In February, Global Reinsurance ran a survey on the potential for mergers and acquisitions in the industry in 2007. Peter Joy presents the results.

The first issue the questionnaire addressed was that of how many firms are currently in M&A discussions. An unusually high number are, it seems. While only 44% of respondents said their firms were definitely not involved in M&A discussions, 36% said they definitely were (and 20% didn't know).

Paul Lumbis, an insurance M&A specialist with Ernst & Young, thinks 36%, although unusually high, tallies with what he's been seeing in the market

"The benign 2006 hurricane season has produced a lot of spare cash in Bermuda and that has definitely heated up the market," he says. On top of that, there is intense strategic interest in many segments of Lloyd's. New legislation in Florida, which removed a significant chunk of business from this important catastrophe market, may also lead re/insurers to accelerate entry into new markets.

Respondents were also asked whether they expected to see more reinsurance and insurance M&A deals completed in 2007 than 2006. In all, 80% of respondents said yes and only eight percent said no.

Lumbis doesn't see the M&A boom outlasting 2007, however. More likely, activity will peak and then drop back again: "Unless there is another market hiccup, whether it be hurricane-related or regulatory-related, 2008-9 could be relatively quiet."

On 2007's potential for "mega-deals" - those with a value of more than $10bn - there was no consensus. While 36% thought the number of such deals would probably or almost certainly increase on 2006, 29% thought it probably or almost certainly would not and 22% opted for "about the same".

Business strategy

How important a role did M&A play in insurance and reinsurance respondents' business strategy? We offered three options and asked them to choose the one that best described their position. Thirty-three percent said their firms had minimal interest in acquisitions, their key focus being on organic growth. But 44% said they would consider exceptionally attractive acquisition opportunities and 22% said that a proactive approach to M&A was "a central part of their firm's business strategy".

Clive Martin, a reinsurance specialist in Ernst & Young's financial services business, says companies are turning to M&A to increase the flow of new business and to diversify. "Why should insurers and reinsurers have to stick with the distribution channels they have always used? The market has been starting to think more laterally about the future, about diversification and how best to increase revenue. Managements are looking at short and long-term options and that is intensifying M&A activity." New rating agency capital requirements, introduced following Hurricane Katrina in 2005, are largely responsible for the pressure to diversify.

Across the globe

The next question was this: if your firm is looking to diversify risk through merger or acquisition in another market this year, to which markets is it primarily looking? Thirty-five percent cited Continental Europe, putting it just ahead of the 31% who mentioned Lloyd's and/or the London market. "For the past nine months, we have seen a lot of focus on growth in Europe," says Lumbis. "But it is interesting to see London and Lloyd's this high. That could reflect the Bermudians looking to grow their platform into Lloyd's or London."

Lumbis thought readers may be interested by the 27% citing the Far East. "As developing markets, the Far East and Middle East have started getting much more attention over the last 18 months," he says. He was surprised that only 19% had mentioned North America, however, also by the relatively low number - 12% - citing Bermuda, given recent moves to achieve better tax-efficiency. "A number of London-based entities are actively looking to follow the model that others have followed for some time."

Who did our respondents expect to be behind most of the merging and acquiring? Primarily Bermudian (39%) and Continental European (36%) firms - though 16% saw London/Lloyd's, and nine percent the US, as the most likely source of acquisition activity.

Drivers and obstacles

What did respondents see as forcing the pace of consolidation? Nearly two-thirds went for the desire to tap new markets or business lines, while 54% cited the search for higher profits. Next down the collective list came rating agency requirements/catastrophe risk reduction strategies, at 46%. Forty-four percent cited competition from existing players as a leading factor.

So if those are the main factors pushing deals, what barriers do they have to push them over? No fewer than 75% cited unrealistic pricing by targets. "Valuation is often the number one blocker in any ongoing valuation," says Lumbis. Feared impact on the acquirer's share price and the hostility of the target's top management were rated the number two and three barriers, selected by 60% and 58% respectively. Fourth were regulatory obstacles, at 52%, and fifth was the potential adverse impact on ratings, at 44%. Despite due diligence, acquirers do worry about finding, too late, a rattlesnake in the accounts.

Scale versus speed?

Finally, GR asked what people considered the main disadvantages faced by reinsurance businesses when competing against the ten largest global reinsurers were; and, conversely, what main disadvantages the latter faced when competing against smaller reinsurers?

The consensus was that the biggest reinsurers' capacity, diversification, strong credit ratings, expense ratios, global reach and economies of scale were powerful weapons that smaller players struggled to match. Capacity constraints were felt to limit smaller reinsurers' ability to price competitively.

"It is difficult for anyone outside the top ten to provide the mix of capacity, credit quality and price that the bigger companies can," said one US respondent. "With size go other resources," said the chairman of a London-based reinsurance service company. "Particularly, knowledge."

The director of a large reinsurer agreed: "The big players have a tremendous franchise. Some of the newer Bermuda players just have capacity. The same is to some extent true for Lloyd's." He added, though, that the ten largest players are far from being a homogenous group.

For almost all respondents, the advantages of smaller reinsurers boiled down to speed of decision-making, agility in exploiting sudden market changes, flexibility, specialised knowledge of niche markets and a lack of capital-chaining legacy claims. Perhaps the most interesting comment was this, from a London-based reinsurance broker: "Global reinsurers face issues of profit centre ownership, causing a lack of internal cooperation and of consistency across lines and between regions in the business they write. By being more nimble and consistent the smaller players can take advantage of that."

How, then, would our experts sum up the M&A situation? Lumbis points out that there is a lot of start-up, capital-raising and public-to-private activity going on. "It's all related to the same issue: people looking to spend accrued money, especially out of Bermuda 2006." In recent months, he says, there has also been focus on privately-owned Lloyd's and London market businesses, many of which are just as big as the smaller listed companies.

- Peter Joy is head of research at Newsquest Specialist Media.