The current operating environment continues to prompt mergers & acquisitions (M&A) among insurers and reinsurers. However, the number of potential M&A candidates has declined and sellers’ expectations of high deal values could make future transactions more challenging, according to a report published by Moody’s Investors Service.
Recent M&A acquirers generally have been “large, well-diversified firms seeking to enter or expand into specialty insurance including excess and surplus (E&S) lines and Lloyd’s markets,” explained Moody’s in the report titled “More M&A deals as firms seek to broaden depth, scale and market relevance.”
M&A helps acquiring firms diversify their operations, expand distribution channels and hold less capital, said Moody’s.
Further, when a larger firm acquires a smaller target company, the target firm “requires less capital than it would have held on its own, due to the diversification benefits of being a part of the larger firm,” explained a Moody’s representative in an emailed statement.
“In recent years, acquirers – generally large globally diversified firms seeking to expand their operating platforms beyond life and P/C insurance – targeted small to midsized specialty re/insurers,” said Moody’s Analyst Siddhartha Ghosh said. “Because a large number of small to midsized firms have been absorbed during the past three years at attractive prices, future transactions will be more challenging given sellers’ expectations of rich valuations.”
High Profile Deals
Bucking that trend were two high profile deals announced in the first quarter of 2018: AIG’s purchase of Validus in January and AXA’s purchase of XL in March, which have a cumulative value of approximately $20.9 billion, the Moody’s report said.
The report noted that the highest prior total value of specialty reinsurance M&A deals announced was $30.1 billion for full year 2015, which included eight deals ranging from the $1.4 billion acquisition by Endurance Specialty Insurance Ltd. of Montpelier Re Holdings Ltd. to the $7.5 billion acquisition by Tokio Marine & Nichido Fire Insurance Co. of HCC Insurance Holdings Inc.
Difficult Market Prompts M&A
Moody’s said the ongoing challenging operating environment is likely to favor additional M&A.
“Despite last year’s record catastrophe losses, post-event price increases have been muted because there is significant capacity in the reinsurance market,” said the report.
“Although pricing was stable to moderately positive at the January 2018 renewal, it fell quickly through the next few months with modest increases at the June 1 renewal, well short of historical post-event price hardening cycles.” The report attributed these lackluster rate increases to alternative capital providers’ injecting fresh capital into the sector.
With abundant capacity and competitive pricing, “small to midsized reinsurers will remain under pressure to meet their return hurdles, and will likely consolidate into larger, well diversified firms to achieve scale and remain competitive.”
Further, the new U.S. tax law is likely to prompt non-U.S.-based re/insurers to consolidate, said Moody’s, explaining that the new tax law “is credit negative for non-U.S.-based re/insurers whose U.S. subsidiaries transfer significant premiums to their non-U.S. affiliates.” As a result, these re/insurers are like to incur U.S. taxes on a higher portion of their U.S. business, “potentially reducing their future profitability,” which could be another factor leading to consolidation of non-U.S.-based specialty re/insurers, the report said.
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