As balance sheets improve M&A is back on the agenda, but is there enough capital? Andrew Holt reports.
The nature of the Top 50 Insurers list is likely to change considerably in coming years as the resurgence of M&A in the insurance industry is now firmly established.
Increasing margin pressures are likely to provide the strongest impetus for further M&A, especially domestic deals with strong synergy potential. Margins have been declining for some time and acquiring competitors would enable companies to improve scale, build volume and exploit opportunities for cost saving rationalisation.
Insurers will need to shape their strategies around the generally limited capital available for acquisition, which has declined in the wake of the weakened investment returns of recent years. Capital is now coming under further pressure from new regulatory demands. Indeed, divestment could be as strategically important as acquisition in this market environment.
But national and foreign regulation is proving a barrier to acquisition activity according to KPMG International, which commissioned the Economist Intelligence Unit to prepare research for a report entitled Run for Cover? M&A appetite and strategy in the global insurance industry.
The survey also finds some scepticism among senior management in the industry as to the added shareholder value of acquisitive growth.
Despite these difficulties, not surprisingly, 71% of respondents said they expected consolidation within the global insurance sector to accelerate over the next three years, as the industry anticipates an increasingly competitive environment both from new entrants and through customer demand.
Sixty four percent of European and 63% of North American respondents believe consolidation will accelerate in their national markets. Only 43% of Asia-Pacific respondents expect the same to happen to their own markets.
Francesca Short, insurance partner at KPMG Transaction Services, says: "There are a number of reasons why the industry should expect wide-ranging consolidation in the insurance market, some of the most compelling of which include capital efficiency and growth opportunities. However, insurers must be prepared to overcome a variety of obstacles first, including regulation in their own countries and abroad."
The downturn in the equity markets had a negative five-year impact on M&A activity in the insurance sector. "Now that balance sheets have largely been repaired, insurers can react in a largely positive fashion to the opportunities open to them in the market," says Short.
On a global scale the survey also highlighted marked differences in approach around the world to acquisitions. European respondents had been the most acquisitive, with 36% having acquired at least one company in the past three years, compared to 26% in North America and only 20% in Asia Pacific.
Larger companies, those with annual insurance premiums over $500m, tended to be more acquisitive as 81% are actively looking to acquire compared to 61% of smaller companies. Europe, with five of the world's top six insurers and eleven of the top 20 by total assets, is the only region where participants are anticipating spending more than $5bn over the next three years.
As far as growth strategies are concerned, insurers continue to be opportunistic. Thirty six percent of respondents said that organic growth would be the most important strategy, whereas only 22% said that they would place their primary focus for growth on acquisitions.
KPMG found that most deals have been overwhelmingly domestic in nature. For example, 72% of acquisitions in Europe were domestic.
For all respondents, cash reserves were viewed as the primary means of funding acquisitions in the next three years. For businesses with premium income under $500m, private equity investment was cited as being the primary means of funding for 20% of respondents. Larger companies cited share issues (18%) and corporate bonds (13%).
Short concludes: "The greater transparency in capital efficiency that is the result of new solvency requirements is allowing insurers to focus on their core strategies as well as giving them greater understanding of return on capital.
"The influx of private equity has facilitated the process by providing a liquid market for non core assets and given the consolidation the kick start that was needed. Although the unlikely alliance of regulators and private equity are not currently a feature across the entire global market, it is likely that both these influences will become more relevant in the future."
But while large mega-deals are still on the cards, one view is that they are likely to prove the exception rather than the rule as regulatory and shareholder demands continue to put pressure on capital and shape the scope and nature of takeover activity.
But merged insurers' ability to deliver value is likely to come under more intense scrutiny following the move to the International Financial Reporting Standards (IFRS).
IFRS is also changing the way insurers' financial statements are presented and the criteria by which financial services organisations' performance and prospects are judged by customers, analysts and investors.
In an increasingly competitive marketplace, the move to IFRS has been welcomed as an opportunity to improve the comparability of financial statements and help companies to compete for investment with businesses from other countries and industries.
Initially, however, there may be some uncertainty and inconsistency as firms and the users of their accounts grapple with a largely untested regime.
Insurers particularly have faced uncertainty and potential asset-liability mismatch as a result of interim arrangements that left the accounting treatment of insurance contracts unchanged.