The ongoing convergence of the insurance, reinsurance, and insurance-linked securities (ILS) markets is expected to persist, and combined with continued pressure on earnings and an increasing need for scale and relevance, is expected to drive further reinsurance sector consolidation, according to S&P Global Ratings.
Despite the global reinsurance sector taking advantage of much needed rate increases following a prolonged softened cycle and two years of catastrophe losses, the space remains challenging.
While record-breaking losses occurred in 2017 and 2018, the availability of both traditional and alternative capacity has remained plentiful, cedants’ demands continue to shift and combined with the commoditisation of property risks, this has pushed reinsurers to try to strengthen their relevance and improve the resilience of their business model, says S&P.
One of the ways reinsurers have looked to improve relevance, resilience and scale is through merger and acquisition (M&A) activity. In total, the deal value of M&A activity in the insurance world in H1 2019 is below the recent average, at more than $20 billion, but analysts at S&P feel that this “represents a temporary lull rather than the end of the M&A dance.”
Adding, “Continued challenging business conditions, coupled with cheap financing in the debt market, will continue to fuel M&A activity for the next few years.”
Analysts also highlight the ongoing convergence of the insurance, reinsurance, and ILS markets through M&A activity, noting that it expects this to continue in the months ahead and contribute to the M&A push.
An example of this type of deal can be seen with the world’s largest ILS manager, Nephila Capital and its acquisition by re/insurer Markel towards the end of 2018.
Alternative capital players showed their resolve and commitment to the marketplace following the 2017/2018 cat events and subsequent loss creep. While the entry of ILS slowed when compared with more recent years, the market is sophisticated and increasingly growing in maturity, and the realisation amongst the more traditional players that it’s here to stay led to a rise in M&A activity between primary insurers, traditional reinsurers, and the ILS world.
Interestingly, S&P does not expect any M&A to occur among the top 10 reinsurers, which already account for around 70% of the total net reinsurance premium emanating from the top 25 reinsurers. S&P also notes that many of these firms have their own, material volume of direct insurance business and warns that a merger among these firms would carry substantial execution risk and counterparty concentration risk for the cedants.
According to the financial services ratings agency, from a credit perspective, the reinsurance industry’s M&A record is “patchy,” and in fact, deals are typically credit-neutral at best for the acquirer once the deal has completed.
Ultimately, S&P warns that the pressure is on the less-diversified and higher-expense-base reinsurers, adding that those with a narrower business profile or limited geographical reach will likely either consider M&A or become targets themselves.
“Diversified players with scale, breadth, and depth of products, sophisticated underwriting capabilities, and the ability to build long-term partnerships with cedants are better positioned, in our view, to navigate the difficult business conditions. These factors provide reinsurers with greater flexibility to change the portfolio mix by dynamically increasing or decreasing the line size across products and markets as pricing/conditions change,” says S&P.