M&A is no reinsurance panacea, caution Deutsche Bank analysts

by Artemis on February 19, 2015

Increasing merger and acquisition (M&A) activity amongst insurers and reinsurers, at a time of ongoing reinsurance market competitive pressures calls for greater caution, according to Deutsche Bank Markets Research.

The Germany domiciled and world leading financial services organisation’s recent report on the January reinsurance renewals, ‘January Renewals, Better than expected, but…’ states that while the pricing trend this January was perhaps “not as bad as some feared,” the firm are “more cautious on the space than before.”

M&A activity was a common topic of discussion for many firms during the renewal season, as investors, clients and brokers showed interest in how companies felt about a hike in market consolidation.

Artemis recently discussed Lancashire’s stance on this phenomena, with Group executives revealing they see the M&A movement as a benefit to the firm, as more business becomes available and noted that scale does not necessarily equal the relevance that some reinsurers claim to be seeking.

Rating agency Standard & Poor’s recently said that mergers and acquisitions will not provide reinsurers with any protection from the competitive market pressures, nor will they stop reinsurance rates from declining. S&P also highlighted the risks that a poorly executed M&A deal could leave reinsurers in a worse state than before.

Munich Re shared another view during its renewals investor conference call, saying that in the long-term consolidation is, for it, “a very healthy development because it takes a number of players out and it takes capacity out of the market.”

Alleviating the re/insurance market of some of the excess capital that continues to pressure pricing, and which the growth of alternative capital in catastrophe bonds, insurance-linked securities (ILS), sidecars and other third-party capital vehicles exacerbates, would be a welcomed shift for many sector participants.

Although brokers, reinsurers, insurers and analysts alike all agree this won’t be happening anytime soon, as further capacity is anticipated throughout the coming months, while third-party investors interest in reinsurance and catastrophe risk is not expected to abate.

“In terms of the impact on market conditions, we think consolidation creates a complex picture. Initially, there could be opportunities for companies not involved in transactions. Longer term, companies with greater economies of scale should be able to better absorb rate reductions,” explains Deutsche Bank.

In spite of the perceived benefits, there are some doubts surrounding the M&A market trend that is currently taking place in the sector, stressing that M&A positives should be viewed with caution and that it is no panacea to the firms involved.

To back up its cautious stance on M&A trends in a softening market, Deutsche Bank draws on data from the M&A spree that occurred during the last major soft market, 1995-2001. Noting that, this period of consolidation “failed to exert any visible beneficial influence on rates” and that “overall, we would expect limited relief of market pressures as a result of consolidation.”

Commenting on the M&A deals that went through in this period, the analysts warned; “What is clear is that almost all of them underperformed the market in the years after acquisition. While there were clearly specific and unique circumstances around each deal, this underscores the intuition that acquisitions (especially those done in an already soft market) do no not necessarily create value.

The report continues to explain that when pricing finally did stop sliding, in 2001, this wasn’t because of market consolidation, but rather a pricing floor being reached coupled with substantial losses from 9/11.

As recent market trends, of softening rates, broadening terms and competitive pressure, continued during January renewals, Guy Carpenter revealed that alternative reinsurance capital grew its market share during this period, as covered at the time by Artemis.

Reinsurance brokerage firm Willis Re, also stressed the expanding presence of fully-collateralized reinsurance and ILS within the international reinsurance market at January 1st renewals, as cedents increasingly added some third-party capital to their reinsurance programmes.

It seems evident then that the market is enduring some structural changes, as a prolonging absence of major losses, heightened competition and ample capacity continue to test the relevance and sustainability of companies small and large.

Consolidation is seen as a viable option for companies to navigate the tough market environment, but as explained in Deutsche Bank’s report, “gives us little to look forward to in terms of market-wide pricing improvements.”

Noted in the report and discussed by Guy Carpenter, cat rates dropped by 11% this January, the same amount as at January renewals in 2014. This was helped by a catastrophe loss year totalling just $30 billion in 2014, 25% lower than in 2013 and the lowest total for four years.

Absent a single major loss, or several smaller but significant losses, further softening of prices is expected to continue throughout 2015, leaving many expecting an ongoing surge in M&A transactions.

While pricing remains under pressure several reinsurers have noted the importance of disciplined underwriting, while keeping an eye on growth and innovative opportunities. However observers are beginning to question the rationale behind M&A and it is likely that future deals will come under increasing scrutiny.

While M&A may be no panacea for reinsurers looking for a quick fix to the challenging market, it may set them up for longer-term success though. If they can achieve or maintain relevance with their clients, execute M&A in an efficient way without too much overlap and crossover of business, and come out the other side a leaner, more efficient underwriting machine, the long-term outlook may be healthier.

If they fail and lose relevance, business, efficiency, or simply stagnate, then perhaps even the merged firms could then become targets for takeovers by the largest reinsurers, who may find lower valuations, of firms where M&A is not the hoped for panacea, rich picking as market pressures continue.

Also read:

Reinsurance M&A won’t ease softening or competitive pressure: S&P.

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