M&A has inherent risks—but so does not participating
Despite the large number of mergers and acquisitions (M&A) that took place this year, the re/insurance market is still grappling with excess capacity, Stuart Shipperlee, managing director of Litmus Analysis, told Baden-Baden Today.
“People were hoping that the net outcome of the M&A activity would be to remove some of the excess capacity from the market, but that really hasn’t been seen,” he said. “S&P made that point at a Litmus event last week, and we would concur that it’s not happening.”
Shipperlee explained that one of the reasons is that a not-insignificant part of the M&A activity is coming from investors external to the industry buying into the industry with ambition. The natural consequence of that is an increase, not a reduction, in capacity.
“M&A is not a positive pricing event; it’s not an activity that appears capable of turning the market in pricing terms. If anything, it might reinforce reductions in rates,” he said.
“That begs the question: why acquire in a soft market? If the outcome is not to reduce price-based competition then what is the strategic logic for an acquirer?”
According to Shipperlee, Litmus Analysis sees two possible explanations.
The first is that there is simply a large number of niche insurance businesses around the world with attractive business models, both primary and reinsurance.
These typically deliver a superior performance due to some form of sustainable competitive advantage. This may be in the form of specialist underwriting or claims expertise—which for reinsurers also becomes part of their ‘offer’ to cedants to enhance their own business models and hence reduces cedant price sensitivity—or may be based on entrenched distribution advantages.
“The problem with that from the point of view of a large acquirer is that pretty much by definition those organisations are quite small, certainly relative to the large acquirer,” Shipperlee pointed out. “An acquirer might try to obtain several of those businesses, as bolt-ons, but they’re hardly going to be transformational.”
The second explanation is that acquirers are simply taking a long-term view and that, even if a meaningful multiple to book value is paid, the view is that at some point the market will return to healthy pricing and post-acquisition the business will have fundamental advantages enabling it to benefit.
This would also include any diversification benefits, but should really be based on a more profound holistic view of what a future successful reinsurer should look like, Shipperlee said.
“That seems a perfectly reasonable rationale, but it should come with a big caveat, which is that it’s very hard to be clear about what the long-term evolution of the industry is going to be.
“Is there going to be a new normal and—if so—what is the optimal business profile for that?
“Nobody knows whether the traditional cyclical behaviour will repeat, whether we will return to a hard market and what the quantum of that hardening market will be. We don’t know what the non-traditional players will do in the event of a market-hardening catastrophe: be spooked by the losses or excited by the potential future pricing?
“We don’t know if that non-traditional capacity is here to stay without such an event. Will it be tempted away by other investment opportunities when and if interest rates materially increase?”
Shipperlee concluded: “Will cedants really want to trade with only a limited number of truly global players? That is not to say that large scale M&A is wrong, but it does come with an unusually high degree of strategic risk at this point. But of course, arguably, so does not doing a transaction.”
