The financial world is bracing itself for recession. J.P. Morgan for example expects a contraction this quarter of 4% (on an annualised basis) in the US, 3% in the UK, and 2% in the eurozone. For 2009, it predicts 0.4% global growth, but advanced countries shrinking 0.5% and emerging regions growing 4.2%.
For the insurance industry, recession means more claims. People short of cash will look to insurers, or any source of cash, more often and more insistently. The insurance industry is in for a challenging time.
However, even recessions present opportunities. M&A activity will increase. Expect some big deals, with some big name insurers merging.
A vast source of M&A activity is of course the AIG asset sale. AIG is in a race against time to sell off assets to repay government loans currently totalling $123bn. AIG is undertaking a massive task – selling up to about half the company – and finds itself in a highly unattractive negotiating position: a forced seller in a falling market.
Potential buyers do not find it easy to raise capital in current financial conditions. The term of the US government loan to AIG is two years. That should normally be time enough; however, the government loan attracts a high interest rate of 3-month Libor plus 8.5% – far more than AIG is accustomed to paying on its corporate debt. The longer the loan remains outstanding, the more expensive it will be. Meanwhile, rival companies are making active efforts to poach key AIG staff.
Neither have rivals been shy about targeting AIG clients. So AIG is attempting to sell wasting assets. One tactic for buyers would be to hang tough, waiting to pick up assets cheaply as the pressure on AIG intensifies. This tactic could be used by private equity companies, but insurance industry buyers are unlikely to avail themselves of it. Insurance companies’ concern will be to preserve the franchise of the businesses they are buying: they would be motivated to a speedy purchase, while key staff remain on board.
M&A deals of even large size can be agreed quickly, and due diligence can be completed, with focused effort, in three or four weeks. Regulatory approvals usually take longer, but regulators both in the US and internationally may expedite matters in the light of their governments’ efforts to solve the credit crisis. Companies such as Allianz, Munich Re, the Prudential and others are actively interested in the unique opportunity the AIG asset sale offers.
AIG’s Asian assets, for example, offer an exceptional opportunity to access the fast-growing Asian market. Companies could raise the necessary cash by rights issues, and, at the time of writing, the credit market shows signs of easing.
However, AIG is unlikely get paid a good price. Life insurers, for example, are trading at a substantial discount to their embedded value, comparing with a premium over the last several years. AIG could turn out to be selling at the bottom of the market: if buyers believe that, that is precisely why the asset sale could get done.
David Sandham, Editor