A.M. Best has found that a prevailing reliance on Mergers and Acquisitions (M&A) to fulfil a perceived need for increased scale and relevance – particularly in the reinsurance sector, which remains under pressure from alternative capital – as well as meeting difficult target returns in an intensely competitive environment, is fuelling a drive by insurers for market consolidation.
This current climate is further pressurised by soft market conditions further complicating the ability to generate strong underwriting returns, as well as low interest rates hindering companies’ capacity to obtain acceptable yields from investment portfolios.
A.M Best notes how inexpensive borrowing has been leveraged by some insurers to finance deals, while elsewhere M&A represents a means for cash rich buyers to deploy excess capital. Furthermore, excess capital in combination with intense competition has seen private equity backed buyers drive price multiples higher.
In relation to the various strategies deployed following an acquisition, A.M. Best identify the majority as relating to the original motivation for the deal. For example, after similar businesses merge, intentions are generally geared towards increasing scale and relevance in existing markets, therefore the focus is on realising expense synergies and economies of scale.
Additional efforts will also be made to minimise any loss of business but at the same time ensure that, where there is overlap, exposures remain within tolerance. Despite obvious risks associated with execution, A.M. Best considers this type of consolidation a positive move, as there’s a tendency to enhance the position of the company in the insurance value chain.
For reasons stated above, A.M. best expects consolidation to continue at its current rate, particularly for smaller insurers. It also predicts that, as retail business and the smaller end of the commercial market become increasingly commoditised, largely due to the increased use of technology, companies that have access to and the ability to underwrite more complex specialty business are proving attractive.
Additional features that add value to a company, making it more likely to become the subject of a takeover, include data and analytical capabilities, strong management teams, as well as diversifying portfolios and associated capital efficiencies.
A.M. Best concludes by pointing out that buyers will seek to avoid potential unforeseen legacy issues and exposures that are outside their risk appetite as challenges in the current M&A environment are diverse and include overpaying, which could erode shareholder value.
