Cheapest Cost of Capital is King

Cheapest Cost of Capital is King:

In the race of disruptors, at the end of the day – it comes down to one thing -capital.  The cheapest cost of capital is king.

 

Why was Amazon able to disrupt the retail sector?  Did they immediately come in and disrupt?  No…it was long term price disruption, which built brand loyalty, and allowed for better user experience, products, etc.  Amazon shareholders were in it for the long haul, and were not looking for quarterly gratification.  The stock price continued to rise with capital being redeployed into the business.   In essence, their capital was cheap enough to allow for Amazon to build it’s platform at the expense of shareholder returns.

 

In today’s insurance world, there is a competition to become that same disruptor.  There aren’t too many insurance stocks that trade as growth companies – the AIG model of 15% growth each investor call has not been replicated.

 

One problem arises when applying the Amazon model to Insurance, XYZ manufacturer knows their Cost of Goods sold (the cost to product their product), and can discount their sales price to provide less margin in an effort to support growth.  Hence if you think you are selling the product at a 10% discount with 5% of margin, and in reality you sold it at a 150% loss – it gets tricky.

 

Compare that to the InsurTech start ups of today, the cost of goods sold – is always unknown at the time of sale, discounting this number can be a risky venture.  But if your cost of capital is cheap in enough and willing to withstand the pain for enough time, in an effort to see the long term gain… Checkmate.

 

This race, is a marathon.

 

Here comes the kicker.  The cheapest cost of capital is king.

 

This capital is coming in all different forms and structures -with different return requirements.

 

Whether that be in return period or expected returns for the capital being cheaper, the capital matching only the risks it seeks for a lower return, or securitization of insurance products and services.  The period of low interest rates and abundance of capital has allowed capital from all over the world searching for yield.

 

As mentioned in one of our guest articles, this is the Uber of Insurance.  The speed and ability to deploy capital and match it to risk.  That is the biggest disruptor thus far.

 

Now if it chooses to seek InsurTech platforms and partner long term, or seek incumbents with proven portfolios or historic returns.   It will probably be both.

 

Value creation will be measured by the ability to deploy capital and seek appropriate returns for the risk taken.  The days of Scale for the sake of Scale are over.  The days of hiding casualty underwriting errors in the profits of property successes have evaporated.

 

Many types of Insurance company expenses like executive perks, expenses, etc. will eventually go the way of the dinosaur.

 

Companies will have to deploy capital quicker and cheaper to their clients.

 

You will have smaller firms with less infrastructure managing more capital on behalf of investors and creating value in a much more efficient manner.  Think about the small hedge fund strategy.  This may pose risks to the reinsurance industry as we know it today.  Reinsurance firms will likely have to pivot and embrace unknown risks or the unknown unknowns to provide capital to bigger unknown threats like Cyber.   Or face returning capital to shareholders – as the easily modeled perils/risks are trading at different returns due to lower cost of capital pressures.

 

One of the best interviews seen thus far is with Samir Shah, CEO of Ledger Investing, where he talks about the disruptive nature of capital and Insurance linked securities.  See the article here.

 

This topic isn’t the end of the industry, nor will the technology alone cause the end of the industry, there will always be the need to have risk supported by risk based capital.  There will be opportunities to provide value throughout the chain -technology will enable these firms to provide it at low costs and greater speed.  This will cause firms to accumulate larger capital pools to manage on behalf of clients as well as larger risk pools and distributions to source.

 

The question becomes – are you positioned with the lowest cost of capital to maintain relevance?

 

How can you lower your capital?

 

As we know about success and competition, if you aren’t constantly improving and the organization isn’t staying relevant into the future – your competitors are…

 

Stay focused, push forward, and like a Shark always keep moving.

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