The morning after

The pace of mergers and acquisitions (M&A) on Bermuda’s re/insurance market turned from a steady drip to a frenzy this summer. The proposed AXIS-PartnerRe merger was thwarted by an outsider to the sector in the form of Italian investment fund Exor, which eventually won what became a long and sometimes bitter battle for PartnerRe.

Other deals including XL’s takeover of Catlin slipped through with less fuss. But there is no doubt that the market is being reshaped by this current activity and will continue to adjust to a number of new dynamics increasingly coming to the fore in the market.

John Andre, group vice president at AM Best, says the activity is being driven by a perceived need for companies to diversify into new products or markets and develop scale in order to be perceived as relevant in the market. He argues that cedants increasingly want a smaller number of strong partners to work with that can provide more complex products and strong protection.

Taoufik Gharib, director, insurance, at Standard & Poor’s, agrees. “It seems the industry is favouring larger reinsurers at the moment, and there are multiple reasons for this,” he says. “First, primary insurance companies are streamlining their reinsurance programmes as they are using fewer reinsurers for protection.

“Reinsurance purchasing decisions have moved to the holding companies to benefit from the economies of scale, and optimise risk exposure on an aggregate basis. As a result, many large, global insurance companies are choosing to do business with a select few reinsurers that can offer capacity across a range of lines and regions. This is increasingly marginalising smaller, less-diversified reinsurers.”

Gharib also attributes the trend to declining rates across many lines of business, driven down by overcapacity.

“This has been exacerbated by the influx of third-party capital that has significantly affected property-catastrophe business and may potentially spill over to other lines of business,” he says.

“We believe competitive pressures will remain heightened in the reinsurance sector, and we don’t expect the recent spate of consolidation will alleviate that burden. In fact, we believe this trend toward greater scale highlights how hard it will be for management teams to defend their market positions.”

Merge in haste, repent at leisure

The grass is not, however, always greener, warns Brian Schneider, senior director at Fitch Ratings. There are inherent risks involved for companies consolidating in search of economies of size and scale. The smoothest mergers occur when a company considers potential partners in the long term.

“Companies also need to manage integration issues,” he says. “They don’t want key underwriters to move out to join other companies because they’re unsettled by the merger.”

Mariza Costa, senior financial analyst, AM Best agrees that a merger has to involve companies achieving a good fit with each other. “It is essential. Significant due diligence is foremost for any deal to be successful,” Costa says.

“When there are legacy or potential legacy issues at stake, these need to be identified up front. Finding the right fit is extremely important. Finding the right product line and geographic presence that will complement a company’s existing book of business is the focus for many.

“Companies understand that finding the right partner that will allow that company to reach a larger audience or diversify their current books of business with expertise they did not possess prior to that ‘marriage’ is what could make a company more successful than some of its competitors.

“On the other hand the possibility of combining with a company that is not a good fit or only increases one’s exposure or risk may become costly in the case of an event. So the importance of the right fit should be a top requirement when deciding on an acquisition or merger.”

S&P’s Gharib also highlights this issue, stressing that one of the most important aspects of a prospective merger or acquisition is what eventually emerges several years afterwards.

“The industry doesn’t have a good track record here,” he says. “Acquiring another company for its size alone is not a good idea—it must add value. The strategic fit is important. You need to find the right strategic partner, at the right price and for the right rationale—are the cultures of the two companies compatible?

“There is always a degree of execution and integration risk inherent in these deals. Some transactions can take one to two years to fully integrate, and there’s the danger of things falling into the cracks in that time, such as underestimating the aggregate risk exposure.”

A matter of timing

The issue of when exactly is the best time to push a merger through is a tricky one to answer. According to Andre at AM Best the timing for any M&A activity naturally has a great deal to do with what is going on in the market at that time.

“The reinsurance market has too many companies that are fighting for a shrinking piece of the pie so the number of companies competing must decrease or diversify in order for returns to remain acceptable,” Andre says.

“The most important consideration in terms of timing for the reinsurance market is that companies should be conscious that if they merge or combine with another reinsurer with risks that could possibly overlap with their own before a renewal season (when books of business can be rewritten) then the risk of being overexposed on a particular risk in the case of an event could lead to higher than expected losses.

“In our view, timing hasn’t really disrupted renewals in recent years, but rather changes in retentions by the cedants. The more recent M&A have been driven by strategic moves by companies not for the purpose of manipulating or disrupting renewals.

“As the reinsurance market has changed and the market headwinds persist, rated companies need to evolve in order to remain competitive. How they address the changes is up to each specific management team. We will not prescribe a right or wrong way. We would expect highly rated carriers to have prudent, well-plotted plans for diversification that they can articulate to us, so the rating impact can be determined.”

Timing is not the only issue. Regulatory oversight is a vital part of the process, as without the approval of the regulators a merger is doomed. The Bermuda Monetary Authority (BMA) obviously plays a key part here, as anyone looking to complete a merger or acquisition involving a company on the Island will need its approval. In addition the BMA regularly publishes statements detailing any changes to its regulatory regime, making it the obvious regulator to consult on a merger.