Among other industry topics Standard & Poor’s Ratings Services’ 2007 Insurance Conference, “In Pursuit of Sustainable Earnings,” held June 3-5 in New York City, discussed possible consolidations in the reinsurance sector.
S&P has released a summary of the panel discussion at the conference, moderated by credit analyst Damien Magarelli. The panel delved into such questions as: “Will the reinsurance industry benefit from more consolidation? Is financial strength related to size? And are reinsurers in danger of harming their credit quality with ill-fated or badly timed M&A activity?”
All of the participants recognized that the reinsurance sector is coming off a very strong year. 2006 not only produced no huge loss catastrophes, but also saw higher rates and stricter attention paid to underwriting standards. As a result Bermuda and U.S-based reinsurers in particular now have stronger balance sheets, which could well rekindle takeover activity.
RenRe’s CEO Neil A. Currie commented “I would be surprised if there weren’t one or two combinations in Bermuda. There are good companies there trading at low prices.”
However, some other panelists were more cautious, given that the upcoming hurricane season is forecast to be an active one. Any consolidations “might have to wait until this year’s hurricane season plays out,” suggested John R. Berger, President and CEO of Harbor Point Re Ltd. Although he also agreed that Bermuda would seem the most likely place to expect further M&A activity.
S&P credit analyst Peter Grant said that achieving successful mergers could still prove difficult. “All other things being equal, greater size and diversity will be viewed positively from a ratings perspective,” he noted. “However, the pursuit of either for its own sake is a high-risk strategy. We don’t have a default stance on M&A and will look at each deal on its merits. It is important for us to understand the strategic rationale for the acquirer and how it addresses the attendant execution risks, be they strategic, financial, or operational.”
Both Currie and Berger expressed the opinion that size makes a difference. While Currie indicated that “there is a little premium to being larger–but not enough by itself to make you go out and do a deal,” Berger explained that “while size and diversification might be harder to realize for the largest mergers, at the lower end, there is a sense that you have to be bigger to survive.”
Currie also pointed out some technical difficulties involved in growth strategies. Firstly “growth can stretch some insurers’ underwriting expertise. As you scale up in reinsurance, your intellectual capital in underwriting is harder to expand. He added that overcoming this problem is easier in personal lines, like autos, and in addition “acquisitions can also be a way to acquire talent. Generally, when you make acquisitions, you want the people. That’s different than it was a few years ago.”
Secondly, Currie noted that mergers could pose difficulties for larger, more diverse insurers in allocating capital to whichever arm of the parent company might need it the most. “Scale can be friend or foe,” he stated. “It is not easy to deploy capital as you scale up.” He used RenRe’s 1998 acquisition as an example, indicating that while it’s important to learn “from other people’s mistakes, but sometimes we have to learn from our own.”
Overall Currie indicated that sometimes acquiring companies are too anxious to make a deal, rather than a good deal. “People are overpaying for mediocrity,” he continued. “He also observed that there are other options to deploy excess capital, such as buying retrocession insurance or repurchasing common shares if market conditions are favorable.
The appetite for M&A activity is linked to the strength of the reinsurers right now, and the pricing strength of the markets–which is now weakening in some regions. “Pricing is now more logical than earlier in my career,” Currie continued, “but things move much more quickly now. In the U.S., prices have held up pretty well. Only profit diversifies.” Berger added: “The last few years, results were better than we hoped. But market rates and prices are going the wrong way. It’s just a matter of time before something breaks and we see some companies scramble.”
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