After the swathe of M&A transactions throughout 2005, Tom Gifford finds that the consolidation trend is still running strong well into 2006
A long, hot summer of consolidation lies ahead for the insurance industry if recent M&A activity is any guide to the future. Research by analyst KBW found there were 47 insurance M&A transactions in 2005, with deals totalling $49bn (£26.9bn) - the largest deal value since 2001. Among these were Swiss Re's €6.6bn (£4.55bn) bid for GE Insurance Services and the Skandia/Old Mutual tie-up.
This appetite for doing deals shows no sign of letting up. Already in 2006 AXA and Winterthur have joined forces, Generali has acquired Toro and SCOR has picked up German life reinsurer Revios for €605m (£417m).
The UK's largest insurer, Aviva, also remains firmly on the acquisition trail, announcing this month the acquisition of US life business AmerUS. Chief executive Richard Harvey has a point to prove after talks with Prudential fell at the first hurdle earlier this year.
But what are the drivers behind this heatwave of M&A activity, and is the latest spate of deals a signal that further consolidation is on the way?
Bankers specialising in the financial services sector certainly seem to think so. Speaking off the record, one senior M&A investment banker noted: "Things are now moving very rapidly. SCOR was a surprise to us. Toro also. Then there was the AXA/Winterthur tie-up. The market seems to have woken up. These deals indicate there is an appetite for M&A."
Likewise, a recent report by consultants KPMG cited European financial services as one of the "hotspots" for mid-market consolidation. Over 50% of corporations questioned said they believed mid-market M&A would increase within the ensuing six months, while 30% of those questioned said activity would "greatly increase".
There are a number of factors that help to explain the consolidation taking place. Industry experts point to the recovery of stock markets, which have helped to rebuild insurers' balance sheets.
The sector had faced a difficult few years post-9/11, with D&O liabilities in the US, unprecedented hurricane activity and a prolonged bear market forcing insurers to get combined ratios below 100% because they could no longer rely on investment returns.
Although the industry is unlikely to regain its pre-2001 level of excess capital in the immediate future, ratings from the likes of Standard & Poor's (S&P) and Fitch are now beginning to reflect renewed confidence in the financial strength of insurers.
With stronger balance sheets, insurers have the choice of repatriating capital through dividends or share buy-backs - as German reinsurance giant Munich Re has indicated it will do - or acquiring competitors. For many insurers the acquisition strategy makes sense.
A second major deal driver is falling prices in a softening market. Mergers, if done right, allow companies to extract synergies and become leaner, more efficient beasts.
In the words of JP Morgan analyst Roger Doig: "We're at a stage in the underwriting cycle where premiums will fall and not rise. We're not going to see a major increase in pricing so we're expecting to see a few cost driven mergers. SCOR's deal with Revios was an example of this: SCOR is repositioning itself from a sector that will be under pressure in terms of pricing into an area that will experience less pressure."
As well as being an aggressive acquisitor, Aviva is also increasingly cited as a potential takeover target. The £18bn group made headlines earlier this year with a bid for UK peer Prudential. The deal is believed to have foundered after news of the bid was leaked to the market, creating friction between the two company's management teams.
A number of City sources believe that once the six-month ‘put-up-or-shut-up' clause has expired Aviva will have another crack of the whip. One M&A banker close to the situation said: "Fundamental barriers to a deal still remain, but there is compelling logic. Watch this space."
Ironically, Aviva's failure to entice Prudential's board to enter negotiations has exposed the insurer's lack of options for organic growth, and its relative weakness outside the UK. US companies interested in gaining a foothold in the UK market, like AIG and Berkshire Hathaway, could be waiting in the wings to make a counter bid. Richard Harvey, who was roundly criticised in City circles for what one banker described as a ‘botched effort,' will be looking to silence his critics with some bold decisions.
Another potential UK target is the non-life operation of Royal & SunAlliance (R&SA), which has staged a remarkable turnaround since almost succumbing to crippling losses on its US liability account in 2003.
Following a successful restructuring operation initiated by City wunderkind chief executive Andy Haste - which saw the sale of a large tranche of its life and international operations - the company has been rejuvenated and is once again making bolt-on acquisitions while also being touted as a target itself.
For R&SA, the main barrier to the sale remains its US liability business. Here, however, steady progress is being made: it continues to reduce headcount and simplify the regulatory burden in the US, helping it to post a £4m profit in the first quarter of 2005. The UK business is certainly attractive but any potential acquirer will have to devise a way of ring-fencing US liabilities and that, analysts suggest, is still some way off.
Outside the UK, Switzerland-based Zurich Financial Services (ZFS) is another company potentially on the market. In March of this year, press reports named the company as a target for US rival St Paul Travelers. In the event, regulatory concerns and shareholder antipathy destroyed any momentum a deal might have had.
Commentators pointed towards the difficulties of pulling off transatlantic mergers and St Paul's previous patchy M&A record. ZFS shareholders are also reportedly still concerned about the degree of exposure the company has to the US non-life sector. Industry analysts believe these concerns will be too difficult to surmount to make ZFS a realistic target in the short to medium term.
The reinsurance markets in the UK, Bermuda and the US looks a more obvious area for consolidation. Although the rumours of wholesale mergers and acquisitions that swept the Lloyd's market in 2004 are long gone, there is still enough activity in the sector to whet the appetite of the City's dealmakers.
In the wake of 2005's devastating series of storms, the balance sheets of insurers with any exposure to the southern US were decimated. This led to the demise of Goshawk, Alea and Quanta - all of which have sold or are in the process of selling business renewal rights and run-off operations.
More recently the owners of Lloyd's insurer Creechurch appear to have hoisted a ‘for sale' sign over the operation, with Converium and Lloyd's insurers Argenta Syndicate Management, Canopius and the Jubilee Managing Agency mooted as interested parties.
The Logan Trust, which also owns UK motor insurer Hastings Insurance Group, is thought to be seeking an exit, citing a lack of scope for synergies between its Lloyd's and non-Lloyd's operations.
Rumours continue to surface that a number of Bermuda players are looking to diversify away from mono-line catastrophe reinsurance programmes by buying either into Lloyd's or London market companies.
XL chief executive Brian O'Hara spoke for the market when he said M&A would be a key feature for Bermuda's ‘Class of 2001' through the course of 2006.
Picking targets and bidders in any market is a speculative art. In the insurance sector, pricing, regulation and the impact of natural catastrophes on balance sheets add to the uncertainties. Only time will tell whether the heat generated by recent deals will translate into further consolidation. IT