Over the last two to three years, the insurance industry has seen an almost unprecedented wave of mergers and consolidation. Bermuda and its high growth insurance industry have not been spared in this period. Indeed, some of the more interesting and innovative transactions have occurred recently with Bermudian companies being either the buyer, seller or, in some cases, both comment Alan M. Levin and Don Watson.
This drama was launched in 1996 when ACE Ltd, emboldened by new ceo Brian Duperreault, acquired Tempest Re, at that time the seventh largest of the island's eight catastrophe reinsurers. The move was well thought out and made eminent sense; at one stroke, ACE bolstered its capital by 42% and significantly diversified its product portfolio. After the acquisition, ACE Ltd added a property business contribution of approximately 18% to a revenue base which had been nearly 100% excess liability.
A year later came the acquisition by EXEL, Ltd of Global Capital Re (GCR). In this case the motivation was similar to that of ACE, but there were some differences. While ACE benefited from the all stock deal to acquire Tempest in that the capital base of ACE increased significantly through the transaction, EXEL did not add to capital, but instead redeployed what many had come to regard as excess capital in the all cash GCR deal. In addition, whereas ACE had little property exposure prior to the Tempest acquisition, EXEL had for some time been building property exposures organically, and the acquisition of GCR only accelerated that trend.
In January of this year, ACE acquired Westchester Group in the United States which gave it an opening to the US market on a more direct basis. More recently, both ACE and EXEL made significant moves to solidify their now more diversified books of business. EXEL moved to acquire the shares in Mid Ocean it did not already own through a tender offer, and ACE announced the acquisition of CAT, Ltd, for cash. When these transactions are completed, both excess liability titans will have transformed themselves into specialist companies with highly diversified business profiles.
What caused companies to merge?
By far, the most common reason given for mergers has been the competitive insurance market, and the consequent desire on the part of managers to realise economies of scale. In essence, if they cannot grow in the basic business of providing insurance, growth can be achieved through acquisition or merger. This motivation was clearly a large part of the CNA/Continental and Travelers/Aetna mergers in the US, the AXA/UAP, Royal/SunAlliance and Commercial Union/General Accident mergers in Europe. There are many truths to these thoughts, as indeed the 10 plus years of price competition has left the industry with few apparent unmet needs, and buoyant investment markets have left many companies with the strongest balance sheets in memory.
Armed with an abundance of capital and little prospect to employ it profitably by writing new business, management must choose either to redeploy the capital in another venture or justify not returning it to the shareholders. Indeed, many observers would suggest that the only real option is to return the capital to the shareholders, as they should be the ones making the choice on redeploying capital in other ventures. We will not comment on the right answer to that question, but it seems clear that many management teams are reluctant to return the capital to the shareholders, and thus, growth through acquisition is the option toward which many are turning with increasing frequency.
More mergers coming?
While we are reluctant to gaze into the crystal ball, it seems clear that with no end in sight to the competitive conditions and with the industry coming off what was nominally a very strong year in 1997, there is little reason to expect a change from the trend. In fact, as is often the case in these matters, the next transactions will, in all likelihood, be larger and more sweeping in their scope, as with the Travelers/Citicorp deal, if only because the main participants in this activity themselves are getting larger. Therefore, it takes an ever increasing acquisition target to generate significant savings or to add significantly to the scale and scope of the enterprise.
In addition, as insurers merge and become larger, brokers have also merged and become larger themselves, partly so they can stand toe-to-toe with the new, larger insurers. Similarly, reinsurers have combined, so that they, too, can be large enough to satisfy the needs of their clients, which, of course, encourages further insurer consolidation to allow insurers to negotiate on a more level basis with the larger reinsurers, and so it goes on.
Companies in Bermuda have a distinct additional advantage - taxes. While in most of the world, insurers like all business enterprises, must pay one-third to one-half of their operating income to the tax man, companies in Bermuda (and certain other tax friendly jurisdictions) have the ability to generate capital 50%-100% faster. This capital can, in time, be used to finance acquisitions all over the globe. Some have remarked that Bermuda is the optimal location for a holding company for this reason. Clearly, anything that provides a competitive advantage can and will be used by management. We do not expect this to be an exception. Thus we anticipate that Bermuda based companies will continue to be active participants in the world trend toward consolidation.
Alan M. Levin is managing director and Don Watson a director of Standard & Poor's Insurance Ratings. Tel: Mr Levin +1 212 208 1686 Mr Watson +1 212 208 8446.