With the spate of merger and acquisition (M&A) activity set to continue as companies look to offset the challenges of a softening reinsurance market, A.M. Best has stressed the importance of addressing the challenges faced by consolidating entities.
The softening reinsurance market, amplified by intense competition, new entrants, growing insurance-linked securities (ILS) influence, benign loss periods and ample capacity, has stimulated a growing wave of M&A transactions across the space over the last 15 months.
And despite the potential advantages consolidation can offer, including reduced expenses, cost efficiencies, product and geographical diversification, and access to niche, specialist business lines, there are some significant execution risks that if handled poorly can leave a re/insurer in a worse position than before the consolidation process started.
A.M. Best Group’s Vice President, John Andre explained that the company sees “numerous drivers fuelling M&A activity,” continuing to add; “In the reinsurance sector, a significant factor has been that rates and terms and conditions remain under pressure as a result of the recent period of benign loss activity and the influx of alternative capital. As competition is intensifying, operating margins are being squeezed.
“Additionally, primary companies are well-capitalised and retaining more risk on their balance sheets. Brokers are establishing smaller panels of reinsurers, with expertise and experience in particular lines of business, and the size of a company’s balance sheet is increasingly being seen as a way to strengthen negotiating positions with intermediaries.”
The reasoning and desire for firms in the global insurance and reinsurance landscape to seek M&A deals has been a hot industry topic for some time now, but in a recent report, titled ‘Insurance and Reinsurance Market Conditions Set the Scene for Further Takeover Activity,’ ratings agency A.M. Best importantly underlines the inherent risks associated with deals of this nature.
“A combined entity can lead to economies of scale and reduced regulatory cost burdens, although value from synergies and a reduction in expenses will depend on successful post-completion integration and the need to offset upfront transaction costs.
“The success of any merger or acquisition will include a strategic fit between the companies, solid business rationales and cultural compatibility,” says the report.
A valid and sound warning for any insurer or reinsurer in the process, or considering embarking on any kind of M&A transaction, as despite potentially benefits, consolidation is by no means a panacea for companies that have been feeling the pressures of an increasingly challenging sector.
A.M. Best advised that despite possible diversification benefits post-consolidation, proper market knowledge, insight and most notably, underwriting expertise is essential.
Furthermore, notes A.M. Best, post-M&A entities in the past have often tried to grow their niche, specialist business lines into new regions, that they perhaps were unable to access pre-consolidation, too fast.
Something the ratings agency warns “has been the downfall of many companies, resulting in significant downgrades and insolvencies – particularly following the last significant soft market from 1998 – 2002.”
Clearly the execution of any reinsurance M&A deal is vital to the success of the new entities future, and if this is executed poorly re/insurers could even find themselves in a worse position than before they sought, or were subject to consolidation.
Earlier in the year Artemis covered the results of an industry survey geared towards M&A undertaken by Xchanging’s insurance software unit, Xuber, which also noted potential challenges for newly combined companies.
Xuber highlighted that despite all the M&A activity in the international re/insurance sector, this doesn’t mean competition will reduce as the number of companies entering the space, utilising sources of traditional and alternative capital is still growing.
Furthermore, while firms are concentrating efforts on successfully implementing and completing M&A transactions, they can risk being left behind as players in the space not concerned with M&A can continue business as usual.
Looking to the future, Director, Research & Communications for A.M. Best, Yvette Essen commented; “A.M. Best expects that smaller reinsurers will continue to struggle as dominant companies can have more influence on terms and conditions or can steer business towards an affiliate.
“The policy holder theoretically will have less choice from an insurance provider, but at the same time can benefit from greater security through the purchase of protection from a stronger financially-sound entity with highly-refined underwriting ability and product offerings.”