The leading insurance and reinsurance rating agencies once again have mixed views of the latest proposed reinsurance M&A deal, which saw AXIS Capital and PartnerRe announce an $11 billion “merger of equals” yesterday.
However there is one item that stands out as perhaps the biggest risk that the rating agencies see for this deal. M&A execution risk, the risk that integrating the two reinsurance firms is not as simple as hoped, takes longer than expected, costs more than budgeted for or does not deliver the efficiencies that were anticipated.
Here in lies a risk to reinsurers looking to acquire scale from a merger in order to compete with the top-tier of the reinsurance world; can you get there quickly and smoothly enough to be able to capitalise on your new-found size and reach, or will the complex task of merging two cultures and businesses let the larger competitors streak ahead.
Artemis discussed this yesterday in an article titled ‘‘Big enough’ to be relevant in reinsurance keeps getting bigger‘ when we wrote:
One final point to consider is the fact that while smaller reinsurers focus on arranging and executing M&A deals, the largest global reinsurers are working on product diversification, growth into profitable areas of the market and other new initiatives.
Without the burden of a merger, the cultural fit issues, implementing cost-savings and generally going through the corporate tasks associated with a merger, these already ‘big enough’ reinsurers could find their advantage increasing over those burdened by planned or ongoing M&A.
There is a real risk to merging firms that, at the rate the reinsurance industry is evolving right now, by the time they have completed the lengthy task of merging business, processes, people, offices, business lines and accomplished the task of bringing together two large portfolios of risk and pools of investable assets, that the rest of the industry has moved away from them.
There is also a risk that the insurance-linked securities (ILS) market continues to evolve and innovate and that by the time the merger is completed the larger reinsurer faces a new threat, from another new business model, which today has not been foreseen.
Rating agency Standard & Poor’s spelled this risk out yesterday, when it placed the ratings of both AXIS Capital and PartnerRe on CreditWatch with negative implications saying:
Within the next 24 months, the management teams will face many challenges in integrating two complex entities and effectively executing the new strategy.
Credit analyst Taoufik Gharib from S&P explained;
“There are uncertainties around how the combined entity will manage its capital adequacy and efficiencies, property catastrophe exposure, and potential business overlap and the resulting attrition. More importantly, it is not clear how the enterprise risk management (ERM) programs will be integrated rapidly and efficiently and how the new risk tolerances will be defined. However, these risks are partially mitigated by the familiarity between both companies’ management teams.”
S&P said it intends to engage the management team of the merged reinsurer to establish just how the new business will operate, and how it plans to become more efficient and competitive as a larger concern:
We will resolve or update the CreditWatch placement within the next three months, following discussions with both management teams. Among other things, we will focus on how the combined entity will manage its capital adequacy and efficiencies, property catastrophe exposure, business overlap, how the ERM programs will be integrated rapidly and efficiently, and how the new risk tolerances will be defined. In addition, we will discuss how the new combined company will successfully compete with other top global reinsurers given its new position in the market.
A.M. Best also placed the ratings of both AXIS Capital and PartnerRe, as well as subsidiaries, under review with negative implications. Again, this rating agency also cited the complicated merger process:
The under review status reflects A.M. Best’s concern associated with this merger’s size, scope and complexity. Along with combining two company cultures under one leadership team, the successful integration will need to be completed in a timely manner and optimize operational and systems infrastructure while retaining key personnel.
A.M. Best also noted that while the merger is being completed the combined firm will face risks during this transition:
During the integration period, A.M. Best believes there is greater inherent risk to the ongoing operations of the combined company. This transaction has inherent execution risk although this is partially mitigated by the collaborative nature of both management teams.
However, A.M. Best also sees the bright side to this M&A deal, explaining that there are compelling reasons for bringing the two firms together:
Looking beyond the aforementioned risk factors, there is a fundamentally strong strategic rationale for this transaction. This combination brings two strong companies together that will have enhanced scale, a more diversified product mix and the transaction offers the ability to generate meaningful capital efficiencies and synergies.
Moody’s Investors Service took a slightly different tack, focusing on the potential positives, of which there are of course many and affirmed PartnerRe’s ratings while reviewing AXIS Capital’s for a possible upgrade. Moody’s explained:
According to Moody’s, the merger will provide both franchises with strategic and financial benefits. Currently, PartnerRe’s business mix is predominantly reinsurance oriented, while AXIS is balanced between primary insurance and reinsurance. The combination of the two platforms would result in a firm with significantly greater scale, increasing their relevance to clients, and a highly diversified business mix.
PartnerRe brings a highly reputable and well-diversified global reinsurance franchise, while AXIS brings a profitable global insurance business with particular expertise in professional lines, liability lines, and accident & health insurance as well as good capabilities in reinsurance.
Financial benefits include improved prospective profitability due to management’s estimated $200 million in projected annual pre-tax expense synergies.
Moody’s too mentioned the execution risk associated with a large merger such as this but, like the other rating agencies and most observers, believe that the fact that CEO Albert Benchimol has experience of both firms stands in the mergers favour.
While the transaction carries some business and operational risks, Moody’s believes that the integration and execution risks are manageable given Mr. Benchimol’s prior tenure as CFO of PartnerRe and the complementary nature of much of the businesses, with the exception of moderate overlap in the P&C reinsurance lines.
Specifically, on PartnerRe, Moody’s cited the:
Prospective strengthening of its business profile through the increased scale resulting from the transaction, as well as improved product diversification by gaining access to AXIS’ profitable specialty insurance platform.
And on AXIS Capital, Moody’s explained that it foresees:
An expected improvement in the business and financial profile of AXIS following the merger. In particular, AXIS will benefit from greater scale and product diversification in its reinsurance platform and gain access to PartnerRe’s deeper and broader international presence.
So all three of the leading reinsurance rating agencies mention the execution risks associated with the integration of the two firms, but with differing views on how negative this could be for AXIS and PartnerRe.
These firms are large enough and should be capable of bringing together two companies of this type. There appears to be some concern over the fit of the two portfolios, with S&P spelling out the fact that there is risk in how the overlap is managed as well as the combined firm’s catastrophe exposures.
Issues such as this could lengthen the merger process, if they prove difficult to address, however for the majority of the short-tailed business written by AXIS and PartnerRe, the combined firm will be able to essentially start with a clean slate around the January 2016 renewal, which should mitigate some risks in how the portfolios combine.
As long as the M&A integration execution risks are well-managed the merger should be successful for both firms, resulting in a larger, stronger, more competitive reinsurance company which sits up around the middle of the top-ten global reinsurance players.
However, some questions won’t go away until the merger process is finished and the resulting company, which is yet to be named, proves itself as a combined entity.
Firstly, ‘how big is big enough’, in order to maintain relevance in a reinsurance market facing structural change? Secondly, will the merger propel these firms quickly enough to a position where they can profit from the increased scale? And thirdly, will the rest of the reinsurance and ILS industry evolve increasingly rapidly, leaving those engrossed in M&A behind, before the synergies, cost-savings and increased scale, can be put to good use?
Time will tell. One things for certain, M&A isn’t simple and, unless very well-managed, it can put you in a position where you risk getting left behind.
Also read our initial thoughts on this deal, ‘AXIS Capital & PartnerRe to merge in response to structural change in reinsurance’, our a follow-up asking how much size matters, ‘‘Big enough’ to be relevant in reinsurance keeps getting bigger’ and our discussion on how the combined firm may stand to benefit from scale to attract alternative capital investors ‘AXIS + PartnerRe enhances ability to leverage third-party capital.’
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