September 30th, 2015

Disruptive Forces to M&A Activity: Soft Market Rates Have Had Limited Impact on Company Returns

Posted at 1:00 AM ET

A key tenet of the anti-correlation theory is that the impact of lower (re)insurance rates will eventually be felt within carriers’ return on equity, thereby forcing action.

The release of historic reserve surpluses within each turn of the cycle cushions the impact of softening rates. This cycle is no different, with annual releases continuing to be recognized from an ever depleting pool of reserve surpluses.

However, within this soft cycle, insurers have also benefited from relatively benign loss activity, especially in terms of global catastrophe activity. Since the international catastrophes of 2010 and 2011, results have not in general reflected normalized loss experience, which over the long term will be the measure of rating adequacy.

Reinsurers’ combined ratios in 2013 and 2014 outperformed 2006 and 2007. This was largely a result of the combined effects of reserve releases and a benign loss environment. This occurred despite reinsurance rate declines of approximately 25 percent in the same period. f-10-relationship-of-reinsurers

In addition, insurance carriers have experienced ever escalating regulatory capital requirements. While the increased requirements are less prominent in specialty insurance and reinsurance markets, the escalation is still evident and provides a greater loss absorption capacity than carriers would have had in previous soft cycles.f-11-increasing-regulatory

The combined impact of reserve releases, a benign loss environment and more robust balance sheets have helped to cushion the impact of the softening cycle and hence delay the onset of mergers & acquisition (M&A) pressures.

However, these delaying influences cannot be expected to endure. Reserve surpluses are finite, loss activity is unlikely to indefinitely continue at below normalized levels and higher capital requirements reduce operational leverage, thereby placing further pressure on underwriting margins.

It is reasonable to anticipate that the declining rate and low investment yield environments will eventually be realized more fully in financial results. At this time, businesses will face further challenges and consequently may pursue corporate M&A transactions. As such, the inflection point in returns where carriers focus on M&A to address low profits should continue to be relevant. Its full arrival has been delayed so far - with a possible exception in the reinsurer landscape.

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