Fitch Ratings says that it expects to see an increase in merger and acquisition activity, across the insurance and reinsurance industry, as market participants come to terms with lower profitability and see M&A as a faster route to growth or an improved capital position.
The recent announcement of Bermuda-based reinsurance firm RenaissanceRe’s agreement to acquire Platinum Underwriters could spur merger and acquisition activity among reinsurers, Fitch Ratings says. While this deal itself is not a blockbuster, Fitch says, it may provoke a shift in market attitude to embrace more consolidation as a strategic option to combat the current challenges facing the reinsurance market.
At the same time, Fitch says that it expects that M&A activity in the European insurance sector is likely to increase, particularly as firms make the transition to the Solvency II regulatory environment at a time when their profitability remains under pressure.
For the reinsurance sector, Fitch says that record levels of capital among traditional reinsurers as well as the growing capacity provided by alternative capital providers and ILS are softening reinsurance pricing and broadening policy terms and conditions.
As a result, M&A is an increasingly appealing option for reinsurers that find themselves marginalised, due to having too small a market share to enable them to remain relevant. Fitch says that it sees no catalyst for a reversal of the reinsurance market’s fortunes in sight.
The RenRe Platinum deal is a combination of two reinsurers, notes Fitch, with achieving scale and growing diversity through acquisitions seen as beneficial, because absolute capital size remains an important competitive factor in the reinsurance industry.
This capital size is particularly meaningful for reinsurers, says Fitch, as the purpose of reinsurance is largely to absorb earnings volatility on behalf of clients. It is also important as the more capital and capacity you wield as a reinsurer the more relevance you will gain when it comes to renewal. If you want to be seen as a leading market for reinsurance then scale is going to be required in the currently challenging environment.
Fitch explains that larger reinsurance organisations have an increased opportunity and a greater financial ability to lead reinsurance programmes, which puts them in a better position to evaluate and select risks, and negotiate pricing and terms and conditions.
In the currently competitive environment, with the growing competition from non-traditional sources of capital, stronger, more established reinsurers are maintaining capacity at the expense of smaller, weaker companies, Fitch continues.
Fitch also notes that many reinsurers are entering primary lines of business in search of diversification and to avoid the competitive areas of the reinsurance market. Fitch suggests that this focus on diversification into primary markets could lead to a broader variety of mergers and acquisitions, perhaps suggesting that reinsurers could buy primary insurance operations.
Fitch sees some consolidation as a modest positive for the reinsurance sector, given that a reduction in the number of reinsurers and their associated underwriting capacity would be likely to ease competitive pressures for a time.
For European insurers Fitch notes that low interest rates have driven down profits across Europe and business models have come under strain from reforms and regulation in some markets, such as the UK, where pension law changes have hit the market for annuities.
Again, scale seems important here and Fitch explains that the saturated markets in most big European countries will make buying market share through consolidation an attractive option for some insurers. However, Fitch believes that deals are most likely among smaller insurers because the upcoming transition to Solvency II regulations is likely to be less of a problem for the larger European insurance firms.
Fitch explains that the larger European insurers are more likely to receive a benefit for diversification in the calculation of their capital charges, are generally likely to be better prepared for the new regulatory environment and also have enhanced access to capital if it is needed. As a result, Fitch believes that the cost of becoming and maintaining compliance with Solvency II will be a greater burden for smaller insurance firms, which are also likely to be less well prepared.
Results of Solvency II preparedness tests show that many insurers in Europe remain vulnerable and could be seen as takeover targets as a result. The option of being taken over may prove to be very appealing for these firms as a way to reduce the overall Solvency II burden by scale through acquisition.
Fitch notes that in both the cases of reinsurance and primary insurance players, consolidation comes with both benefits and risks. M&A can be positive if it increases diversification, market share and leads to economies of scale, says Fitch. But significant execution and integration risk can be a problem, especially where there are cultural differences between buyer and target.
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