Analysts Weigh Travelers Deal, Other Issues

By | December 1, 2003

It’s “inevitable” that the advanced merger discussions between Travelers Property Casualty Corp. and St. Paul Companies succeed, according to one industry analyst.

Though most insurance industry consolidations fail, this one “seems less likely to head for divorce” because the parties to the proposed marriage know each other very well and consequently the “execution risk” will be lower, according to Mike Paisan of Legg Mason.

Paisan was one of five analysts participating in a panel discussion on investing in the industry at New York’s Harvard Club in Manhattan recently. The two-day conference was staged by The Wall Street Transcript (TWST) and a number of media sponsors.

The definitive merger agreement would create the nation’s second largest commercial insurer, which was initially reported by the Wall Street Journal as somewhere in the $10 billion to $17 billion range. To be called The St. Paul Travelers Companies, it would be second in the property/casualty arena only to American International Group (AIG).

“The numbers, at least on the surface, seem to be pretty reasonable,” Paisan said. Going forward, the new company and AIG “are going to significantly separate themselves from the rest of the pack and be very well situated as we meander into a potential soft market.”

Indeed, this may be only the start of further acquisitions by the newly combined entity, said Michael Lewis, an executive director in the financials group of UBS Investment Research. “Travelers was put on this earth to consolidate the P/C industry and this is the easiest one to do,” Lewis said. “Now, what happens to other companies that want to have a national presence? They’ll have to rethink their game plan.”

From a broader perspective, said Michael Hallett, vice president at Fox-Pitt, Kelton Inc., the deal may be viewed as a potential negative for the industry. “We think the signals this sends to the market is that we are in the later stages of the cycle.” Transactions like these, he said, normally occur at the end of an insurance cycle, so the deal may well indicate the beginning of a turn away from the current hard market.

Senior equity analyst Michael Dion, an associate director with Sandler O’Neill & Partners, agreed that the timing of the potential transaction is an indicator of where the industry is in the current cycle and may well augur a softening of the insurance market. It certainly raises the question among others as to whether it’s also time to partner, he said. “It may be the start of a wave of deals,” he said, cautioning, “There has not been one successful merger to date” in the P/C industry. “It remains to be seen what happens long term with this one.”

The situation sets an interesting dynamic, in the view of Adam Klauber, managing director of the research department of Cochran, Caronia & Co. Klauber agreed that the market has shown the early signs of softening. He said that with this acquisition one of the few strong large market companies left is taken away. “You might see bifurcation of the market between stronger carriers and weaker carriers,” he said. “It has the potential for extending the hardened market.”

Besides the Travelers-St. Paul story, the panel addressed a number of other issues. Among them:

The insurance cycle
The question put to the panel was whether there will ever be an end to, or moderation of, the hard-soft market cycle or whether it’s “same old, same old.”

To UBS’ Lewis, nothing is about to change.

“Once you recapitalize the industry and you give these guys two nickels and they rub them together and they think they’re rich, the mantra changes: it’s not disciplined underwriting, it’s market share.”

Insurance is a mature industry, he said, and “when you have too much capital chasing too little business, there’s only one way to go.” And no matter how many smart people you have in the business, people who won’t make the same old mistakes, “you have enough dumb people” who will chase market share down “the slippery slope,” he added.

Michael Hallett, vice president and research analyst at Fox-Pitt, Kelton Inc., saw little reason to be optimistic that the current hard market will extend beyond 2003 into 2004 or 2005. But the bottom-line, the “nuts-and-bolts” of insurance is that it’s an industry that inevitably generates excess capital over time, which makes it necessarily cyclical.

Rating downgrades
Paisan allowed that the numbers still aren’t the same as they were in 1997-1999, but he said those numbers weren’t real, so it’s unfair to make the assessment that the industry today isn’t performing the way it should. It’s not the best of times, to be sure, he added, especially with the industry “making up for past mistakes,” but “it is getting better.” Paisan, who used to work for one, said “rating agencies have to justify their existence, so they’re always going to take the most pessimistic look.”

The key factor is what happens next, Klauber commented. Trends in paid losses, for example, have been improving “quite rapidly which is a reflection of what the industry has done to restructure itself over the past few years. There have also been significant price increases and tighter underwriting standards, he said, and if these trends continue there should be significantly better earnings next year.

“There’s not a lot of differentiation between the good and the bad companies,” Lewis added. Investors are not taking the point of view that this is going to be an extended hard market and that the earnings, the ROEs, or the profit margins are attainable and sustainable, according to Lewis. “Companies that get on top of their legacy issues have an opportunity for outsized profits over the next few years,” he said. “One wild card is what’s happening in terms of putting a lid on claims costs through tort reform, which is moving aggressively at the state level. The investor has to differentiate between companies that can do this and those that will spend an entire cycle addressing prior years’ problems.”

Tort reform
“Trying to figure out Washington is a fool’s game,” Paisan said, but he’s convinced that, overall, general tort reform stands a better chance than reform in medical malpractice or asbestos liability. There’s a good possibility, he said, that general class action tort reform, with “a little tweaking” will pass. Meanwhile, there’s substantial progress at the state level. “Overall tort reform is going in the right direction.”

Sandler O’Neill’s Dion said tort reform is most likely going to wait until after the Presidential election. If President George Bush loses the election and the Republicans lose the slim majority they have in the United States Senate, “there’s probably not a chance you’re going to see it,” he said. “But if he is re-elected, I think the chances for tort reform increase immensely.”

Tom Slattery, an independent journalist. He is currently a managing director of Slattery-Esterkamp Communications, Baldwin, N.Y. Contact: t.j.slattery@worldnet.att.net.

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