A match made in … how re/insurance M&A should be judged

Sometimes in the re/insurance world, the stars can align and two companies can come together, perfectly complementing each other’s business model: they will find easy cost and revenue synergies, offer complementary business lines, investors will be delighted and the people working for them will get on well together.

Unfortunately, deals do not always work out this way and some mergers and acquisitions (M&A) can end up with the attributes of a bad marriage: integration is difficult, there is friction between people, and growth, profits and the share price all suffer the consequences.

How should the success—or failure—of a deal be judged? And when? Here, we offer four perspectives on assessing whether a merger or acquisition was really worth it.


Cost-cutting and seeking growth: an intermediary’s perspective

Paul Schultz, CEO of Aon Securities, believes that two principle contributors to success are cost synergies and growth.

Cost synergies may ensure that savings can be met while a good deal will also provide the companies with new capabilities and revenues streams, whether that’s through new products or innovation or both, Schultz says.

But, he notes, such benefits are more likely to be found between trader buyers as opposed to involving speculative investors from outside the industry.

“Given where valuations are today, to be able to achieve these means that the likely buyers or likely deals are between more trade players,” he says.

“It’s the industry consolidating and creating new capabilities and taking costs out, as opposed to seeing a lot of private equity or financially driven deals where you cannot achieve those because you need to combine the companies to get both.”

The exceptions to this are instances where companies do a deal to access a new technology, Schultz says, as these deals are focused on growth.

In terms of cost synergies, Schultz says, a lot of assumptions may be made before any deal goes ahead—but whether they come to fruition as planned is another story.

Reinsurance spend is a good example of this. “If we look at reinsurance spend between two companies we can ask what kind of cost synergies or what kind of reduced reinsurance spend we can anticipate in year one, year two and year three,” he explains.

He adds that in some instances, it can be easy to see if a combined entity is making progress on delivering on forecast synergies and cost savings.

“For those of us who are in the industry on a daily basis it’s pretty simple to measure and observe. You generally know whether progress is being made without seeing the financial numbers, because you can see there are now two underwriters assigned to one unit, for example,” he says.

Measuring whether growth is thanks to a deal can be harder.

“It’s harder to evaluate growth assumptions because if you’re bringing in new product capabilities or targeting new geographic capabilities it’s much more difficult to make assumptions as you are taking a forward-looking view on what those opportunities are,” he says.

“The time horizon becomes an important aspect of evaluation. If you have a two-year perspective on achieving some new things or a 10-year perspective, that’s obviously a critical component of whether things have been successful.”


Beware of downgrades: the rating agencies’ perspective

One method of assessing the success or failure of a deal in its aftermath can be through examining the impact—if any—on the surviving company’s ratings.

In some ways, this is a relatively narrow perspective because of the rating agency’s specific outlook on things—a financial strength rating (FSR) is a measurement only of that company’s financial strength and ability to meet insurance policy or contractual obligations. In theory, an FSR can be very high and stable regardless of other metrics such as profitability and growth.

On the other hand, a downgrade can have serious implications for a company, so assessing any change in ratings, and the reasons for it, can be extremely revealing.

Dennis Sugrue, director of insurance ratings at S&P Global Ratings, highlights the findings of an S&P study that analysed the 50 largest transactions involving rated insurers since the year 2000. It showed that almost two-thirds (64 percent) of acquirers had their ratings affirmed following the announcement.

However, 22 percent of acquirers were put on a negative outlook or CreditWatch and more than half of these subsequently downgraded in the next five years.

This compares with 14 percent of acquirers that were placed on a positive outlook or CreditWatch, with all of them eventually upgraded.

Sugrue stresses that for all the talk around the cost synergies and growth by the companies themselves, S&P tends to not to give credit for that within its rating analysis.

“It’s very often quite difficult to realise these things,” he says. “When a deal is announced management might say ‘here are the synergies that we would experience over the next two to three years’, but once the deal is closed, or maybe after the first couple of quarters these things tend to fall off the agenda for investors and for management teams.”

S&P tends to focus on the core issues around the impact of a deal. “We examine some of the key risks, such as is there a negative impact on capital? How are they funding the deal? Will that harm their leverage or flexibility?

“S&P would view a deal’s potential to offer greater diversification as a positive, while if a deal will boost capital, that is also something that could have positive implications for the ratings,” he adds.


Delivering on targets: a change manager’s perspective

The measure of whether a deal should be regarded as successful is simple, according to Paul Clark, partner and managing director at Boston Consulting Group and a specialist in change management. He says a deal should be judged simply on whether a re/insurer achieves the targets of its integration.

Clark says it is crucial that insurers should be clear and transparent on their objectives before entering into a deal, and in what direction they will take the business after it.

He believes that a majority of M&A underperform and fail to achieve their initial objectives—and that can also be perilous for the executives driving the deal.

“One of the quickest ways for a CEO to get fired is to buy another business and then mess up the integration,” says Clark.

While objectives will differ from acquirer to acquirer, identifying the rationale behind the merger is very important, whether it is to increase growth, to increase innovation or to complement each other’s existing position in the market, says Clark.

For two companies coming together, Clark suggests that one company may sell products through the other’s distribution, or there can sometimes be a geographical coverage that can fill a gap.

“If two insurers are coming together where one has a strong position in the London Market and the other very good technical capabilities, they may be looking to sell more product into the London Market. You would then look to see whether revenue has increased,” he says.

“If they were both growing at 3 percent before, and from years two, three and four after the integration the combined business is growing at 5 percent, then you say great—they’re now growing faster.

“Equally, if the objective is to reduce costs, if costs have decreased by 20 percent after two years and revenue is still holding firm, that could also be considered a success.”

Re/insurers often lay out their rationale to their shareholders, as they are the ones who need to be convinced that the deal is a good idea.

“They will explain the benefit they expect to get from the merger. Then a few years later—because obviously it takes a while to integrate these big businesses—we look back and review our original objectives for the merger. Did we achieve them? Did our growth increase? Did we reduce the costs? Did we manage to sells products to each other’s customers?” Clark explains.

Shareholders will be most interested in how value will be generated from the merger, and sometimes this is not always made clear, or stuck to by the acquirer.

He adds that another characteristic of successful integration is that the newly built organisation will have stronger capabilities than the two businesses that came before. But he stresses that clarity of purpose is vital.

“You can have mergers where people are unclear on the objective, and then clearly nothing particularly good is going to come out of that, because nobody is quite sure what they are doing,” he says.

Another common problem Clark sees is where the objective is clear, but the process of integration does not go to plan.

“For example, where the organisational structure isn’t integrated, you end up with a hybrid organisation rather than a clean, clear, consistent organisation.

“You don’t fully do the integration or you don’t take the costs out because you are worried about the effect on morale, and then you end up with a bloated organisation that is less efficient and ultimately morale is lower because nobody enjoys working for a bureaucracy,” he explains.

In such instances where staff do not buy into the ethos behind a merger, Clark says that an organisation may still not capture the right culture even if it delivers on short-term benefits.
Such a lack of integration may result in an organisation performing less well in the medium term.

Unless a rigorous structure is followed, the collision of two separate companies’ cultures can have negative consequences.

“If you appoint a 12-person management team and 11 of them are from one business it might cause a problem. You need to follow a rigorous structure but you also need to be aware of the perceptions created by the decisions you make,” he says.

Clark points out that if you are integrating two businesses with 1,000 people in them, the complexity is quite high.

By contrast, if the merger is a ‘bolt-on’—essentially adding in another department—it doesn’t hold the same level as risk as the merging of two large companies.


Markets don’t lie: share price as an indicator of success

Another method that may be used to determine the success of an acquisition is the effect it has on a re/insurer’s share price in the months and years following a deal. While many forces converge to determine investor sentiment towards a company—and thus its share price—some see this as being the most honest of all measurements of post-deal success.

A report published by Willis Towers Watson in collaboration with Cass Business School and Mergermarket, Measuring the correlation between acquisitions and share price performance, found that insurers engaging in M&A are increasingly outperforming their competitors in terms of share price development.

Specifically, the margin by which insurers are outperforming their competitors in terms of share price following a major acquisition has almost quadrupled since 2008.

Analysing all deals with a value of more than $50 million in this period, Willis found that the acquirers had delivered significantly better share price performance than their peers in the 12 months surrounding the deal.

On average, acquirers outperformed their insurance sub-sector index by 3.7 percentage points since 2008.

The study showed that the pattern has steadily become more pronounced over time, with acquirers outperforming their sub-index by an average of 12.5 percentage points in 2015 alone.

Fergal O’Shea, EMEA life insurance M&A leader at Willis Towers Watson, says: “While our figures show that these deals ultimately pay dividends, it takes time to garner results.

“This lack of immediate reward coupled with the uncertainty on day one around a big deal are among the reasons why investors have been slow to acknowledge the benefits of M&A in the insurance sector.”