Majority of re/insurance M&A negative, synergies rare, says S&P

After a busy 2015 for M&A activity in the insurance and reinsurance industry, 2016 is expected to follow suit. However, a new Standard & Poor’s (S&P) report shows that re/insurance sector M&A is more often than not negative for those involved, with synergies rarely achieved.

The persistent challenges facing insurers and reinsurers, underlined by ample capacity, lower returns and limited organic growth opportunities, resulted in a wave of industry merger and acquisition (M&A) activity last year.

And, with the same drivers of the softening landscape continuing in 2016 the view among many in the sector is for further re/insurance sector consolidation in the coming months, as firms look to secure relevance, increase scale and ultimately avoid being left behind in a rapidly evolving industry.

“While buyers, sellers, and their investment bankers appear to have taken a brief break from the frenzy, we believe the deal-flow will continue, albeit at a slower pace, in 2016.

“Fuelling this will be record high capital in many segments, primarily reinsurance; scant opportunities for organic growth; low or uncertain investment returns in domestic markets; and evolving regulation such as new capital requirements in Europe under Solvency II or the Affordable Care Act in the U.S.,” says S&P.

While the drivers of M&A activity among insurers and reinsurers is clear, historically, the sector’s record of successful consolidation “is not very strong,” according to S&P.

The rationale for embarking on some form of M&A becomes ever more prominent at times of industry turmoil, when profits are hard to come by and joining forces or being taken over is seen as the only way for some to avoid diminishing all together.

However, according to research from ratings agency S&P, since the year 2000 more than two-thirds of re/insurance industry M&A deals failed to improve the financial strength enough to permit an upgrade to the buyer.

For the buyers in the 50 largest M&A transactions involving rated insurers since 2000, 64% saw their ratings affirmed/stable outlook, with 22% experiencing negative outlook/CreditWatch actions, meaning that just 14% of buyers saw any positive ratings action following completed consolidation.

While this does change somewhat for the targets in those deals, with it being almost a 50/50 split between positive ratings actions and the combined negative/stable outlooks, it highlights just how difficult it is to successfully integrate a re/insurance industry M&A deal.

Increasing expenses, a lack of large loss events, and low investment returns are often cited as reasons for embarking on re/insurance industry M&A, as buyers and sellers praise the potential increase in profitability post-transaction owing to a range of synergies across the respective business models.

But as S&P explains, these synergies are very rarely achieved.

“However, we rarely factor these synergies into our ratings until we can see that they have been realized. In fact, we have only identified synergies as a strength to an announced deal 5% of the time since 2000,” notes S&P.

Adding, “History shows that these synergies are often difficult to achieve, and quite often the goalposts move or are forgotten in the years after the deals are done.”

The global insurance and reinsurance market landscape is unlikely to turn anytime soon, at least in a way that means more profitability for re/insurers absent reserve releasing to bolster low underwriting performance and limited investment returns.

As a result, it’s expected that more M&A activity will take place in the coming months.

But the warning from S&P suggests that consolidation in the global re/insurance industry is for the most part negative, and with margins becoming ever more thin as reserves begin to run low, the benign loss environment persists and so on, it leaves some in the space with little to no options for attempting to navigate the softening marketplace.

“We take a conservative view on M&A for rated insurers, and we place a heavy emphasis on the risks associated with execution and integration of a transaction.

“That said, we recognize the potential benefits from improvements in diversification and competitive position, which we believe can improve future earnings and capital strength. However, our empirical research indicates that over multiple time periods – and using several measures – the global insurance industry’s track record of success is not very strong,” concludes S&P.

It’s worth considering whether, for those reinsurance firms seeking growth opportunities, it might be better to partner with alternative capital investors than to engage in complex M&A transactions. By adding a pool of efficient, lower-cost capital to their business structures there may be the opportunity to grow, while supporting certain lines of existing or new business with ILS capital.

At this stage of a soft market this may be able to increase efficiency for reinsurers even more than going for growth through M&A, while avoiding all the complexities of fit, culture and of course the cost of a more traditional growth strategy.