While M&A activity in the non-life insurance sector has shrivelled away to almost nothing in recent months, companies looking to expand in the life market are scouting around for opportunities across the globe.

There were no billion dollar-plus deals in the insurance sector in the first quarter of 2002. In fact, deals of any value have been few and far between since the beginning of the year. Some of the most marked declines in the financial services industry were in the insurance sector, where deals all but completely stopped.

"Obviously, this is one of the worst quarters in financial institution M&A recent history," said Bjorn Turnquist, director of financial services and insurance research at SNL Financial in a statement.

"Investors continue to be skittish toward M&A. They're still coming to grips with accounting and economic uncertainty. I don't think companies are willing to do deals as there continues to be constant rumours of some mega-mergers. But companies are focusing on the profitability of their core businesses and still digesting deals from the past."

Just $99.7m worth of M&A deals were announced/completed in the first quarter of the year; this represents a 97% decline when compared to figures for the same reporting period last year. There was a total of 52 deals compared to 71 in the first quarter of 2001: a 27% decline in volume. Deal value fell to $99.7m from $3.9bn in the same reporting period last year (this figure has been corrected to exclude the failed $24bn bid for American General Corp (AGC) by Prudential - American International Group [AIG] did not announce its counter bid until the second quarter of the year).

"There's uncertainty with the insurance industry, as companies are currently unwilling to take the risk of another company's business and infrastructure," said Turnquist. "There also have been plenty of rate increases, so there is not as much pressure to grow through acquisition."

Life and health insurers, partly as a reaction to the bull market for stocks, have started to move away from traditional `protection products' such as life insurance to asset accumulation products. Annuities have become a hot product for many insurers according to SNL Financial, as the sector continues to experiment with new distribution channels in a bid to reduce costs and improve profitability.

Despite the dearth of M&A activity, PricewaterhouseCoopers Transaction Services Group has said that there could be an increase in cross-border deals over the next 18 months. Bigger European firms may look to the US for possible acquisition targets as harder-hit firms look more attractive.

Managed care
Deal volume and value decreased significantly for US companies in 2001 with most deals occurring in the first half of the year. European acquirers were scarce; with the exception of Old Mutual's $635m acquisition of Fidelity and Guarantee Life, European insurers buying into the US were notable by their absence.

Similarly, there was little evidence of interest in the insurance sector from banks or financial institutions in the US. Despite clear regulatory go-ahead, thanks to the implementation of the Financial Services Modernisation Act, banks gave insurers a wide berth, instead continuing to focus on the fee-generating side of the business by acquiring insurance agents, which offer products that can be channelled through the branch network.

Just one life-related deal scrabbled its way into the top ten US and US cross-border transactions across industries for the quarter, according to figures from US firm Mergerstat: Anthem Inc's acquisition of Trigon Healthcare. The deal, worth an estimated $4bn based on Anthem's closing price on 29 April 2002, saw Trigon shareholders get $30 in cash and 1.06 shares of Anthem stock per Trigon share. Indianapolis-based Anthem operates Blue plans in Indiana, Kentucky, Ohio, Connecticut and other US states, and the acquisition continues Anthem's aggressive strategy of buying up managed care plans across the country. The company put in a $675m bid for Cerulean Cos, the parent of Blue Cross and Blue Shield of Georgia in November 2000, but lost out to WellPoint Health Networks, which offered $700m. Trigon also made an offer CareFirst, but once again was beaten by WellPoint, which secured the deal with a $1.3bn stock and cash offer. The deal catapulted WellPoint to the top of managed care companies in the mid-Atlantic area.

The decline in M&A activity in the life sector was largely the result of less favourable economic and capital market environments, the immediacy of claims payments following September 11 and a period of post-merger integration after high levels of consolidation between 1998 and 2000. But activity is expected to pick up in 2002 and beyond, as competitive forces including slower organic revenue growth, a converging financial services marketplace, and the advantage of size - in terms of economies of scale and ability to ride out economic environments - make growth through acquisition more attractive, according to rating agency Fitch.

The rating agency has given the North America life insurance industry a negative ratings outlook for 2001-2002, although it is planning to review this later in the year. The outlook is driven by several factors: intense competition; a shift to lower-margin products due to changes in consumer demographics, expectations and preferences; declining sustainable earnings and capital growth rates; and increased earnings volatility resulting from an increase in earnings drivers outside management control.

During 2001 there was just a handful of notable deals beginning with AIG's acquisition of AGC. Without AIG's $23.4bn counter bid for AGC - the target of Prudential's failed bid - the top ten deals, which totalled $33.4bn in 2001, would barely have scraped the $10bn mark compared to the $18.3bn total for the top ten deals in 2000.

Prudential's bid received a negative response in London, Wall Street asked questions about the viability of such a transaction, and AGC shareholders indicated that they were not happy with the all-paper nature of the deal, as they didn't want Prudential stock.

Valuations for the deal varied dramatically. Prudential's offer had an implied value of $49.5 a share, but a 15% drop in American Depository Receipts (ADRs) and a fall in stock price saw the original offer price drop to $23.4bn, and at one point below $20bn. Prudential's stock was savaged by investor concerns that at three times book value it was paying too much for AGC, although many analysts felt this was in line with market values.

The high levels of market and shareholder disapproval left the door wide open for counter-offers and just three weeks later AIG made an unsolicited counter-offer for AGC, outstripping Prudential's offer by $5 per share. Unlike Prudential, AIG put a collar mechanism in place to protect US shareholders from any fall in share prices, which added to its attraction. The tussle was short-lived and AIG won the battle, leaving Prudential with just a $600m break-up fee; small comfort to the company that had missed out in quite spectacular fashion.

The AIG/AGC deal was just one of a number of transactions in the North American life sector in 2001, a year that saw little deal action in the non-life arena, the notable exception being XL Capital's acquisition of Credit Suisse Group's insurance subsidiary, Winterthur International Insurance Company for $600m.

Swiss Re also hit the acquisition trail, buying Lincoln Re, the reinsurance arm of US insurer Lincoln National Corp, for $2bn. The deal saw Swiss Re, the world's second-largest reinsurer, consolidate its leading position in the US market, adding Lincoln Re to its North American life and health unit.

The acquisition provided the company with a 29% share of the US life and health market for reinsurance.

Lincoln National decided to sell off its reinsurance unit because of unpredictable earnings and planned to use the proceeds from the sale to buy back stock. It also opted to spin off the reinsurance arm to concentrate on the asset management side of the business.

Liberty Financial's deal with Sun Life Financial Services of Canada in May might have been nothing to write home about in terms of value compared to AIG/AGC, but the deal was, nevertheless, very significant for the Canadian firm. Liberty Financial's divestment of Keyport Life Insurance to Sun Life for $1.7bn in cash - a value which included Liberty's Independent Financial Marketing Group - almost doubled the size of Sun Life's US annuity business, making it the tenth largest competitor in the US variable market and in the top ten in the fixed income market.

The deal ended months of missed opportunities as prospective whole-company buyers simply passed by. At the time analysts labelled the transaction as a good move for Sun Life which would gain some additional capabilities at a reasonable price.

Liberty, which had languished on the market following announcements that it was up for sale in the autumn of 2000, got a good price, according to analysts. Prudential, AGC and First Union Corp were all rumoured to be interested in the Boston-based subsidiary of Liberty Mutual Insurance. But no concrete bid emerged: Prudential instead made a bid for AGC and First Union Corp bought Liberty rival Wachovia Corp.

How the land lies
The life M&A landscape is likely to become more varied over the next few years compared to 2001, according to Fitch, and is expected to include more insurance company acquisitions of asset managers and stand-alone concerns, and ultimately convergence. Although a number of insurance companies, which bought investment management companies in the boom years, have been burnt by a significant reduction in value due to the equity market downturn and the subsequent decline in assets under management, insurers that shied away from the sector may again look at asset managers, which are now more reasonably valued.

Heavy losses in 2001 have spurred companies to rethink corporate strategies and in many cases make a swift exit from unprofitable business lines in an attempt to stem further profit losses. St Paul Cos, which has put its domestic and international medical malpractice unit into run-off, is opting to shut specialist business units rather than sell them off. The firm has also said its reinsurance unit will no longer underwrite aviation reinsurance, bond and credit reinsurance or offer financial risk and capital markets reinsurance products. It also plans to significantly reduce the North American business it underwrites at Lloyd's.

St Paul was the second largest writer of medical malpractice insurance with forecasted written premiums of $530m for 2001 - about 10% of the medical malpractice market. Its departure from the market will cause significant levels of disruption, according to Fitch, as policyholders "scramble to replace lost coverage and other insurers look to increase their market share".

Fitch believes that similar action could be taken in the future by other companies exiting major lines of business because of concerns about future profitability.

There is also evidence of primary insurance companies retreating from the reinsurance sector. Lincoln National sold its reinsurance unit to Swiss Re for $2bn because of volatile earnings and in order to concentrate on the asset management side of its business. Zurich cut its ties with its reinsurance operations, now known as Converium. Similar moves include: Fairfax's sale of 26% of Odyssey Re Holdings; the retrenchment of CNA Re, Hartford, St Paul and Denmark's Alm; and Copenhagen Re's decision to stop writing new business.

Eastern promise
In 2001, AIG, Manulife Financial and Prudential Insurance Company of America followed GE Financial and European insurers AXA Group and ING in partnering or purchasing Japanese companies in order to establish sales and marketing presence. This continued the push into the Japanese life market predominantly by North American insurers.

Aegon has said it is looking at M&A opportunities in the Taiwan life market which continues to consolidate.

"We see a lot of opportunities for us . . . we will continue to look at acquisition opportunities," Alexander Wynaendts, group executive vice-president of Aegon told reporters at a briefing ahead of the signing of a joint venture agreement with China National Offshore Oil Corp (CNOOC).

Since starting greenfield operations in Taiwan in 1994, Aegon has made a number of acquisitions.

"Taiwan has been a market that has been consolidating a lot; the number of players has been reduced and some foreign players have exited the market, especially players who have not been able to achieve critical size. So we see a lot of opportunities for us," said Mr Wynaendts.

The joint venture with CNOOC, which has yet to be named, is a 50:50 agreement, under the terms of which each company will invest $24m. Aegon has been granted a license to operate in China through its subsidiary Transamerica and plans to combine its insurance expertise and management skills with CNOOC's knowledge of the Chinese economy. The joint venture will be headquartered in Shanghai and launched in 2003, provided it receives regulatory approval.

Total life premiums in China in 2001 were $17bn, up 43% from the previous year. Shanghai accounted for 10% of this increase. Growth is expected to continue as China's per capita GDP grows and the population becomes more aware of welfare protection and wealth accumulation.

Bancassurance as a concept is still struggling to take off in the way industry observers and analysts had expected. In the US, convergence is rare and in the wake of news about Citigroup's decision to spin-off Travelers it is unlikely to be welcomed - in the non-life sector at least - for sometime. Indifference towards convergence has been attributed to complex regulatory burdens and vastly differing business models. The main reason however, is more likely to be that many insurers' lines of business are too volatile to be an attractive prospect for banks, which are already being pushed to make higher revenues than at present - a level that exceeds current insurance revenue streams and undermines the need for banks to acquire insurers.

According to rating agency Fitch, the slower, reliable revenue growth of life insurers would be a better bet. Prior to the events of September 11, Fitch suggested convergence would have a greater impact on the life sector, as life insurers continue to evolve further into asset accumulation companies with products similar to those offered by other financial services providers.

By Clare Bates

Clare Bates is the deputy editor of Global Reinsurance.