In a reinsurance sector loaded with traditional and alternative sources of capital and competition, the search for relevance is at the forefront of discussions, and the resulting merger and acquisition (M&A) activity looks set to change the fundamental operating environment of the sector.
Ratings agency A.M. Best’s recent global life & non-life Briefing, ‘Many Triggers Fan the Flames for Larger M&A Deals,’ notes the drivers and reasoning for the surge of M&A activity in the global insurance and reinsurance sector, highlighting a divergence from the “white knight” M&A deals of the past, to the “combination of equals” trend currently impacting the sector.
A.M. Best notes that the three large M&A deals that have taken place so far in 2015, the forming of XL Catlin, ACE and Chubb Group, and Tokio Marine’s purchase of HCC Insurance Holdings, “emphasised underwriting acumen exhibited by proven defensible niches, global capabilities and innovative product solutions.”
Apart from the significant increase in the size of the above-mentioned deals, A.M. Best claims this is the start of a developing trend, where strong, stand-alone re/insurers are combining with firms of a similar size and scale, “to become even stronger.”
It’s certainly a valid point, as when players in the global re/insurance space seek M&A deals in order to remain relevant and navigate the ever-softening reinsurance market, partnering or acquiring a smaller reinsurer, unless it’s focused on a particularly niche business line, might do more to dampen balance sheets and the outlooks from ratings agencies than have a positive impact, for the near-term at least.
“An important offshoot of these mergers and increased size and scale is the ability to exhibit improved purchasing power to significantly influence reinsurance terms and conditions, or in many cases, enhance the firm’s ability to access alternative capital for reinsurance solutions through sidecars or other special purpose vehicles,” said A.M. Best.
The latter point here is particularly noteworthy, as putting to work some of the ample alternative reinsurance capacity in the space will help to alleviate some of the current pricing pressures.
The establishment of alternative capital structures has grown in recent years and continues to do so, with new companies bringing a wealth of third-party capital to the sector through underwriting platforms and temporary vehicles.
And this could be an area where existing players look to do M&A business, diversifying their portfolio mix through partnering with an alternative capital provider, but again potential size and relevance is a factor here.
According to A.M. Best, one of the impacts of mergers of increased size and scale is that typically less premiums are ceded to the traditional reinsurance sector, meaning primary insurance brokers are left searching for client value through continued innovation.
Although challenging for the broker, this shouldn’t be viewed as a negative aspect of M&A as innovation is what keeps the industry moving forward, ensuring it protects against the most extreme risks in the most efficient manner.
“This new round of M&A activity clearly points to a long-term shift in the operating environment of the insurance industry. The capital markets are more and more willing to take on insurance risk through various approaches. However, they are looking for the right partners and possessing strong underwriting fundamentals is key,” advised A.M. Best.
It’s essential for re/insurers to adapt and evolve to the changing market landscape, where new sources of capital and emerging, large-scale risks are at the forefront of challenges and look set to reshape the fundamentals of the re/insurance operating environment.
For smaller firms, perhaps not considered large enough by its peers to be worthy of any M&A activity, perhaps a focus on niche, emerging business lines or capital providers in these areas is a wise avenue to go down.
Looking forward, A.M. Best concludes; “The insurance market reminds one of its start, where capital providers looked to partner with organisations with a strong underwriting track record and reliable source of business.”
“Insurers with these capabilities will be able to more efficiently manage their own capital structure by supporting it with reliable temporary capital from the capital markets. However, without a strong underwriting foundation, a company has no certainty of acceptance by capital providers.”