Article

Reinvigorated insurance M&A enriches capital management strategies

Focused, purposeful deals

December 13, 2017
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By Joseph Milicia and Fergal O’Shea

Insurance merger and acquisition (M&A) activity by value rebounded in 2017, with a growing emphasis among (re)insurers on transactions that help structure their businesses and portfolios to optimize available capital.

After a significant decline in insurance M&A activity from 2015 to 2016, many insurers and financial investors regained their enthusiasm in 2017.

The 2017 edition of our annual joint study of global insurance M&A trends1 with global intelligence provider Mergermarket shows that completed deal values increased by 170% in the first half of 2017 compared with the same period in 2016, while deal volume dropped 17.7%, suggesting shifting priorities (Figure 1).

Figure 1. Volume and value of global insurance M&A H1 2007 to H1 2017

(Global insurance underwriters; does not include brokerage)

Figure 1. Volume and value of global insurance M&A H1 2007 to H1 2017

Source: Willis Towers Watson and Mergermarket

One notable trend is the prevalence of very large deals, as companies seize the opportunity to realize their growth objectives in fewer, more targeted transactions. The study recorded 11 deals worth more than US$500 million in the first half of 2017, when only 14 were completed in the whole of 2016 — and that’s without two megamergers that were blocked on anticompetitive grounds in the U.S.

More broadly, the study uncovers some changes in the motivations for the buying and selling of insurance assets, driven in particular by a greater focus on deploying capital to optimize returns.

Capital optimization

Insurers face hurdles that make the efficient use of capital imperative. In recent years, a combination of tepid growth in premiums, low interest rates and the burden of regulatory requirements has created a tough environment to achieve reasonable returns, particularly in developed markets. Already this is evident in some insurers’ asset strategies, with many turning to alternative assets in the search for higher yields. Indeed, furthering this trend, more than three-quarters of survey respondents said they expect to increase their exposure to alternative assets over the next three years.

Now, it seems, similar priorities are being reflected in divestment and acquisition strategies.

On one hand, preferred capital optimization strategies often involve the divestment of capital-intensive businesses or divisions that are expensive to manage and/or difficult to scale up. Over half of survey respondents said they had reduced their exposure to capital-intensive products or increased their exposure to less capital-intensive products, while 65% intend to act over the next three years.

Activity is most pronounced in the annuities market, where large closed books are increasingly up for sale. For example, Solvency II has been the catalyst for regulators in certain European countries, such as Germany and the Netherlands, to require many insurers to strengthen their balance sheets. “Lower for longer” interest rates have made the problem even more acute for companies with traditional participating business. These two factors have badly damaged the dividend potential for many companies, and some of these are now seeking to shed portfolios with high capital requirements, low return on equity, or both. Consequently, the closed book deals that have become relatively commonplace in the U.K. are likely to rise in frequency across Continental Europe.

Others are firmly on the growth trail. After years spent retreating in the face of heightened regulatory scrutiny, many companies are growing more confident and looking to expand their operations in tandem with optimizing capital. This is reflected in how companies expect to use their capital in the next three years (Figure 2). While maintaining a strong balance sheet and capital ratio will remain important, more companies say they are aiming to scale back dividend support and share buybacks to invest for growth, including M&A.

Figure 2. More firms intend to use capital to invest for growth

What was your top use of capital three years ago? What is your top use of capital now? What will your top use of capital be three years from now?

Figure 2. More firms intend to use capital to invest for growth

Source: Willis Towers Watson and Mergermarket

M&A can put capital to work

Nevertheless, there are strong indications that insurers are becoming more selective in seeking M&A targets, as the volume figures for the first half of 2017 confirm.

Detailed survey responses point to a flight to quality over quantity, with activity driven by factors such as the need to create synergies, build brand equity and tackle technological advances. As a result, companies expect to complete fewer deals in the next three years than in the past three (Figure 3). This finding belies a small group of serial acquirers, many of whom indicate they remain hungry for further deals. The majority (78%) of respondents said they expect to undertake one or two acquisitions in the next three years, compared with 90% that have made one or two acquisitions in the past three years. Moreover, 17% of companies expect at least one of their acquisitions over the next three years to be a major deal (greater than US$500 million), compared with 8% that have made one such acquisition over the last three years.

Figure 3. Number of acquisitions undertaken in the past three years and anticipated in the next three

How many acquisitions has your firm undertaken in the past three years? And how many do you expect to undertake in the next three years?

Figure 3. Number of acquisitions undertaken in the past three years and anticipated in the next three

Source: Willis Towers Watson and Mergermarket

Deal motivations

So, what are insurers looking for (Figure 4)?

Figure 4. Drivers of acquisition activity

What have been the drivers of your acquisition activity over the past three years? And what are the drivers of your anticipated acquisition activity over the next three years? (Select all that apply.)

Figure 4. Drivers of acquisition activity

Source: Willis Towers Watson and Mergermarket

The most common motivation for acquisitions over the next three years is to build brand strength, which survey interviews suggested is heavily influenced by the demands of technology-based distribution and industry digitalization. This fits with a recognition that the transition to digital sales requires a strong, recognizable brand. The need is accentuated by lower rates of insurance purchased by millennials, which insurers believe signals a need to work harder than ever to win and retain business in this age group.

Unsurprisingly, given the pressures of a soft market and continuing — even if better understood — regulatory burdens, 65% of respondents noted revenue, cost and financial synergies as a major driver.

Also fairly predictably, the third highest motivation for deals in the next three years is to access innovation and technology. Yet, as we found in our report published earlier in 2017, New horizons: How diverse growth strategies can advance digitalization in the insurance industry, firms are pursuing multiple avenues in their technology strategies, including internal innovation incubators and corporate venturing arms. This may account for the decline from 66% to 59% in the number of companies that expect technology goals to anchor future M&A deals.

Target refinement

The study data show that a more value-oriented approach to estimating return on capital is a priority for more respondents and is how companies assess potential targets. This again speaks to the defining trend of the study: insurers’ overall pervading aim to ensure that capital is efficiently invested in a low margin, low interest rate environment.

With this as the common starting point, other factors that insurers expect to help refine their M&A targets include areas of operation offering growth potential, the goal of staying closer to customers in order to boost retention, and the perceived need to boost competitiveness in the face of technological innovation and new market entrants.

Notably, with low growth in developed economies, insurers are beginning to seek higher returns in geographies such as Asia. There is a home bias: Only 5% of respondents currently generate more than half of their profits outside their home region, but 15% expect to do so in the next three years.

Economic growth prospects are the main factor in determining attractive target geographies, far exceeding the next most important consideration: a favorable regulatory environment. Consequently, 40% of respondents expect emerging Asia to be a focus of M&A over the next three years, driven by rapidly growing middle classes and relatively low insurance penetration levels in populous countries such as Vietnam and Indonesia. North America follows, reflecting recent, strong economic indicators (Figure 5).

Figure 5. Where companies expect to focus their M&A activity in the next three years

In which regions/markets is your acquisition strategy likely to be focused on over the next three years? (Select all that apply.)

Figure 5. Where companies expect to focus their M&A activity in the next three years

Source: Willis Towers Watson and Mergermarket

Even so, growth potential must be balanced with operational pragmatism. For example, the existence of strong incumbents and the known challenges of operating in the Chinese and Indian markets, in particular, mean that only 18% of insurers anticipate their acquisition strategies will focus on developed Asia, despite the obvious growth potential.

Funding mirrors the value agenda

Preferred methods of financing deals are also revealing and consistent with the increased emphasis on capital optimization. One benefit of the regulatory scrutiny that insurers’ balance sheets have undergone in recent years is a clarity about capital and cash reserves and where they may be overly prudent. Further, benign trends in recent years have led to significant favorable prior-year reserve runoff for property & casualty companies, which has led to a capital buildup.

Consequently, the vast majority of firms (95%) plan to finance their next deal with existing cash reserves, with 38% saying this will be the most important way of bankrolling a transaction. This is followed by 46% that will use the proceeds from the disposal of a business, with 27% ranking this as the top source of financing. Just 4% of respondents expect to pursue M&A with a debt-led approach.

Clear purpose

For the growing cohort of companies that the study shows intend to pursue a capital efficiency agenda, those that pay the closest attention to their strategic aims, and how managing their capital and pursuing M&A can underpin those goals, are likely to have the best chance of success.

Interestingly, only just over half of firms say they have a capital optimization strategy in place. That leaves more than two out of five with no such strategy to determine where capital would be best deployed. Some will undoubtedly also need to revisit their portfolio strategies to reinforce an in-depth understanding of suitable geographies, disruptive technology and intellectual properties, and the ability to recognize existing business lines that are either unscalable or overly capital intensive.

As the industry’s M&A focus increasingly turns to strategic considerations and growth, insurers will benefit when they dedicate resources to understand how the most efficient use of capital can protect and create value.


 

Endnote

  1. Download report on willistowerswatson.com: Hitting the targets: How insurers are optimizing their capital strategies and what this means for the M&A market.