Reading the runes in Insurance M&A *

This blog appeared in the Eastern Daily Press business section: 24 July 2015

Two giant deals in July have maintained a spotlight on the insurance industry. Willis’ merger with Towers Watson, and Ace acquiring Chubb a day later, were both mega deals. Ace CEO Evan Greenberg paid just over $28bn for Chubb, a price that drew gasps from an industry that is nevertheless becoming well-used to high value deals.

Consolidation has accelerated rapidly during the last 18 months, thanks to an unprecedented combination of macro-economics, regulatory and insurance market factors, so much so, that it’s hard to see where this will end, and whether it will end badly [probably – ed]. What are the reasons behind this consolidation, and how long will it last?

As interest rates have fallen and stay at historic lows, investors’ hunt for yield has become ever more pressing. Insurance apparently offers an attractive option because underwriting profits are not correlated with  other returns, and those profits offer a useful pick-up over low rates.

Alternative finance sources such as hedge funds now have the ability to invest in insurance assets without accepting unlimited risk (e.g. through catastrophe bonds), which means that the downsides can be capped. Insurance is a cash generative business and so attractive to investors, both in private equity and within the industry itself. Capital is more mobile than ever before; before the Global Financial Crisis, insurance capital tended to stay in insurance, and banking capital in banks. In 2015 capital has become more mobile and is more likely to cross industry boundaries as investors seek improved returns from other sectors.

Next, the increasing sophistication of actuarial modeling has created – probably misplaced – confidence that the future can be predicted. Many investors have placed large bets on the current benign claims environment continuing indefinitely. It won’t, but in the meantime, investors have a rose-tinted view of the returns available from insurance. 

The impact of regulation means that liabilities are increasingly supported by similar assets. Where insurance companies used to compete both on underwriting and investment [Berkshire Hathaway used equities to back long tail risk], this will be unaffordable under Solvency II rules, so companies are now focused on underwriting and scale, driving more M&A and consolidation in the insurance value chain.

The insurance market is being disrupted by technology. The ready availability of data and its effect on underwriting threatens to lower barriers to entry. Google, Apple and other technology giants are ever more interested in insurance. The traditional carriers are holding their position by chasing scale and hiding behind the protective blanket of regulation. But this is a tussle with a very uncertain outcome. Zeroing in on the value of insurance and pinpointing where the risk actually lies has become increasingly hazy. Take self-driving cars, or the connected home, for example. Neither has any insurer really responded to the sharing economy, growing at 25% annually in the UK alone.

An unforeseen consequence of data availability is the evolution of peer-to-peer and other insurance models via social media. Although little more than a twinkle in the insurance industry’s eye right now, this may lead to the rapid emergence of micro insurers, whose novel distribution will be readily supported by that most traditional of businesses, the Lloyd’s coverholder market. The rise of micros insurance via social media could seriously undermine the consolidation benefits being so expensively purchased by the larger players.

Looking outside the UK, Asia is growing its presence in insurance as it is in so many other areas. The Japanese insurers - sleeping giants in the insurance industry - are being prodded by a very un-Japanese wave of investor activism to earn better returns and are doing surprising things. Tokyo Marine has bought HCC, and Sompo acquired Lloyds of London insurer Canopius. This interest in insurance from Asia has accelerated the M&A market and is leading to defensive behaviour, for example Ace’s acquisition of Chubb. Expect more interest from that other sleeping giant, China, too.

The wave of M&A has also driven up valuations, giving management teams an extra incentive to sell out while prices are toppy. And of course, some players such as Willis or RSA are performing badly in a highly competitive market, and thus merger is one of few strategic options left open to them.

Given all these factors, is it any surprise that insurance CEOs are scurrying around Leadenhall with a target on their backs? Brokers, insurers and suppliers, none are immune, and it is not a question of if there will be another deal to rival Ace and Chubb, but when.

* With thanks to John Hodgson for his insight