Stefan Holzberger, Chief Rating Officer, AM Best
Further substantial mergers and take-overs are on the cards for the insurance and reinsurance market following the dozen such deals in recent times, credit ratings agency AM Best has forecast.
Consolidation is moving briskly in the traditional reinsurance sector, as so-called alternative capital offers rival products. Already the top 10 reinsurance companies account for around 72% of the global reinsurance premium, analysts at AM Best told market briefings in London and Monaco as the biggest reinsurance gathering of the calendar, the Monte Carlo Rendezvous 2015, got underway.
The agency’s prediction of new mergers and acquisitions (M&A) coincided with the opening of another important event: the 2015 conference, in Berlin, of the International Union of Marine Insurance.
The top five reinsurance groups in 2014 according to AM Best research were Munich Re, with unaffiliated gross written premium of $39bn, Swiss Re with $33.3bn, Hannover with $17.5bn, Berkshire Hathaway with $14.9bn and Scor with $13.76bn. The Lloyd’s market was sixth with $13.2bn.
AM Best is maintaining its outlook for the sector as a whole at negative, citing the many headwinds facing the market. The strain on profitability would ultimately place a drag on financial strength, it said.
Nick Charteris-Black, managing director for market development, AM Best Europe Middle East and Africa, said the environment was one of softening rates, low investment returns, and an influx of alternative capital, which “all sounds rather familiar: very much the theme of this time last year.”
Stefan Holzberger, global chief rating officer for AM Best, declared: “M&A has captured the hearts and minds of management” and there was sometimes an irrational desire to get into that game. One had to raise an eyebrow at some takeover strategies, in terms of the ability to sustain profitability. “Over time there are all sorts of synergies and benefits, but in the current market it is hard to see what they are going to achieve in the next four or five years.”
AM Best’s European office, London
Mr Holzberger questioned how valuations in some agreements had been struck, with price to book value multiples as high as 2.4 in the Mitsui Sumitomo/Amlin deal. The Japanese group Mitsui has just announced that it will buy 100% of the shares of Amlin, which operates the second largest syndicate at Lloyd’s, for $5.3bn. Mitsui Sumitomo said that the price represents a premium of 32.9% over the weighted average share price for the previous month. It will use cash on hand and external financing for the purchase. In the 2014 fiscal year, Amlin, which is strong in marine and reinsurance business, reported gross written premiums of £2.56bn ($3.9bn).
This means that since June 2014, 11 major takeovers have been announced. Earlier in 2014, Sompo Japan acquired Canopius, a top 10 Lloyd’s insurer as measured by gross premium income, for £594m. Canopius underwrites property and specialty lines including marine and energy.
AM Best says that in addition to advantages of scale and expense savings, reinsurers understand that the ability to “move in and out of certain classes of business swiftly through market cycles will lead to a strong advantage over competition.”
Mr Holzberger observed that Japanese insurers, who had faced negative interest rates, had to decide what to do with their stockpiles of cash. M&A was the opportunity for them to put their cash to work, rather than returning it to shareholders. Cultural issues were no longer holding back M&A.
Large reinsurers felt that they needed “to get out there and find some smaller segment reinsurance operations, such as the following market at Lloyd’s questioning whether they have the size and scale to carry on in the market as broker panels shrink and the leaders get preferential terms. At the end of the day the market remains very much influenced by the global leaders.”
The trends in reinsurance meant that “it’s a buyer’s market.” Primary companies were retaining more, there was increased use of alternative capital, terms and conditions were broadening, and rates were under pressure, with at every renewal a 5% to 10% decline (especially for loss-free business) “ Industry consolidation is creating a ripple effect, ” said Mr Holzberger.
Companies were interested in building niche classes of product and shying away from less competitive products such as US catastrophe lines.
Mr Holzberger said that pressure on margins at reinsurance companies came as they had “almost no investment income available.”
AM Best entitled its latest report on the reinsurance sector: “It is Not Your Father’s Reinsurance Market Anymore” – The New Reality. The report said: “Primary companies are retaining more risk and are increasingly utilizing alternative markets for their risk management needs. At the same time, the old playbook of private equity starting a traditional reinsurance company and then exiting via an IPO is becoming less attractive. Investors would rather put capital to work for a relatively short period of time (typically one to three years) as opposed to creating new companies that require longer-term capital commitments with a less certain exit strategy.”
The report said: “With current market conditions of double digit price declines, increasing commissions, lower premiums and increased competition, the need for M&A is becoming clearer and AM Best believes that consolidation will continue, particularly among smaller players in the market as acceptable returns become increasingly harder to achieve.
“Reinsurance companies understand the need to form larger, global, well-diversified operations with broad underwriting capabilities to assess risk and to serve as transformers of risk to the capital markets.”
Many observers now believe that these changes are more structural than the cyclical pattern that defined the past evolution of the reinsurance sector.
In regard to hedge funds, Mr Holzberger said that the traditional approach of ratings companies did not work and “we will bring in a specialist team to understand the hedge fund strategy, liquidity measures, volatility, how they can perform over a cycle. We are looking much deeper into the governance controls and structure.”
While hedge fund involvement in the market was growing, there were stumbling blocks in terms of the willingness of a primary company to cede capital to a relatively new, relatively small reinsurer. Munich Re and the other established leaders had proven they were going to be around for a claim with a tail of, say, 10 to 15 years.
Although catastrophe bond issuance continued to grow strongly, some of the bonds were in litigation, said Mr Holzberger, “and there is some concern whether that is the right vehicle to get out into the capital market.”
The AM Best report said that Lloyd’s occupied an excellent position as a specialist writer of property and casualty risks, but an abundance of traditional and alternative capacity was creating difficult trading conditions in its core markets, particularly for reinsurance. Consolidation of broker panels and growth of pre-brokered facilities were putting pressure on participants at Lloyd’s, particularly the smaller managing agents with a niche offering. The growth of regional reinsurance hubs, combined with the comparatively high cost of placing business at Lloyd’s was reducing the flow of business into the London market.
Total reinsurance premiums at Lloyd’s fell 5% in 2014 to £8.5bn, largely because of softening premium rates in property and marine. Lloyd’s was responding to the threats to its position with an ongoing drive to improve access to international business. AM Best assigns a financial strength rating of A (excellent) to Lloyd’s.
