It seems that everyone agrees: the time is ripe for mergers and acquisitions in the reinsurance sector. Global Reinsurance asked four market practitioners for their views on the factors fuelling the appetite.
Our four commentators are: Bryan Joseph, global head of the actuarial group at PricewaterhouseCoopers; Ryan Warren, a senior consultant at Watson Wyatt; Andrew Turnbull, chief actuary and chief operating officer of Torus Bermuda; Mark Watson, president and chief executive officer of Argo.
Bryan Joseph says that the financial crisis has put pressure on reinsurers
The reinsurance market continues to be under considerable pressure from the financial crisis. Although the industry has survived relatively unscathed when compared with other financial services, it has faced falling asset values which have damaged balance sheets and weakened reinsurance companies. This has been coupled with rates failing to harden in the non-life market following Hurricane Ike and the dislocation in the capital markets. The result has been damaged balance sheets over the past 12 months.
External regulatory and accounting conditions are also creating changes to balance sheets. The impact of “mark to market” accounting on company balance sheets has meant there have been significant writedown of assets previously thought to be rated as AAA. The situation has also been compounded by currency movements. After a period of relative stability, the major currencies have moved against each other with declines in the dollar and sterling relative to the euro. Company balance sheets have not been immune to these changes.
Finally, in Europe, Solvency II has meant that companies need to carefully consider their capital position in relation to the risks that they accept. While this has not impacted many reinsurance companies, it does mean that balance sheets are weaker than they have been.
The relative position of companies has moved, and the stronger can opportunistically target weaker rivals. This, coupled with the pressure on balance sheets, means that there is likely to be further consolidation in the market as companies move to strengthen their balance sheets.
Bryan Joseph is global head of actuarial group at PricewaterhouseCoopers
Ryan Warren believes the cost of reinsurance could hold the key to continued M&As
The number of mergers and acquisitions in the reinsurance market continues to grow. Such acquisitiveness is expected to continue for a number of reasons: access to new capital; targets trading at attractive rates; and an increase in demand for reinsurance. However, appetites could be dampened should there be lower eventual demand for reinsurance.
Reinsurance is currently one of the most accessible capital markets for insurers, providing a way to rebuild their balance sheets. The increased cost of capital from debt and equity markets and reduced capacity in the insurance-linked securities markets is driving a return to traditional reinsurance.
Reinsurers are taking advantage of this by increasing their market presence through the acquisition of companies that are currently trading at or below book value, at the same time increasing risk diversification and scale. In addition, excess capital held by snubbed potential acquirers will drive future M&A activity.
Other factors increasing reinsurance demand include enhancements to enterprise risk management programmes, lower risk appetites, uncertainty of the Florida Hurricane Catastrophe Fund’s ability to fund its liabilities; greater regulatory capital requirements; and pressure from rating agencies to restore capitalisation.
While M&A activity should remain high in the near term, it could slow down if demand falls away due to reinsurance appearing expensive to insurers or a resurgence in the syndication of risk among a pool of reinsurers at the expense of its transfer to a smaller number of highly rated players.
Ryan Warren is a senior consultant at Watson Wyatt
Andrew Turnbull says mergers are more likely than acquisitions
With the reinsurance market expected to harden, companies are looking to increase their market share. But organic growth is difficult in the current soft market. Consequently there has been a flurry of M&A activity, especially in Bermuda, and, after the recent IPC Re deal, further consolidation is likely.
Currently, markets are looking to strengthen their capital base as poor investment returns have caused capital erosion. However, the tough markets mean that the ability to sell stock or issue debt remains constrained. M&As can boost capital, particularly stock-for-stock combinations and current depressed valuations make M&As competitive mechanisms.
Combinations can also result in capital efficiencies. With companies facing more onerous rating agency capital requirements, increased diversification can be beneficial. Growth will also allow cost cutting as IT systems, staff expenses and other fixed costs can be spread across a larger premium base.
Private equity backed vehicles may also be looking for attractive mergers as existing shareholders can convert their stake into a more attractive platform, with the potential for special dividends. The IPC Re deal is a reminder to boards of their obligation to produce shareholder value. Consolidation will also reinforce the hardening market as it tends to reduce market capacity, both in terms of pricing and terms and conditions.
So mergers are more likely than outright acquisitions. And there are – in Bermuda at least – more companies than distinctive business models, so combinations will occur.
Andrew Turnbull is chief actuary and chief operating officer of Torus Bermuda
Mark Watson believes niche players could attract plenty of suitors
It would appear that the market is indeed “ripening” for acquisitions, although I would not be in a hurry. The industry as a whole has faced several challenges over the past year. With the capital markets seized up, the resulting shortage of affordable capital, the flight of talent, one thing is constant and that is change.
To a large degree, the financial markets have begun to settle. Stock prices have stabilised, ratings agencies have had a chance to reaffirm many companies and, as a result, the new capital that was so scarce only a few months ago is starting to return.
What remains are essentially two types of companies; those with strong business plans and appetites and those with challenged business plans left pondering their next steps.
Companies that have below-average operational performance, yet have maintained a strong asset side to their balance sheet, will be the most sought after.
They will be strongly pursued when they officially go on the market. The recent battle for IPC Re demonstrates that once a deal is announced and in the works, others may want to get in on the action.
The main catalysts of activity will be companies that have successfully made it to this point with a solid business plan and the resources to effectively grow their market share or broaden their product range through acquisitions. This could make some niche players particularly attractive and there are a few out there that are likely to be the centre of attention.
Mark Watson is president and chief executive officer of Argo