XL Catlin deal will spark defensive consolidation

The industry will face a trend of defensive consolidation following XL Group’s $4.1 billion takeover of Catlin.

This is according to Meyer Shields, managing director at Keefe, Bruyette & Woods (KBW), who said: “The senior management of XL believed that a preference for bigger insurers will benefit them in the future.

"If you accept that premise, then you want to do it early on so that you have your pick of consolidation partners. This means that your deal will be done when others begin to respond with defensive consolidation and you can benefit from whatever turmoil is created."

Shields explained that KBW was not expecting this transaction for two reasons.

“Even when the news first broke that Catlin had engaged in discussions, we ran through a number of companies that we thought might interest it and XL did not cross our minds,” he said.

“Firstly, this was because XL still has some work to do in terms of improving its overall insurance segment results. It’s done a very good job so far but the initiative wasn’t complete. It’s a very difficult undertaking to continue to generate that improvement. This is true at the best of times, and it’s even more true as the insurance rating picture becomes less favourable and as interest rates become more difficult.

“Secondly, we were surprised that a company trading low book value would use its own shares as currency to pay a significant premium for another insurance company.”

Shields explained that KBW was very confident in XL’s ability to improve itself, but that it is still underperforming in the industry.

“It’s generating relatively low returns on equity and the market is appropriately sceptical of assuming future improvement. Because XL has been an underperformer in terms of underwriting profitability, the rating agencies preferred for XL to carry more capital,” he added.