M&A pressure to continue for Bermuda re/insurers: Fitch

Pressure on insurance and reinsurance companies to enter into mergers or acquisitions (M&A) is expected to continue, as pressure on earnings remains. However the consolidation trend in 2016 is expected to be slower than seen last year, according to Fitch Ratings.

“Fragile conditions” in the insurance and reinsurance market, as seen in the decline in pricing and weakening of terms and conditions, are continuing to pressure re/insurers in Bermuda, Fitch Ratings says in a new report.

“Organic growth options are limited and scale and diversification are driving a rapid pace of M&A activity for Bermuda insurers and Fitch expects industry consolidation to continue,” commented Brian Schneider, Senior Director at Fitch.

The urge to merge continues apace, with companies looking to whatever tools or strategies they can adopt to enhance or lower their cost-of-capital, improve their underwriting efficiency and gain market advantage.

Scale and diversification remain attractive, enabling firms that were once more narrowly focused to enjoy the benefits of diversification within underwriting portfolios and effectively allowing them to write more efficiently, often at lower prices.

Fitch notes that while its insurance sector rating outlook is stable, pressure is evident and will remain. Meanwhile for the reinsurance sector Fitch maintains a negative sector outlook, as pricing is expected to decline further in 2016, while investment returns remain low.

The Bermuda insurance and reinsurance market is strong, Fitch says, with the islands favorable tax status and strengthening regulatory framework enabling it to compete in the global re/insurance market.

However Fitch does expect some of the larger, publicly listed re/insurers in Bermuda to report weaker results for full-year 2015, although still favorable. And there is a good chance that while market conditions remain unchanged the weakening of results could continue.

Hence the M&A trend is thought to be here to stay, by Fitch, with both the desire from within the re/insurance market to find a way to offset the pressure, as well as interest from foreign investors and companies both expected to drive some deals.

However, Fitch warns, that any M&A activity that it deems to simply be about acquiring scale or diversity, with no regard for future strategy or clear rationale, will not be looked on favorably.

On pricing, Fitch explains that reinsurance pricing is already nearing the level of cost-of-capital for some Bermudian players and that further material price declines could result in negative rating actions on some re/insurers.

Capitalisation among traditional Bermuda domiciled insurance and reinsurance firms is expected to remain high, even though profitability is clearly on the decline. With losses remaining largely low or attritional, particularly at the reinsurance level, capital still builds leading companies to seek to return capital over deploying in the current market.

As a result, Fitch does see some further consolidation among Bermuda re/insurers as positive, as it will help to reduce local market capital somewhat and perhaps ease the competition a little.

Fitch also expects continued “fierce competition” in some areas of the reinsurance market where alternative capital and ILS are taking market share. As a result of the influence of alternative capital Fitch does warn that increased M&A will have a limited effect on supply side dynamics and competition.

So market conditions remain ripe for further Bermuda insurance or reinsurance M&A and consolidation. However, the longer these market conditions persist and the more established alternative capital and ILS becomes the more difficult it will be to effect an M&A deal that shows clear and rapid benefits.

The longer market conditions persist the increasingly shrewd the players that got in early in 2014 with M&A and that have now integrated and completed their transactions appear. The thought of integrating two major re/insurance firms over the coming year, while pricing moves close to or even below cost-of-capital, ILS continues to grow and take share, efficiency continues to grow in importance and reserve releases perhaps begin to look less sustainable, looks increasingly like a difficult task to achieve and keep shareholders happy.

The strategic rationale will need to be clear, providing shareholders and stakeholders with absolute evidence why entering into M&A in a time of market flux and change is a positive thing to undertake. That adds pressure to board and exec decisions on M&A, and it may only be the brave and strategically minded (or perhaps foolish) who try over the coming year to effect a deal.