Delivering on the M&A wave
There has been an uptick in mergers and acquisitions (M&A) in re/insurance, with large deals such as AIG-Validus and AXA-XL making recent headlines.
The management of involved companies are often excited when presenting the deal, describing them as adding significant value to the company and presenting an opportunity to add expertise and create synergies. However, the verdict of rating agencies such as S&P Global Ratings can be more sober.
In a panel discussion titled “Has the M&A race just begun?”, Eunice Tan, S&P senior director, discussed with other experts the potential consequences of the recent tranche of M&A. Acquisitions may be the only way to build a meaningful market share in some territories, Tan said.
Transactions can, however, have many drivers. “Companies might want to acquire new distribution channels or new technology, or they might be forced to change their business composition due to regulatory changes,” said David Alexander, head of P&C Reinsurance Hong Kong & Taiwan at Swiss Re.
Although regulation is becoming increasingly important in Asia due to the introduction of new accounting regimes such as IFRS, acquiring companies may have more short-term motivations such as financial market movements opening up new opportunities.
In addition, a particular underwriting situation may result in M&A transactions. “If it’s a poor time for underwriting then there are bound to be some players who are vulnerable,” Alexander noted.
Reinsurers often benefit from M&A deals as the companies involved want to avoid negative surprises during the acquisition process.
“Helping reinsurance clients to manage their way through M&A could be around the funding aspects, or risk management of the process itself, or about execution certainty by using reinsurance to take away troubles and blocks of business to make the sale a bit easier,” Alexander said.
“It could also be around asset management, reshaping the reinsurance programme or helping the acquirer post-acquisition to extract value from the operation,” he added.
He pointed to a case where a US client was involved in an acquisition and both firms had almost agreed on the terms, but when discussing the transaction with the ratings agency executives were told that it would result in a downgrade as the deal would impact the company’s capital.
A reinsurance deal allowed the firm to reduce its required capital, bolster the solvency position and protect its ratings, and enabled the transaction to be completed.
“S&P traditionally has a neutral view on M&A, with a slight negative bias,” Robert Greensted, associate director, EMEA insurance ratings at S&P, explained.
“Looking back, the reinsurance sector has had a fairly mediocre track record of M&A,” he noted.
S&P leaves the majority of acquirers on a ‘stable’ outlook but if it includes ‘credit watch’ there is usually a bias towards the negative side, he said.
At the same time, M&A transactions can have positive attributes or consequences such as an increase of diversification, Greensted noted.
“We see this in a positive light for the company’s position in a market,” he explained. In addition, scale can help reinsurers navigate a challenging operating environment. For S&P, both are ways of protecting market positions. “They are unlikely to drive a rating change positively,” Greensted said.
On the negative side, a significant amount of goodwill may have a negative impact as it is not accretive to capital. In addition, a debt-funded deal may have a negative impact on both leverage and coverage metrics, he explained.
Side-effects
Other consequences may be harder to measure, such as the potential management time and focus needed for a transaction which might be a distraction from the core business, particularly in very large transactions, Greensted said.
Furthermore, the impact on staff and clients needs to be considered: “No-one wants to work under a cloud of uncertainty,” he noted, and a deal may also not play well with customers.
“When we are talking about M&A we are looking to increase value,” Monica Cramér Manhem, chief executive officer of Sirius International, said. And in this respect, the cultural fit of the entities being combined are of great importance, she added.
M&A transactions come in cycles, Cramér Manhem noted. She pointed to the Nordics where a significant amount of M&A in the past resulted in a limited number of insurance and reinsurance companies.
“It is now difficult to penetrate the market as a foreign company. It is not really open,” she said. But after market consolidation through mergers creating bigger entities, there have been spin-offs and companies divesting their reinsurance operations to focus on primary insurance. In a next step, new operations are being created, she said.
“Clients, brokers and others require diversification of the people and the contacts they deal with,” she noted.
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