The execution risk associated with the impending merger of Canadian property & casualty insurance and reinsurance group Fairfax Financial Holdings Limited and specialty insurance, reinsurance and investments player Allied World Assurance Company Holdings, AG, sits largely with the latter it appears.
Rating agency A.M. Best highlights that while there are “inherent execution risks” in this transaction, as there are in any merger or acquisition deal, the majority appear to sit on the side of Allied World in this case.
The rating agency notes M&A transaction execution risks for Allied World, the risk that as Fairfax’s ratings are lower than Allied World it could see its rating drop once the merger is completed and also risks to Allied World’s ratings if the transaction didn’t close as planned.
On Fairfax Financial’s side though, A.M. Best notes that “the inherent execution risks of the transaction are mitigated by Fairfax’s demonstrated capital market access and decentralized operating strategy” and that the “proposed deal structure affords Fairfax flexibility in terms of financing and management of downside risk.”
The rating agency also notes that Fairfax should benefit from “diversification of its business, reinsurance opportunities,” but perhaps more encouragingly for Allied World also highlights potential “advantages that may ultimately be derived from Allied World’s rating profile.”
The difference in ratings, with Allied World having the higher rating from A.M. Best, is what seems to have driven a negative outlook for the companies ratings with the agency.
It suggests that there is more risk sitting with Allied World than Fairfax in this deal, particularly should the merger fail to be completed.
However, with a strong cash boost possible as part of the deal, to counter any other offers, it does seem likely that Fairfax will close the transaction as planned.
Fellow rating agency Standard & Poor’s also pointed to more risk sitting with Allied World than Fairfax within the planned M&A transaction.
S&P said that Allied Word’s executives haven’t entered into agreements to keep them with the firm and that therefore, any potential key executive departures after the M&A closes could be a negative rating factor.
However, S&P also highlights that after the M&A closes it would likely consider Allied World “a
strategically important entity within the Fairfax group” as it will be a significant contributor to the group’s profits going forwards.
S&P also explains the possibility that cultural challenges could emerge as Allied World gets integrated into Fairfax, adding that there are of course the standard range of M&A execution risks as well.
Finally, and again pointing towards more risk on Allied World’s side of the M&A deal, S&P notes that while it views the firm’s enterprise risk management (ERM) as strong, it views Fairfax’s ERM as only adequate, which could weaken S&P’s view of Allied World’s ERM construct under Fairfax’s ownership.
With Allied World expected to operate on a decentralised basis within Fairfax this risk seems minimised, however the fact that the one aspect that will be centralised is the investment portfolio could be enough for Allied World’s risk profile to change, it appears.
Mergers & acquisitions are always fraught with risks and while in this case the risk does seem more on the side of Allied World, the fact remains that the two companies look like a good fit and the expansive ambitions of Prem Watsa’s Fairfax and his investment strategy could help to drive up Allied World’s relevance as a global insurance and reinsurance firm.