‘Big enough’ to be relevant in reinsurance keeps getting bigger

The question ‘how big is big enough’, in order to maintain relevance in the currently challenging reinsurance market as it faces structural evolution, is not a simple one to answer, especially as ‘big enough’ keeps getting bigger with every announced M&A deal.

This morning the latest reinsurance merger has been announced, featuring Bermudian firms AXIS Capital and PartnerRe who are set to combine to form a reinsurer with a total capitalisation of over $14 billion.

The AXIS – PartnerRe deal will position the combined firm as a top five global reinsurer the pair claim, based on combined gross written premiums of over $10 billion. That compares to $2 billion of GWP for the soon to combine RenaissanceRe – Platinum deal and XL Group – Catlin with a reported combined net premium of $10 billion.

AXIS – PartnerRe claims it will be a top five global reinsurer after the merger, however sixth may be more realistic taking into consideration Munich Re, Swiss Re, Hannover Re, Lloyd’s of London, SCOR and Berkshire Hathaway as all larger than the combined entity. We’re not sure which one AXIS and PartnerRe haven’t included in their sums. Update: the reason the firm’s place themselves as fifth is that they are not including life and health premiums, so SCOR drops below the combined entity.

XL – Catlin said the resulting combination of their two firms would put them in the top-ten of global reinsurers, with $17 billion of combined capital and $10 billion of net premiums. So, placing into the same lower-middle of the top-ten global reinsurance players as AXIS – PartnerRe it would seem.

Update: AXIS and PartnerRe are focusing on the P&C aspects of the combined entity, which places them significantly larger than Catlin-XL (see chart further down). However, this is based on P&C premiums, which is the most competitive area of the market. The question will be whether AXIS – PartnerRe has enough diversity in this case.

Analysts at Keefe, Bruyette & Woods speculate that ‘big enough’ today may not be ‘big enough’ tomorrow and that as deal’s get announced the pressure increases on others which have yet to secure an initiative that can add scale to their operations.

“More broadly, given the very real market pressures facing smaller reinsurers (and each announced deal raises the bar on what constitutes a ‘big enough’ reinsurer) and the perceived (and real) pressures facing smaller specialty insurers, we believe that almost every Bermudian (re)insurer should now be considering whether to sell itself or buy another company,” the analysts at KBW, led by Meyer Shields, explain.

KBW says it is “generally skeptical” of insurer and reinsurer M&A, noting the clear execution risk that exists in all of the announced reinsurance M&A transactions. However, in the case of AXIS and PartnerRe, the KBW analysts say that there are “a few aspects of this combination that we like.”

Firstly, CEO Albert Benchimol’s links to both firms, having served as CFO at PartnerRe, should smooth the transition to a degree. It also realises what some sources suggest has been a long-term aim of Benchimol’s, to get PartnerRe under his own watch again.

KBW’s analysts say they are not fully “sold on the value of scale in specialty insurance beyond potential expense synergies,” for the AXIS – PartnerRe combination. However they do “fully recognize the rising importance of scale and enhanced diversification in reinsurance,” which is where the majority of the combined entities premiums volume will come from.

Additional scale in reinsurance is expected to assist as “cedants consolidate their reinsurance panels, and as property catastrophe reinsurance’s expected profitability fades,” the analysts explain.

Another factor that makes this deal perhaps a more attractive combination is the fact that PartnerRe does not have a huge primary operation, which implies fewer integration challenges, but the firm does add more obviously useful scale in accident and health lines, the analysts continued.

The outlook for a combined AXIS – PartnerRe will be no brighter based on the market, which shows no signs of becoming easier to navigate. KBW explains; “A more concentrated industry is good for (re)insurance pricing, but we don’t think we’re likely to see anything better than decelerating reinsurance rate declines in 2015. Natural catastrophes could lead to very temporary localized rate increases, but broader rate increases will almost certainly require higher claim cost inflation and much lower reinsurance underwriting profits.”

Looking ahead at the potential for more re/insurance M&A, KBW’s analysts expect; “Most of the consolidation to focus on reinsurance, but as this phase plays out, we see many potential acquisition candidates in Bermuda and amongst both domestic U.S. specialty insurers.”

Meanwhile, analysts from Morgan Stanley, led by Kai Pan, commented on the deal; “The combination is strategically imperative for both companies as size and breadth becomes increasingly important in a competitive global reinsurance marketplace.”

The Morgan Stanley team see the merger meeting two key objectives which will assist with maintaining and increasing the combined firms relevance in the market. They see the combined firm as sixth largest in reinsurance, based on 2013 premiums, as demonstrated in the chart below.

AXIS Capital - PartnerRe combine to create a larger global reinsurance firm - Source: Morgan Stanley

This second chart is taken from a presentation that AXIS and PartnerRe will be giving to investors shortly. It shows the combined firm as fifth largest property and casualty reinsurance firm, excluding life and health premiums and Lloyd’s, where the Morgan Stanley chart includes these elements.

AXIS and PartnerRe's position as a combined reinsurer, excluding life and health premiums

Firstly, the increased scale in reinsurance will clearly help the firm going forwards, with AXIS growing in reinsurance lines with the addition of PartnerRe. Secondly, the combined entity expands into primary insurance, with the beneficiary largely PartnerRe in this case, thanks to AXIS’s large specialty insurance business.

Morgan Stanley also cites the benefits of Benchimol having experience of both firms and expects this will help the management transition to be smoother, with better cultural fit and Benchimol being the “natural leader of the combined firm.”

While this industry consolidation is a logical response to the structural change facing reinsurance and the growing influence of third-party capital and ILS, Morgan Stanley’s analysts note that “substantial strategic, cultural, and financial barriers remain.”

As these mergers and acquisitions progress, with more expected to be announced, the size of the top reinsurers is growing which will make it incrementally more difficult to acquire the scale necessary to break into the top-ten, as each deal completes.

As a result, ‘big enough’ will get bigger. Those yet to announce a deal may eventually begin to run out of viable options, if they are to position themselves at a size that is truly ‘big enough’ to enable them to maintain market relevance and acquire the scale required to compete with an increasingly large top-ten group of global reinsurers.

Could this lead to some three-way mergers, as reinsurers put scale ahead of everything else? Or perhaps some of the largest reinsurers, already in the top-five, may look to pick off some of the smaller ones in order to add incremental value? Hard to say.

Achieving scale and maintaining relevance is likely to remain the mantra for those seeking an M&A deal, with a dash of efficiency and cost-saving on the side. How big is ‘big enough’ and is size even the most important aspect of a deal, is impossible to answer. This will only become clearer as the market shakes out over the coming year or more.

One final point to consider is the fact that while smaller reinsurers focus on arranging and executing M&A deals, the largest global reinsurers are working on product diversification, growth into profitable areas of the market and other new initiatives.

Without the burden of a merger, the cultural fit issues, implementing cost-savings and generally going through the corporate tasks associated with a merger, these already ‘big enough’ reinsurers could find their advantage increasing over those burdened by planned or ongoing M&A.

Read our follow-up article on this deal: AXIS + PartnerRe enhances ability to leverage third-party capital.

Also read:

– Axis Capital & PartnerRe to merge in response to structural change.

– Re/insurance & ILS investors to focus on value creation in 2015.

– XL Catlin deal a sign of how bad the reinsurance market really is: KBW.

– What to do with all this ‘superabundant’ re/insurance capital?

– Insurance and reinsurance mergers and acquisitions to increase: Fitch.

– XL buys Catlin for £2.79B. Makes XL more attractive to third-party capital.

– Combined XL – Catlin a “perfect partner” for third-party capital: McGavick.

– Reinsurance rate softening, broadening of terms ahead in 2015: KBW.

– Flat commercial U.S. P&C insurance rates signal 2015 soft market.

– RenRe will look to share Platinum prop-cat book with third-party capital.

– RenaissanceRe to buy Platinum Underwriters in $1.9 billion deal.