Following recent merger activity in the market, what are the pros and cons of consolidation?
The reinsurance industry is buzzing with talk of mergers and rumours of more to come. There have been two high-profile unions recently: Validus’s fierce battle for IPC, and the less fraught merger of PartnerRe and Paris Re. But what are the pros and cons for firms considering merger?
For: Mergers are a way for smaller reinsurers to increase financial strength. Reinsurers can combine their capital base and so increase their attractiveness to cedants. For example, PartnerRe’s merger with Paris Re has produced the world’s fourth-largest reinsurer, bringing shareholders’ equity to about $6bn.
Against: Big is not necessarily beautiful. Several smaller reinsurers, such as Tokio Millennium Re, have demonstrated excellent results, whereas the giant Swiss Re has suffered problems. Furthermore, cedants like to deal with a diverse spread of companies. They are concerned about concentration of risk, and do not want to become over-reliant on only a few reinsurers.
For: Mergers are a way for reinsurers that are valued poorly by the stock market to come to the attention of investors. Non-specialist investors find it hard to differentiate between reinsurers based on subtle differences in strategy, but will pay more attention to larger companies.
Against: Investors also know that historically most mergers do not add value, and they may penalise companies that have difficulties (real or perceived) in digesting the new acquisition and in retaining key staff. Also, theoretical efficiencies can turn out to have unforeseen snags. In the case of PartnerRe and Paris Re, the integration of the two technology platforms will not be simple, for example. More generally, companies often find they have overpaid for their targets.
For: Merger can be a way for a reinsurer concentrated in one line to diversify its book, thus spreading risk. This was the argument used by Max Capital and IPC in their agreed merger (which was later called off). Combining with Max offered IPC diversification.
Against: A counter-argument is that reinsurers should stick to their core business and leverage their expertise in core areas, instead of wandering into terra incognita.
An exit for investors
For: Mergers can offer an exit route to private equity investors. Paris Re agreed to the approach by PartnerRe because six private equity companies wanted to exit their investment. A merger may be welcome when an IPO is not possible because of volatile stock market conditions.
Against: A merger is an exit only if the bid is in cash or for publicly traded shares. Also, private equity often has high profit requirements, and may set a price that few buyers are willing to pay.
For: The Validus-IPC merger has shattered the myth that hostile bids cannot succeed in the relationship-driven reinsurance business. Some of Validus’s legal tactics were creative: for example, applying to the Bermuda Court for a scheme of arrangement for IPC.
Against: Validus did not succeed because of its legal tactics, but because it convinced IPC shareholders and offered them a cash element as well as shares. Generally, companies may be shy of making merger deals during hurricane season, when nature could scupper all calculations.
- Arguments for mergers are: increase financial strength; attract stock market investors; diversify book; they can offer exit to private equity; and hostile tactics can work
- Arguments against mergers are: small can be beautiful; mergers don’t always add value; mergers may stretch competence; and the hurricane season is not the best time to merge