Rumours that Ariel Re is a frontrunner to buy Lloyd's insurer Talbot Underwriting could signal the start of M&A fever in 2007, predicts Mairi Mallon. Particularly in the wake of new Florida legislation.

Scor and converium, ariel and Talbot - takeover talk is once again the stuff of industry gossip. Not that it has slowed down in any way since last year. Mergers and acquisitions (M&A) were high on the agenda in 2006 with a softening market everywhere and hurricane-affected US coastal areas already peaking, there seemed little room for organic growth. Added to that, the regulatory bodies and rating agencies demonstrated their preference for well-diversified portfolios across different lines and geographies. Along with the weak dollar, M&A activity seemed logical.

There was a huge amount of M&A speculation during the past year. Were St Paul Travelers and Zurich Financial Services teaming up? Was there a deal to be done between SCOR and Axa? Was a takeover on the table of Royal & SunAlliance by either Berkshire Hathaway or Axa? And was there going to be a merger or acquisition involving Wellington and Aspen or Kiln?

Some of the headline deals that actually made it were Swiss Re buying General Electric's reinsurance arm, GE Insurance Solutions (announced at the end of 2005), SCOR's purchase of Revios and Catlin's takeover of Wellington. Despite the ones that fell by the wayside, in 2006 there were a total of 157 M&A transactions in the insurance and reinsurance world worth a total of $31.2bn - averaging out at $297m per transaction, according to mergermarket, an independent M&A intelligence service.

Florida's shock ruling

Moving into 2007, there are no signs that M&A activity is slowing down soon. In fact, the pace seems to be gaining momentum. SCOR is aggressively targeting Converium, although the Swiss reinsurer has reiterated its rejection of the "unsolicited offer" by SCOR of the whole of the share capital of Converium (on 19 February, SCOR announced it had bought 32.9% of Converium's share capital). And having won back its "A" rating, Converium is in an even stronger position to continue to fend off SCOR's advances.

The dearth of hurricanes during the year has also fanned the flames of a potential M&A frenzy, leaving many companies cash rich for 2007. Now, with events in Florida last month, diversification will have climbed higher up the list of priorities for many companies. The new Florida legislation will nearly double the size of the state-sponsored catastrophe insurance fund and allow the state's insurer, Citizens Property Insurance Corporation, which has dramatically increased its claims-paying resources, to offer homeowners cheaper rates than private insurers. It is expected to reduce the world reinsurance catastrophe market by around 15% or by up to $2bn.

This will have a severe impact on those Lloyd's and Bermudian insurance and reinsurance companies which rely on the profitable US coastal catastrophe business. Although Bermudians, which write around 35% of Floridian homeowners reinsurance, will be hit hardest.

Not only will it impact the new Class of 2005 in Bermuda, but it could also affect more well-established mono-line reinsurers, including stalwarts such as IPC Re. According to AM Best, new capacity in the form of Bermuda start-ups and sidecars will become an increasing source of competition in Europe, given the recent events in Florida.

Miles Trotter, analyst with AM Best in London, said the legislation, signed in Florida by new governor Charlie Crist, will increase the potential for M&A activity, both in Lloyd's and the London market and in Bermuda. "It really comes back to reducing opportunities in the market and the lack of availability of opportunities for organic growth," he said. "We have got a softening market for non-cat lines and cat lines have peaked. As a result of this change (in the Florida legislation) there will be less reinsurance business available to private reinsurers and less demand for private market products all round. So you have added pressure as a result of that factor, as an impetus of looking into M&A as an alternative to organic growth."

Trotter said it was "an obvious trend" for Bermuda mono-line reinsurers to start looking at London. "I think there are reasons why the Bermuda companies might look at the London companies in any case, and this change in Florida is an additional spur under the general heading of reducing opportunities for the specialist reinsurers," he explained. RenaissanceRe has already stated that it expects its premium income to go down in 2007, citing a softening market and the events in Florida as reasons. RenRe revised its annual premium forecast for its catastrophe unit from 15% growth to 10% in 2007.

Squeezing the industry out

Other executives in Bermuda have spoken about the challenges posed as a result of the Florida legislation. It is seen as effectively squeezing international insurers and reinsurers out of the catastrophe excess-of-loss market in the state in order to reduce the cost of insurance for homeowners. While some have questioned the wisdom of Florida's move, particularly if it is hit by a damaging year of losses that its state funds will not be able to absorb, companies are preparing for a year of challenges.

"We recognise the uncertainty created by recent legislative changes in Florida which will reduce demand for some of our products," said Neill Currie, RenRe CEO. "We are responding as we have in past cycles by shrinking in areas that do not meet our standards and growing in areas that we find attractive. Overall, we are now expecting our top line to be down slightly in 2007 versus 2006."

Other Bermudian reinsurance companies announced they were looking for ways to offset the lost business in Florida, including Everest Re and Endurance Specialty Holdings. Everest expects to lose $50m of catastrophe premiums in Florida this year according to Tom Gallagher, president and chief operating officer. He said: "Florida was a big part of the 'cat' world. It was throwing off some very healthy rates on lines. Two billion dollars was big chunk of the worldwide cat premium. There is no simple way to get another exposure from Florida to offset that." Everest CEO Joseph Taranto described the situation as a "new curve ball". He added: "How this will shake out in the short and long term is unclear and will depend on evolving issues, certainly including future hurricanes."

Kenneth LeStrange, Endurance Re chairman and CEO, said there could be a redeployment of capital towards commercial insurance and other types of "personal side" reinsurance. Endurance's "peak" exposure in Florida could diminish against its exposure in California and LeStrange said the company is also looking to expand into the "less catastrophe-exposed" side of the market.

AM Best is now adding warnings to some of its company ratings. When issuing a release on Bermuda start-up Ironshore, it pointed out that the change in the law in Florida could impact Ironshore's business. Initially aimed at the US Gulf Coast as its main source of business, Best believes that rival start-up reinsurers seeking alternatives to Florida might provide added competition for the Bermudian company. "It's hard to speculate on how things will play out in Florida," said Ironshore's chief executive officer Robert Deutsch. "I'm not in favour of the legislation. I believe it distorts the marketplace and people end up paying unfair rates for coverage."

David Greenfield, the chief financial officer of Axis Capital Holdings said the company was considering the potential impact of market changes, "including the recent Florida legislation, amongst other items, on our capital utilisation overall. At this time, we have no plans to undertake a major capital management initiative."

Axis CEO John Charman estimated the company would lose about $10m of premium, less than 2% of total reinsurance premiums. He said: "We will, of course, be meeting with clients in the upcoming weeks and months as we continue to analyse the broader ramifications of this legislation. But it is early days yet."

Diversification game

Taken as a whole, these statements are a clear suggestion that many companies are already looking around to find new ways of making up for the lost income. Deputy CEO of Guy Carpenter's UK operation, Nick Frankland, agreed that a market already ripe for M&A would now heat up even more. "I think we suspect there will be more M&A activity in 2007," he said. "The changes in Florida and the withdrawal of relatively large swathes of catastrophe income - and very high-value income at that - from the reinsurance market is going to certainly leave some more than others, probably Bermudian cat writers, somewhat short of income and equally short of spread."

Referring to RenRe's anticipated reduced demand as a result of the Florida events, Frankland agreed it would "undoubtedly have an impact on their profitability for the year or their targets". He said the same would probably apply, but more dramatically, to the newer wave of Bermudians in the Class of 2005. But the "older guard", ie the broadly mono-line model, could also suffer "when losing Florida income is going to look even more exposed for highly volatile business bet".

While Florida legislation is the most recent key driver that may accelerate M&A activity in 2007, Frankland insists there were already factors pushing mono-line Bermudians to seek diversification and hence to consider M&A. "What with rating and regulatory pressure and scrutiny increasing, diversity was already on their agenda and this will probably hasten (the efforts of) the new entrants such as Validus, Flagstone and all the other such entities." He said the combination of mono-lines in a bid for greater diversification and the new Florida legalisation had created "a climate that would suggest that M&A activity would occur."

Lessons from the past

But back in 2002, with the post-September 11 Bermudian start-ups, there was plenty of speculation that there would be consolidation through M&A activity. The market, however, was still smarting from legacy issues from acquired business, which while it had made companies like XL Capital global players, had left them with some big headaches in certain lines. There was also a long list of strong characters and big bank balances backing up these companies, meaning that much of the management at the time was averse to merging or being swallowed up by larger entities.

The most recent shoal of start-ups from 2005 are similarly backed by strong figureheads, and their backers - many of them hedge funds and private equity firms - have even bigger pockets. Instead they may look for diversity by buying up smaller divisions, or parts of operations. A good example of this is Arch Capital, which recently opened up a European office in Zurich. It has also just bought up a team from Danish Re based in Copenhagen. But Arch is a highly established business, with not only reinsurance operations in Bermuda but also insurance operations in New York and in the UK, so was already broadly enough based to start up in Continental Europe. Others are not so well spread-out.

Frankland said: "I think what you may see is the Bermudians looking abroad and seeking diversification away from the dollar as an exposure into all things non-dollar. So you could see those that are not already entrenched in many lines or many territories looking to buy or acquire, I would think, one of the Lloyd's businesses." He confirmed the current spate of rumours circulating the London market that many of the good and great of Bermuda are currently in town sizing up the opportunities. At the time of going to press, rumours that Ariel Re was looking to buy Talbot Underwriting remained unconfirmed. "We have heard over the last year a number of enquires have been made by Bermudians, not necessarily to acquire business, but to look at where they may play in other businesses, either take a strategic investment or hire a team." Frankland added that due to concerns over a softening market in long-tail business this may also affect where M&A interest is shown. "I think they are all watching. There was concern about diversification into non-US property business - there is not enough property business in the world for them to buy into."

Recent loss ratios in long-tail lines, however, have been stellar and this is making buying in this area increasingly attractive. A business like Novae may now be seen as an undervalued Lloyd's business. With its UK regional platform it is largely a long-tail insurance business with a proven track record - and attractive for a Bermudian buyer. Along with Talbot, others considered good buys at Lloyd's include Chaucer, Aspen and Kiln. What seems likely is that the volume of M&A activity will increase in 2007 but whether there will be a bun fight to grow, or whether teams will simply be cherry picked, is hard to tell.

- Mairi Mallon is a freelance journalist.


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