Bill Kennedy, CEO of Global Analytics and Advisory
The global reinsurance sector is adrift. With little conviction in the market’s next move, the challenges of organic growth by primary (re)insurers have heightened. Economic uncertainty, volatility in global equity markets and sovereign debt concerns are dampening CEOs’ confidence. Rates remain challenged, and cost savings are hard to find in the property and casualty (P&C) space. With stocks plummeting and credit markets getting roiled, the pace of deals for the remainder of 2011 is expected to slow.
Growth through acquisition is tough in an environment in which stock and credit markets are in turmoil. However, conditions are in place for mergers and acquisitions to reassert their fundamental purpose: for strong corporate performers to match acquisitions to their long-term strategic objectives and to drive out weak, inefficient players.
Acquisitions that put companies in the hands of better owners/managers or reduce excess capacity can create substantial value for both the economy as a whole and investors. Strategic buyers should seize opportunities where the combination of assets can create value by delivering scale and scope as well as driving out inefficiencies. Strong corporate performers that can exploit strategic and operational synergies should be able to outbid financial players that rely only on operational improvements and leverage.
Deals that emerge in an environment without an ample supply of easy credit will mark a return of corporate buyers with good strategies and great deal execution. Private equity will undoubtedly reassert itself where it can demonstrate that it adds value, but tight credit conditions and compressed leverage ratios for buyouts should subdue private equity participation.
P&C insurance sector valuations are attractive by absolute and relative standards. The market value of many companies is closer to their estimated intrinsic value now than any time in the past 20 years, and cash balances are high. What’s more, a relatively weak U.S. dollar offers insurers in Europe and Asia an opportunity to take advantage of U.S. acquisitions.
Despite the uncertain macroeconomic picture, other leading indicators will likely affect the level of P&C insurance M&A over the next 12 months.
European financial services companies will continue analyzing strategic options for insurance operations in the face of the coming regulatory changes. Focus likely will be on non-core (re)insurance operations and alternative M&A transactions to clean up balance sheets (e.g., the use of run-off sales).
Turn in the market
The unprecedented amount of worldwide catastrophes during the first half of 2011 has placed pressure on reinsurers. Many have exhausted their catastrophe budgets for the year. Should another major catastrophe strike, the tipping point from earnings event to capital event could be reached, thereby causing rates to increase. A hardening of the market would likely change insurers’ focus from growth via acquisition to organic growth.
Pressure on reserves
Guy Carpenter‘s analysis of the U.S. reserving cycle over the past 30 years suggests the tide may be turning and a period of reserve shortfalls looms. Add potential pressures from inflation in some markets, weak investment returns and, in Europe, higher reserving charges from Solvency II, and a challenging cyclical phase may serve as a catalyst for increased M&A activity.
P&C M&A activity for risk-bearing entities in the first half of 2011 was at a level similar to the past two years. There were 22 announced and closed transactions with an aggregate deal value of almost USD3.4 billion during the first half of2011 (see Figure 1). Industry reports indicated that, during the first half of the year, there were an additional 15 transactions that had been announced but not closed. If these deals were to close at their announced transaction values, this would add USDl.8 billion in transaction value to the 2011 total. This is well off the 2008 levels, when there were 67 transactions for a total of USD16.8 billion.
Figure 1: Property & Casualty Insurance M&A Activity – 2003 to Present
(Source: SNL Financial, all closed P&C deals through June 30, 2011)
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* Securities or investments, as applicable, are offered in the United States through GC Securities, a division of MMC Securities Corp., a U.S. registered broker-dealer and member FINRA/SIPC. Main Office: 1166 Avenue of the Americas, New York, NY 10036. Phone: (212) 345-5000. Securities or investments, as applicable, are offered in the European Union by GC Securities, a division of MMC Securities (Europe) Ltd., which is authorized and regulated by the Financial Services Authority. Reinsurance products are placed through qualified affiliates of Guy Carpenter & Company, LLC. MMC Securities Corp., MMC Securities (Europe) Ltd. and Guy Carpenter & Company, LLC are affiliates owned by Marsh & McLennan Companies. This communication is not intended as an offer to sell or a solicitation of any offer to buy any security, financial instrument, reinsurance or insurance product.
Bill Kennedy, CEO of Global Analytics and Advisory