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12 September 2014 Insurance

M&A: A hive of activity

In an increasingly soft market, many re/insurers are turning to consolidation as a means to secure growth. As this trend continues, Rodney Bonnard, a partner at EY, explains to Intelligent Insurer the significance of this for the industry and how activity is varying between regions.

The current soft market conditions, which show no signs of letting up for re/insurers, have encouraged many to seek growth through consolidation.

"We’re in a very soft market for re/insurers and the specialty market and margins are very tight. People are looking for ways to grow, and one way is M&A."

Desperately seeking to fill the void in their balance sheets from a lack of forecasted growth, re/insurers are turning to new growth avenues.

While the industry strives to close this gap, there are some markets, such as the Lloyd’s market, that have been leading the M&A charge.

“There seems to have been a sustained wave of companies from outside Lloyd’s in particular wanting to buy into the Lloyd’s market,” explains Rodney Bonnard, a partner at EY. “Over the last couple of years, there’s been a large number of acquisitions into Lloyd’s at very good prices—from a seller’s point of view—albeit quite expensive from a buyer’s point of view.”

One of the hottest periods of M&A that the industry has seen for a while, 2014 continues to see re/insurers turn to new lines and regions in a desperate bid for growth.

“A year ago we knew that this was going to happen. We’re in a very soft market for re/insurers and the specialty market and margins are very tight. People are looking for ways to grow, and one way is M&A,” says Bonnard.

The charge into Lloyd’s has vanished as there aren’t many entities left to buy, but Bonnard explains that while we can expect to see a few of the larger companies looking to join forces, the most activity is seen around the $10 million mark, with companies seeking businesses that will allow them to grow organically.

“We’re expecting to see a few big mergers, but they’re much harder to get off the ground, so I expect we’ll see only one or two of those in the remainder of 2014. What we’re seeing more of is smaller transactions where insurers are buying smaller businesses as bolt-on acquisitions to support organic growth.”

Bonnard also highlights that these smaller acquisitions are likely to include managing general agents (MGAs) and smaller specialist brokers.

“In reality, this is also likely to involve acquisition of distribution in the form of MGAs or specialist brokers who can be turned into an MGA, providing top line premium growth for the acquiring re/insurer. In addition, there remains a broad range of capital available to support acquisitions, from re/insurers themselves, but also from private equity (primarily US and UK) and from specialist financial investors (hedge funds, pension funds, etc),” he says.

While it might be easy to assume that diversification plays a significant role in making the decision to acquire—especially with tightening regulation such as Solvency II knocking on the door—diversification is, Bonnard says, often just an added bonus on the back of a profit-led decision.

“It’s a bit of a play, but it’s more that companies are looking for profitable niches to add to their books, so while they are diversifying, the ‘bolt-ons’ are not capital-related—they’re more profit-related.

“At the small end of the market it is starting to create a wave and you could argue that the reason for being up for sale is either the cost of compliance with Solvency II, or the expense of the capital for Solvency II. However, when you get to the bigger specialty insurers, they’re doing well on the capitalisation front and are mainly focusing on internal structuring.”

The statistics

While consolidation can be seen in each market, some differentiation can be seen within regions and different sized players.
At the smaller end, this is happening globally in both emerged and emerging markets, with Bermudan and US companies mostly looking to diversify out.

That said, Lloyd’s activity has been much higher than any other M&A activity around Bermuda or the US.

“When you get into the mega mergers, we expect to see most of the big players, which already operate in all three markets, trying to grow in Asia as it’s the area that they’re probably the least developed in.”
A helping hand

While consolidation may be the answer, making this important decision requires professional advice, which is where EY come in.

“We’re helping clients with meeting targets, understanding the risks involved in the purchases that they’re making and ensuring that what they’re buying is what they think and hope it is. We also help them to look at the alternatives: if they don’t do the acquisitions how else are they going to grow?” says Bonnard.

Regulatory and capital implications, as well as accounting and tax considerations, play a large part in a smooth and efficient acquisition, and while companies are anxious to seek growth, they must assume responsibility for all outcomes.

“We also help clients by looking at what they’re actually buying and finding out whether the track record that they’ve been promised plays through. They also need to consider how they are going to retain the talent that’s generated this level of return in the past, and we also help with regulation and deal-specific questions,” says Bonnard.

“Achieving profit growth through acquisition requires a disciplined approach to the M&A process, including identifying the right target, an appropriate valuation, rigorous due diligence, identification of synergies and then effective execution and integration of the target to ensure the synergies are achieved, whether those synergies relate to revenue, operating expenses, capital inefficiencies, reinsurance costs, effective tax rates or other drivers of bottom line profit.”

The road ahead

As re/insurers continue their quest for growth, the market is likely to see further consolidation and a reduction in the amount of capacity available.

“Companies are desperate to grow and M&A does seem to be a very important part of that strategy,” says Bonnard.

“I think we’ll still see one or two large mergers come to the table. There’s a huge amount of pressure to grow and companies aren’t going to find it easy to find the answer to the growth story. By merging, they generate growth and the possibility of cost savings.

“At the bigger end, I expect to see a reduction in the amount of capacity in the market in total—companies tend to limit the amount of capacity that they’re willing to give one entity irrespective of the size of the balance sheet.

“That said, there’s so much capacity on any line, that we’re in a situation where taking capacity out of the market is hardly likely to harden it. It’s more about companies positioning themselves in a way to deal with the soft market.”

Rodney Bonnard is a partner at EY. He can be contacted at: rbonnard@uk.ey.com

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