Amounting to just $4.7 billion in aggregate deal value, the 46 merger and acquisition transactions announced in the property/casualty insurance sector in 2012 were near record low levels, according to the latest annual M&A study from Conning.
In the last 10 years, there was only one year with fewer P/C insurance deals than 2012, notes Jerry Theodorou, vice president and analyst for the Hartford, Conn.-based research and insurance asset management firm. That year was 2004, he says, noting that a “classic hard market” was in full swing in 2004 and “there was no reason to engage in M&A.”
The Conning report reviews deal frequency and dollar values of M&A transactions for all sectors of the insurance industry—P/C, life/annuity, health insurance, insurance distribution and insurance services. For all the sectors taken together, there were 741 deals announced in 2012—representing a 19 percent decline from 2011. The total dollar-value of insurance deals fell 21 percent in 2012.
But for the P/C sector in isolation, deal numbers tumbled more than 40 percent drop in deal numbers, and the aggregate value of P/C deals plummeted more than 60 percent—to $4.7 billion in 2012 from $12.5 billion in 2011.
Theodorou says there were only two years in the last 10 that had lower aggregate valuations of U.S. P/C insurance M&A—2004 and 2009.
“2009 was the year on hold,” he said, referring to the “deer-in-headlights” mentality that paralyzed potential acquirers during the financial crisis. “The only deals that were being done in 2009 were distress transactions,” when AIG and other troubled carriers were trying to unload businesses.
Turning to possible explanations for the muted level of deal activity last year, Theodorou reasons that it is attributable, in part, to a firming market.
“You had rates going up, [and] rate on rate,” he said, noting that insurance prices started to rise in 2011.
“We’re not calling this a classic hard market where you have double-digit rate increases. But a firming market is a period when you typically have less M&A because organic growth is available,” he said, noting that average commercial lines price hikes of 5 percent in 2011, and another “couple of points on top of that” in 2012, were firm enough to quiet deal-making endeavors.
In addition, Theodorou notes that low P/C insurer valuations are “still hanging over the market [to] put the brakes on” M&A deals, referring to the fact that the valuations of publicly traded insurers remained below book value in 2012. And while buyers were reluctant to use undervalued currency in acquisitions, potential targets also hesitated to sell at “fire-sale prices,” the Conning report suggests.
Theodorou says buyers are refraining from using excess cash also, speculating that their restraint relates to the “yellow signals” of the overall economy.
“The economic environment is fragile,” he says. “We don’t know how long the expansion will continue. And it is a modest or anemic expansion.”
“There is so much exposure to an event from Europe or China that may take out the froth in the recovery,” he adds, highlighting the uncertainty that may be limiting appetites for acquisition.
Theodorou notes the presence of reserve risk also. Over the years, there have been so many companies that engaged in large-scale acquisition only to discover later that the reserves were inadequate. “It really takes away from the sheen of the transaction,” when the acquirer must boost reserves, he says.
‘Subthemes’ Of 2012 Deals
For the deals that did get added to Conning’s M&A database for 2012, there was no overriding identifiable theme across all of them akin to the “consolidation-for-scale” theme that typified the wave of mega-deals of the 1990s, or even the wave of the “distress-driven sales” in 2009. Still, there were some “subthemes” apparent through closer analysis of the P/C deals, Theodorou says.
- Specialty lines deals
- Runoff sales
- Small deal sizes
- Strong outbound cross-border transactions by U.S. companies
Explaining the attraction of acquirers to specialty lines, Theodorou says the simple reason lies in a quest for underwriting profit.
With P/C financial results no longer buoyed by investment returns, carriers are still being conservative in their investment strategies—shortening bond durations in advance of the eventual turn in interest rates, he notes. “So they’re looking more closely at the underwriting side. And if you’re going to look more closely at the underwriting side, you’re going to look at lines that are more profitable. Those are the specialty lines,” he says.
He identifies Argo Group, AmTrust Financial Services, Markel and RLI as buyers who participated in specialty lines acquisitions last year.
Theodorou adds that “there are not that many pure play specialty insurers” available for acquisition. This has led carriers seeking specialty business to participate in what he terms “vertical integration”—purchasing managing general agents and managing general underwriters involved in specialty lines underwriting, administration and distribution.
“The MGAs have the expertise and the skills. They know their territory. They know the agents. They know the exposures,” in some cases, because they have worked in the industries for which they’re now creating insurance offerings. “So even though you’ve got a higher commission, you’ve got superior combined ratios,” he says, noting that combined ratios for some specialty lines, such as inland marine are in the 80s, as opposed to the high 90s or over 100 for some of the “vanilla lines of business.”
“Quality MGAs are a very desirable, hot hot commodity,” he says.
The Conning report notes that in addition to the “vertical integration” deals, there were several transactions involving nonstandard automobile insurers and mergers of medical professional insurers.
Separately, last week, during the New York Society of Security Analysts Insurance Conference, Stan Starnes, chair and chief executive officer of ProAssurance, a medical professional liability insurer headquartered in Birmingham, Ala., suggested that there will be more mergers in the sector as a result of the Affordable Care Act and changes in health care delivery generally.
Noting that the medical professional market is fragmented, with no carrier commanding more than 10 percent of the market and 50 percent of the market being held by 10 or 11 carriers, Starnes noted that the many one- and two-states mutuals in the market “are at a true pivot point.”
“More and more health care is going to be delivered through the auspices of large integrated organizations,” such as ACOs and health systems. As large integrated groups of hospitals and physicians emerge, “they are going to be of such financial size [and] such geographic spread, that they will require a company bigger of financial size and large spread to provide their medical professional insurance.”
“If you’re a hospital, you’re not likely to be comfortable to be insured by an organization that’s smaller than you are,” he said, noting that many of the one- and two-state mutual don’t have the geographic reach that will be required.
As for nonstandard auto, Theodorou notes that the nature of the coverage—focused on risky drivers with poor driving records—creates profit opportunities. “Where there’s more risk, you have the potential for better margins and better pricing,” he says.
He identified two 2012 nonstandard auto deals—one which saw Intact Financial buy JEVCO in Canada, and a U.S. deal in which Western National, a super-regional based in Edina, Minn., acquired American Freedom, a nonstandard auto insurer writing just $16 million in premium.
PE Still Interested—In Brokers
While there was less strategic integration among P/C insurance carriers in 2012 than in past years, private equity deals were visible among the largest deals in the most active sector for M&A transactions—insurance distribution.
According to the Conning report, there were 323 distribution transactions announced in the United States, representing the second-highest number recorded. While typical deals in prior years were “roll-ups of small agents,” the report notes that 2012 saw several large broker deals, with private equity sponsor-to-sponsor deals common among the group.
Theodorou says that private equity investments typically have a holding period. “They buy a company, fix it, build it up, and then spin it off with an IPO or private sale.”
“Some investments they had in the brokerage space were approaching their sell-by dates. So there were several sponsor-to-sponsor transactions, where one private equity firm sold to another one,” he said.
Large broker deals in 2012 included:
- A stake in AmWINS Group held by Parthenon Capital Partners going to New Mountain Capital.
- BB&T acquiring wholesaler Crump.
- Alliant going from Blackstone to KKR.
- USI being bought by Onex Corp. of Canada from GS K partners.
- Config Seguros being sold by Genstar Capital to ABRY Partners.
The same factors that made MGAs and MGUs attractive to P/C carriers last year, made MGAs and wholesale brokers a favorite target among private equity buyers, Theodorou notes.
In addition, he says that private equity firms were active in the insurance services segment in 2012, with many sponsor-to-sponsor deals happening there as well.
“It’s really intellectual capital they’re buying,” he says, noting that there is no worry about reserve risk creeping up in these deals.
For information on the other M&A “subthemes” for the P/C insurance industry, see the original version of this article published on carriermanagement.com <https://www.carriermanagement.com/features/2013/03/24/102991.htm> .
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