Septemberr 2014 24 Bermuda:Re/insurance+ILS
“In order to be relevant in an increasingly well-capitalised field you have to put out meaningfully large line sizes.”
Rhoads added that others are pursuing M&A transactions as a means to drive cost efficiencies—an issue that is all the more pressing in the current environment. Consolidation of underwriting teams and back office functions, and other smart synergies, can be achieved following a well thought through acquisition, helping to deliver lasting value in the transaction, he said.
“Acquirers also would do well to consider their capital positions,” said Rhoads, “with pressure evident from shareholders to put excess capital to work or else return it through dividends and share buy- backs.” Citing Markel’s acquisition of Alterra, Rhoads indicated that, in addition to a share exchange, Markel paid $10 for each share of Alterra stock, amounting to cash consideration of approximately $1 billion to Alterra shareholders.
This cash consideration component reduced the amount of post- acquisition shareholders’ equity the merged company would have, making it more capital-efficient. As he explained, “This use of cash helped to deliver immediate value to Alterra shareholders, while signalling a prudent approach to capital management at the new, combined entity.”
Ensuring long-term value
Once the decision to pursue M&A has been made, pressing ahead with the transaction is not without its challenges—particularly in the face of the current soft cycle. As Stuart Shipperlee, partner at Litmus Analysis made clear, “From the acquiring group’s shareholders’ point of view, paying any meaningful premium to book value is a leap in a market where rates are falling. In effect they would be paying to gain more exposure to a soft market.”
He said that while acquisitions can make sense if the current pricing
environment is part of the cycle—“as opposed to a structural shift to a lower price environment”—making the case to shareholders can prove a challenge. An acquired entity needs to deliver “meaningful diversification into long-term attractive lines of business or geographies and/or the creation of substantial absolute scale in any given market”.
“From a ratings perspective, we believe M&A needs to be more than 1+1 equals 2,” said Gharib. “We consider M&A in light of the overall group strategy. Is an acquisition going to deliver a better footprint for a competitive position, strengthen the value proposition to cedants or enhance ROE?”
If there is any uncertainty over the answers to these questions, there
may be reason to caution against a transaction. Gharib warned against the pursuit of M&A when it delivers only scale and not a more diverse underwriting mix. “Successful acquisitions add to your top line and competitive position, delivering new distribution channels, products and profitable business.”
“Substantially enhanced diversification can support risk-adjusted capital and the agencies’ views of the combined group’s business profile.”
Gharib said that if companies have similar profiles and are writing the same lines of business, a merger might in fact prove detrimental. As he explained: “You can’t simply add the premiums of the merged entities together, because cedants need to manage their line sizes with one reinsurer, so they may probably end up cutting those line sizes. The combined entity might see its line sizes reduced as a result”—hardly the outcome those pursuing scale and greater participation are seeking.
Rhoads said that M&A needs to be considered in two ways: strategic and financial. The strategic side is developing the scope and scale of your business and delivering an improved underwriting proposition to clients. The financial side is delivering efficiencies in the underwriting and back office function and potentially pursuing a more aggressive investment strategy on the asset side of the book by leveraging your increased scale and expertise.
Addressing Markel’s acquisition of Alterra, Rhoads described it as a “grand slam”, delivering both strategic and financial benefits for the merged entity. “It was strategic because Markel was not writing reinsurance or large retail P&C insurance business. The acquisition added these two new categories of business, complementing Markel’s existing underwriting portfolio.
“Additionally, we have been able to apply Markel’s successful
investment strategy to the combined company’s invested assets, including a greater allocation to equities and non-insurance ventures.”
Rhoads said that many companies considering M&A are struggling to get a firm handle on either the strategic or the financial benefits of transactions and, in the worst cases, are finding themselves unable to achieve either in their blind pursuit of M&A. Such pitfalls are particularly dangerous for smaller players who feel a pressing need to scale up in order to remain relevant.
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