During the current protracted soft reinsurance market the expectation is that greater scale and diversity will become increasingly important attributes of the reinsurers that succeed, however it remains to be seen what value the current round of M&A deals deliver.
Ratings agency Fitch Ratings warns in a recent report that the lure and promise of mergers and acquisitions may not stack up to deliver the benefits or rationale that an M&A deal had been sold with.
Fitch Ratings reinsurance analyst Martyn Street highlighted these concerns at a recent event; “We’ve seen consolidation taking place through merger & acquisition, it started last year and has certainly heated up in the first part of this year.
“Our concern here is that this could lead to complacency. We view the current round of M&A as unsurprising, we’ve said for some time that we felt that there needed to be a certain amount of consolidation within the sector, it would help to restore the equilibrium between underwriting capacity supply and demand.
“A primary driver appears to be the desire to achieve greater scale and diversity. If we look at the players that are currently involved in any activity its the mid-tier and the smaller specialist companies.”
But the end-result of M&A is not guaranteed, particularly when the reinsurance market continues to undergo the reshaping and there is an expectation that the disruption created by new business models, new capital and new competition will continue to affect the traditional business model for some time to come.
This means that companies will be looking to recognise immediate value from M&A deals, especially as their shareholders will be looking for the pre-deal execution rationale to stack up and become evident.
Street warned; “It remains unclear over the longer-term what sort of value some of these mergers will bring to shareholders as well as cedants.
“Only time will tell, but we view that as time passes if the market stays in its current position which is under pressure, then more firm’s may be forced into or look to merge as a way out and that doesn’t necessarily mean that they will be realising value.”
The M&A wave in reinsurance is expected to remain concentrated largely in the small to mid-sized firms for whom the pressure has been greatest due to their focus on shorter-tailed lines, such as property catastrophe reinsurance business.
Street said that M&A is; “Largely concentrated in this medium and small tier sector. These are companies that are looking to adapt to the current environment.”
And there is no sign of the M&A wave stopping. Fitch expect the activity will continue.
“As we look forward to 2016 our expectation is that we will see further merger and acquisition activity. It will be interesting to see whether we see further consolidation within the space that we already have been,” commented Street.
But the fact remains that companies must prove the pre-deal rationale, proving that the search for scale and diversity has been a worthwhile effort and cost.
Street continued; “Our concern will be that as fewer and fewer players are left in the space, that those tie-ups make sense and are seen to be creating value.
“The valuations of companies in the medium and small tiers has been maintained recently partly because of the expectation of M&A possibly happening.”
But expectation of a successful and profitable M&A deal does not always translate into reality. The old adage of one plus one perhaps not equaling two comes to mind here, something which Fitch does not believe is as easy to put into practice in a pressured reinsurance marketplace.
“If you’ve got a company that’s under pressure in a squeezed market place tying up with another company that’s under pressure in a squeezed market place it doesn’t necessarily mean that you’re going to end up with a good value proposition,” Street explained.
“We’ll be watching very closely what those tie-ups are and what the rationale are behind them,” he continued.
One of the key themes of the talk was that M&A is not the panacea that some hope it will be and that the reinsurance sector cannot consolidate itself out of the soft market it find’s itself in, or improve its rating outlook through mergers and acquisitions.
In fact, Fitch would take a dim view on any reinsurance M&A deals which cannot prove that they are creating value from the transaction. Companies mired in difficult integration, high costs and with little incremental value being created, could find themselves being carefully watched.
“At an entity level, the agency maintains a cautious view on M&A, due to the execution and integration risks associated with mergers,” Fitch’s recent reinsurance market report explains.
“It remains to be seen how successful the latest round of deals are in delivering increased value and what the optimal size for a specialist reinsurer will prove to be in the medium term,” the ratings agency continues.
Finally, Fitch warns; “Mergers that are perceived to be poorly constructed face a number of challenges not least from reinsurance buyers that may be reluctant to place business over the longer term.”
That is the worst case scenario, that two firms merge or go through the difficult process of acquisition execution and integration, but come out the other side of the deal less appealing to cedants and with a damaged profile in the reinsurance market.
It’s no wonder some companies are considering long and hard their prospects, whether to enter into M&A (if a willing partner can be found) or whether to attempt to raise efficiency and reduce cost-of-capital in order to remain competitive and relevant as a stand-alone reinsurer.