re: low, low risk - 40% upside This puppy reports Thursday -...

re: low, low risk - 40% upside This puppy reports Thursday - good prospect of a capital return of 5 - 7 cents . .. . could well be fully franked.

If you are interested, look back over my previous posts under the old code RAC, and have a read of the article below from Reactions.net.


July 2005 - Features << Issue Index

Reinventing ReAC

In March this year, Australian reinsurer ReAC, which has been in run-off since 2000, successfully relaunched itself as a general insurer. Its new chief executive Nick Kirk explains the transformation to Wyn Jenkins.

When Australian reinsurer Reinsurance Australia Corporation (ReAC) closed its doors to new business in early 2000 following big losses and a plummeting share price, it marked the end of an era for the Australian reinsurance market. The company's failure followed those of fellow Australian reinsurers GIO Re and New Cap Re in 1999. Since then, QBE has been the only Australian company offering reinsurance and most of its business is written overseas.

The failure of these companies sparked intense speculation about how three Australian reinsurers failed in two years. A series of natural catastrophes, including hurricanes Mitch and Georges in 1998 and European windstorms Lothar and Martin in 1999, played a big part.

But many observers blamed the companies' underwriting strategies, saying they took on big risks for too little reward. Some also claimed the companies were too far away from where the risks originated to monitor them properly.

Once the dust had settled, however, few expected to hear much about these companies again. It was a surprise to many, therefore, when ReAC revealed in 2004 that it was seeking to start writing business again – this time as a general insurer. It appointed a new chief in March 2004 and started working on a business plan that, it hoped, would culminate in it receiving a licence to operate as a general insurer.

Its main shareholders never lost hope of salvaging something from the company. And they are now well on their way to succeeding. The company has renamed itself Calliden and it received its licence from the Australian Prudential Regulation Authority (Apra) in March 2005.

From plan to reality

The concept of rejuvenating closed companies is not unique. For regulatory reasons, it is often easier for investors to recapitalise the shell of an old company than form a new one. For example, Australian firm Asset Insure bought German insurer Gerling's old Australian reinsurance operations and licence and has built a general insurance business around that.

It is possible to structure such arrangements so that any run-off business is kept separate from the new activities. This is what Calliden has done. It is a single public company with a single management team, but it contains two licensed entities. Calliden Group contains the balance of the run-off portfolio and Calliden Limited looks after the new general insurance business. This ensures the new business and its capital are protected from any liabilities from the old.

The result is that, although Calliden has the same listing and the same main shareholders as its former incarnation, it otherwise bears little resemblance to the old ReAC.

Accordingly, Calliden's new management prefers to try and distance itself from its history. The company now has fresh capital and a new business plan: it writes only domestic, specialised general insurance through brokers.

One of the most important steps in this transformation was the appointment of a new chief. Geoff Vines had been chief executive of ReAC since 2000 and had run the company's self-managed and voluntary run-off procedure. He stepped down to make way for the next stage in the company's history.

Nick Kirk, Calliden's new chief, was working as general manager of speciality for Vero, a division of Australian insurer Promina, when he was approached by an agency recruiting for ReAC. Kirk had spent much of his career at Royal & SunAlliance before it spun off its Australian arm to form Promina.

"It didn't really faze me," says Kirk, when asked if he was worried about working for a company with ReAC's history. "My decision to take the job was based on whether there was the capital to start a general insurer. I knew about ReAC. But I also knew the principal shareholders. I knew they were serious people.

"Plus, you do not get many opportunities to build a new general insurer from scratch. The opportunities you get are never going to be perfect. The focus for me was always going to be on the future and not the past."

At that time, the company had secured the backing of two investors: an Australian property trust and Hunter Hall Investment Management, a long-term shareholder in ReAC that has previously expressed its belief that the company could be turned around. The company believed there was an opportunity to operate as a niche general insurer. But it was Kirk that took over that initial idea and turned it into a solid business plan.

"When I arrived there was certainly an idea," says Kirk. "There had been some research done and there is some similarity between what had been done up to that point and what we have now. But we started again pretty much from scratch. We used the material but started again."

Kirk and the existing team at Calliden spent the next six months researching and refining the original idea. The team spent a lot of time identifying what and where customer demand was. Kirk says he spent hours on the internet studying business models for Calliden's target market in other countries. He also spent a lot of time familiarising himself with Apra's and other regulators' requirements for getting a licence.

Perhaps surprisingly, getting the general insurance licence did not create a lot of extra effort. Kirk says that the work needed to satisfy the requirements for a licence was basically the same as that required to set up the company, so there was little duplication of effort.

The company took shape gradually. "It just came together," he says. "There was a moment when the momentum of the idea was such that you could see it was a matter of when rather than if. It is a moment when the research starts to gel and you can see the customers will be there. It all starts to fall into place.

"I couldn't put my finger on a date but it was a good three or four months into the process. From all the research that we did, the shape of a business started to emerge. It then slowly became more sharply defined."

An important part of the plan's execution was getting the right people on board. Kirk says he expected this to be one of the toughest challenges but he was pleasantly surprised at how well it went.

"It was really funny with hiring," he says. "It is certainly not an easy market to hire in – there are simply not that many experienced insurance people in Australia. But looking back, it was nowhere near as difficult as it could have been. I think that was because of the same reason I joined – an opportunity like this does not come along very often. As a result, we attracted some very good people, who were attracted by the challenge of building something new."

Once the people and the capital were in place – Calliden initially allocated A$40m ($31m) to the new business – it then had to wait for Apra to grant its licence. When the licence was finally awarded, Kirk experienced a mixture of elation and trepidation about what was to come next.

"By the time we got the licence we were raring to go. It was a relief. But to be honest, we also knew the hard work would really start now. There was a tremendous amount of excitement but when you get the licence, that is when the going gets tough – you have got to get out there and make it happen. It is very easy to make money out of a spreadsheet. It is not quite so easy to make money out of an insurer."

Serving the neglected

Calliden's idea is fairly simple. The Australian insurance market is dominated by large companies – five players control about 80% of the market. Many of these big players find it difficult, Kirk says, to underwrite risks that are unusual or not easily quantified.

This is especially true if these risks come from small and medium-sized companies. The premium these firms pay is not big enough to justify large insurers spending a lot of time understanding their risks.

Calliden plans to exploit this area that the larger firms have neglected. Kirk believes there is a niche for Calliden to write business in the markets for small and medium-sized enterprises and specialist personal lines.

The company will not write individual risks. Instead, it will concentrate on covering special interest groups and associations that pool their members' risks and buy insurance on their behalf. Kirk notes that many of these groups are having trouble finding affordable coverage.

"The big insurers have their own way of dealing with small and medium business and what they do is pretty bloody good," Kirk says. "But there are many occupations and types of risks that simply don't fit their model. As a consequence certain groups struggle to find insurance that meets their needs. Many have ended up with overseas insurance."

He says there are many associations in different areas of the building and construction and leisure industries, for example, that have had difficulty finding coverage. He notes that this has been especially true in the not-for-profit industry.

Despite the obvious gap in the market for this type of coverage, Kirk is unconcerned about the potential for increasing competition. "I don't see any competitors to get too worked up about," he says. "They have chosen not to cater for these areas because it does not fit the way they do things and I see no reason why that will change."

As well as being a relatively untapped niche, providing coverage to interest groups and associations brings several benefits to Calliden.

After years of struggling to find suitable and affordable coverage, many associations have assembled comprehensive records of claims in their market and have improved risk management practices. This gives Calliden a lot of information that it can use to assess risks. Kirk says that many of the brokers his firm will use have also gathered information on these clients' unusual risks.

Another benefit is that associations pool their members' risks. This ensures Calliden gets enough premium to justify assessing and writing the business.

"That is the reason we are only looking at groups and associations – so we are not doing research for a one-off policy that, on its own, does not pay much premium. We are looking at business that will generate a level of premiums that will allow us to spend the time finding out more about it," says Kirk.

He estimates Calliden's target market has a premium volume of A$5bn. It is also stable, profitable and does not experience the pricing fluctuations common to other lines of business. He expects the portfolio to comprise roughly 50% long-tail lines such as professional indemnity and public liability, and 50% short-tail lines such as property and motor.

Calliden will only sell its products through brokers. It believes it can cover between 80% and 90% of its target market this way. This will keep costs down for the company. Its main office will be in Sydney, New South Wales, but it plans to have a couple of people based in Victoria.

Kirk is wary of revealing the company's financial targets. Calliden hopes to write A$60m of premiums in the first 12 months and have an annual premium income of more than $200m in five years. It is also targeting a return on invested capital of between 12% and 20%. But Kirk will not elaborate on his financial goals further.

Selling the idea

Kirk's job now is to convince brokers in Australia of Calliden's merits. Kirk and his management team have been conducting presentations to brokers all over the country since the licence was awarded. Kirk says it has gone well so far.

"Without exception, the reception has been extremely positive – assuming brokers are not saying something different when I leave the room," says Kirk. "I would say that, wouldn't I? But it really has been good. It is an area where there is genuine interest – not from every broker by any means – but there is a demand for it and they are interested in something new."

Some believe that for brokers to take Calliden seriously, it needs a rating. But Kirk disagrees. He does not believe a rating is essential for the type of business his company is targeting. Its listing and licence have been enough to win the support of the big brokers, Kirk says. He has no immediate plans to seek a rating but he will consider getting one in the future if he believes there is a benefit.

When the Australian insurance market first became aware of the imminent return of ReAC in 2004, many observers were sceptical about the idea. Many of the company's peers believed ReAC to be a tarnished brand and, even without this handicap, they saw few opportunities for a new player to compete successfully in the market.

Gradually, however, this mentality has changed. Many executives at reinsurers and reinsurance brokers still find ReAC's return extraordinary. But many primary insurance brokers now welcome the company's return. "With a new name and a new story, our clients will consider them," says one broker at Willis.

Kirk's presence at the company seems to be a big boost to its credibility. He seems to be universally respected in the market. Even Calliden's potential rivals appear to have warmed to the company because someone they respect is in charge.

"I know Nick by reputation and I don't believe they will be cowboys," Raymond Jones, chief executive of QBE Australia, told Reactions earlier this year. Others in the market have described Kirk as "very smart" and "a good executive".

The company appears to have done an excellent job of putting the past behind it. It recently launched a marketing campaign aimed at establishing the Calliden brand in its target markets. And Kirk says that people now view Calliden as essentially a new company that offers a different and much-needed product.

"I haven't had a question on ReAC for a long, long time," says Kirk. "In the presentation we make it very clear where the capital has come from. And the brokers we deal with won't have dealt with reinsurance much anyway. There seems to be a genuine desire among people to see this succeed."

Calliden has come a long way in the past 18 months. It has successfully transformed itself from a run-off reinsurer into a general insurer, and has garnered the support of brokers.

But it has not left the past behind it completely. Its portfolio of old reinsurance contracts is still running off. However, the run-off is going well. At the end of 2004, it had commuted policies with 828 clients and cancelled 15,614 reinsurance contracts. It says this leaves only a small number of clients.

The reserves for its remaining contracts are now only A$13.5m, compared with A$50m at the end of 2004 and A$1.1bn when the company first went into run-off. Kirk admits he is looking forward to closing this chapter of the company's history. "It would be nice to complete the run off," he says.

The run-off book also made a A$10m profit in 2004 and increased its shareholders' equity to A$86.7m from A$76.7m at the end of 2003. Of this, A$22m is needed to support the run-off operations and A$50m has been earmarked for the new operations. Of this, A$40m has already been invested. The company is talking to Apra about how its excess capital might be used.

However, it expects to make a A$6m loss for 2005. This is because of the start-up costs associated with establishing Calliden and the fact that the new firm could only write business for eight months of its first year.

Even so, Kirk is confident Calliden will work. He says he has never doubted that he made the right choice in leaving Promina to run the firm.

"I had no fixed view of what it would be like – I have never started a general insurer before," he says. "But I would not go back to my previous job. It has been a lot of fun. There are so many challenges to keep you occupied. We will make this a success – we are absolutely determined. We will make sure a positive addition to the Australian market and enjoy the challenge along the way."