to compete directly in the market where Suncorp has such a dominant presence.  Suncorp is said to be cancelling or concluding several big reinsurance contracts with Berkshire.

 

Warren Buffett has made no secret about his intentions for Berkshire Hathaway Specialty Insurance saying that "BHSI will be a major asset for Berkshire, one that will generate volume in the billions within a few years". Suncorp is a major Australian primary insurer and BHSI competes directly with them.

 Maybe Suncorp had been hearing rumors because just as we were writing this news came that Berkshire bought a stake in Insurance Australia Group, one of Suncorp's rivals and that BHSI will be underwriting 20% of IAG's commercial business. 

 Then we saw ACE go out of its way to reassure its own reinsurers that the existence of ABR Re, which it recently formed with BlackStone as a hybrid type of hedge fund reinsurer, has not strained Ace's relationships with any of its existing reinsurers.  Ace currently cedes about 75% of its reinsurance premiums to a panel of 10 core reinsurers.

 These two stories would seem to validate what Exor has been arguing. When you think about it why wouldn't a primary insurer be perturbed when at renewal their long-time reinsurance partner comes in wearing the uniform of a combined commercial and reinsurance juggernaut?

  We suspect that the theme we hit on in the May issue, that of "pure-play" reinsurers coming back into vogue, will continue to gain attention. Third Point Re's Rob Bredahl made comments to this effect when he affirmed that the company was not moving into primary insurance.

  This is a tough issue and there are conflicting views on it. Michael Sapnar, CEO of Transatlantic Re said earlier this month that the concept of an independent reinsurer (pure-play) no longer exists.  Sapnar said "Let's be clear --the reinsurance industry doesn't exist anymore. Reinsurance is now an arm of a company it's part of --it's a business unit."

 

Maybe Sapnar is right. His credentials are certainly better than ours but insurers are well aware that the commercial rates have not suffered to the same extent as the plummeting of reinsurance premiums. They have even increased their own reinsurance attachment points to keep more of that premium. 

 

When long-time reinsurance partners begin to appear at your door at renewal, and, oh, yes, also now happen to be part of a primary insurance operation which competes for your premium dollar, it may be that John Eikann at Exor will be proven right. Time will tell.

 Not everyone has the clout or pragmatism of Warren Buffett and Ajit Jain to dispense with the reassuring words and go ahead and try to beat people at their own game.

 It could be a lesson to be learned --we won't speculate by whom.

 

 

De-globalization is main risk says Swiss Re

We have a good friend, Brian Spooner. Ph.D., who is a long-time professor of anthropology at the University of Pennsylvania.  His main focus these days is "globalization". He defines that as the increasing rate of change, encountered by humanity, as ever-increasing numbers of people interact with one another in increasing numbers of ways. 

He argues (he is an anthropologist) that globalization has been with us since the earliest communities were formed. People within a community would talk to each other. Later they would talk and interact with other communities and ideas would be exchanged. Change would occur --whether the implementation of a new tool, a new social custom, different planting method and so on.

Indeed some could argue that the whole arc of history could be traced by when ideas were passed off to others and by whom. We have a regular video chat that follows this discussion in relation to modern day events. 

Our friend's observation about globalization, today in 2015, is that it's entered its crucial phase. By that he means that change is occurring so quickly amongst all of humanity that we are moving closer to a completely interdependent society on a global scale. In fact Dr. Spooner has edited a book that was recently released titled "Globalization: The Crucial Phase". The book, quite frankly, should be read by any underwriter concerned with the next 50 years. As you will see below, it is remarkably coincidental with what long-range thinkers at Swiss Re are working on.

You need only remember those photos of horseback-riding Taliban members with cell phones glued to their ears or the explosion of Twitter messages after the Iranian election in 2009 to see that more people are interacting with one another to begin to suspect our friend is correct.

There is no doubt that humanity as a whole is on a high speed train to somewhere and at each stop it picks up more passengers. There are too many communication tools to deny communication and interactivity to anyone.

Naturally the insurance and reinsurance industry has picked up on this trend. The increasing velocity of change affects everything --increased numbers of urban risks, increased potential life and health insureds, increased spectre of drought and pollution disaster --the list is endless but Swiss Re has made a good effort in compiling a list of what they believe the industry needs to be watching.

The number one emerging threat Swiss Re's report identifies is something they refer to as "de-globalization".  By that they mean that the era since the end of the Cold War (the early 1990s) is ending.  That era, Swiss Re observes, was marked by world governments limiting themselves to "principle-based regulation" instead of "hard" actions like invasions, sanctions or other "strong interventionist tendencies".  

These "interventionist tendencies", Swiss Re fears, could wreak havoc with global financial systems, compliance matters and the disruption of the free flow of capital.

Swiss Re says that one symptom of "de-globalization" is the "upsurge in populist and nationalist parties, eventually intensifying the threat of more protectionist and legislation in the near future". The study notes that "In Europe, these could trigger territorial separatism (eg Scotland or Catalonia and eventually undermine integration projects such as the European Union and the Euro area."

It's pretty hard to disagree with that point. Nationalistic tendencies are emerging everywhere. In fact we would argue that there is even more conflict due to social/cultural and religious groups who are dissatisfied with supposed "national" governments who have authority over the areas in which they live.

This type of more localized conflict --tribes or social/political groups versus the government that controls them --we see everyday. Pakistan, Iraq, China, Syria and many countries in Africa have internal struggles they are dealing with, often violently, every day.

Oddly, we view these struggles to be a symptom of globalization rather than de-globalization. We think it's precisely because these previously unheard interest groups are now connected to more contact with the rest of the world that they want to achieve what they see others have achieved.  

Their goals could be a separate state, inclusion in the current government or more important (and this is the scale-tipper) economic equality.  If you don't have enough to eat every day but are able to see images of modern life in the West on your iPhone, and communicate with other people around the world by Twitter and texting, how long is it going to be until you become politically active?  Not too long we think.

Connectivity and contact is increasing at an ever-faster rate and the dissatisfaction of those who feel oppressed will only increase. Swiss Re is probably being conservative. We think that we will be facing an increasing number of clashes between local interest groups and the national governments that control them.  The empowerment that technology has provided to even the most remote and smallest groups has indeed connected them but it has also awakened them to what is possible.