The insurance industry has been going through an unprecedented period of consolidation. Finbarr Bermingham reports on why this is happening, and the ramifications for the political risk and trade credit insurance markets.
Nobody could say they couldn’t see it coming. Analysts have been predicting consolidation in the trade credit and political risk insurance businesses for some time now and it kicked off in earnest last year. A market flush with liquidity and historically low interest rates has emerged at a time in which there has been an overall slowing in the insurance industry, generally. Huge amount of competition for decreasing amounts of business has led many insurance firms to the conclusion that strength in numbers is the best way to keep kicking. After all, it would be remiss of any self-respecting insurer not to hedge their bets.
For some, the scale and swiftness with which the expectation has become a trend has been surprising. The headline deal was inarguably XL’s £2.5bn takeover of Catlin, the largest purchase of a Lloyd’s insurer in history. In the wider insurance market, Brit agreed to a £1.2bn bid from Fairfax of Canada in February. Reinsurance firms Axis Capital and Partner Re merged in an US$11bn deal in January, while Hyperion Insurance Group bought 100% of RK Harrison’s shares for around £400mn shortly after.
Merger and acquisition activity gives insurers more capacity – from both a financial and technical standpoint – to manoeuvre in a market that has become increasingly tough. The common view dictates that it also allows them the flexibility to keep up with future trends in terms of changing trade flows (such as south-south, or a shift to the east) and evolving financing requirements. 2014 was said to be the biggest year for insurance consolidation since 2007. It looks as though 2015 will give it a serious run for its money.
Some of the reasons are fairly straightforward and are behind M&A activity in any industry. Acquiring or merging with another firm is a sure-fire way of increasing the level of staffing, in terms of numbers, specialisms and quality. In an increasingly forward-looking market, it’s also a way to cement in place the requisite technology (although obviously integration can be an issue in the immediate aftermath).
Pricing is another obvious factor. The last year has seen decade lows in the yields gained on certain product lines that are essential to TCI and PRI providers, such as disaster and catastrophe bonds, while simultaneously the likes of marine insurance have seen premiums rocketing. Almost exactly a century after the Titanic hit an iceberg en route to the US, the Costa Concordia shipping disaster became the worst maritime insurance loss in history, with the industry down by almost US$2bn.
In the trade credit and PRI markets in particular, part of the appetite for consolidation can be explained by downward pressure on pricing. David Howden, the founder and CEO of Hyperion, tells GTR that “there is an overall surplus of capacity in the political risks and trade credit arenas, which is good for buyers as it puts pressure on prices”.
Like their banking counterparts, insurers are also keen to impress the impact of a changing regulatory environment, which has forced them to tighten their belts and think creatively about the ways in which to ride out the storm. “Interest and capacity in the specialty line such as TCI and PRI has been growing over the past five to 10 years,” says Albert Lim, head of credit and surety hub for Asia Pacific at Swiss Re Corporate Solutions. “The heightened interest is partly as a result of the many changes in the regulatory environment, such as Basel III.”
This pressure is likely to be even more keenly felt in Europe, where rules over Solvency II will take effect in January 2016. These rules are designed at boosting customer protection, and insurance companies of all scales have been working towards meeting technological requirements for the most part of the decade. Risk management systems need to be completely replaced, with the investments being huge.
The consolidation has been underway with this in mind for some time, but it seems that as the deadline grows ever-closer, the pace is increasing. Other firms have been exiting non-core business areas, and refocusing on the areas in which they are viewed as most specialist.
While Howden doesn’t view regulatory issues as the main driver behind the activity, he acknowledges that it is a factor. “We are seeing a number of market trends, from increased compliance requirements to continued rating pressure that are demanding focus on operational efficiency. M&A is naturally one way to achieve this for some companies. Regulatory costs have certainly increased, but I wouldn’t see them as a key factor, especially as we look towards the larger end of the deal spectrum.”
Impact on the industry
The most obvious impact of consolidation in the market is the creation of insurance superpowers. The top five Lloyd’s brokers now own around 70% of the market share. This will almost certainly make it more difficult for the smaller players in the market to operate independently, meaning they will have to mimic the trends set by market big-boys in order to stay competitive.
But ultimately, those in the industry expect that the trend will be positive and have the aggregate impact of stabilising a market faced with much volatility. “Through consolidation in our class I expect there will be greater opportunities to continue to move our product forward to address our clients’ changing needs. For instance, banks’ expectation of what an insurance product can do for them is changing, as their regulatory conditions evolve,” Mark Houghton, regional manager for Asia Pacific political risk and trade credit at the newly-formed XL Catlin tells GTR.
Those who have been left outside of the recent cluster of activity are equally bullish. Lim at Swiss Re says that the industry “will continue to grow, especially in the Asia Pacific emerging market – as can be seen by the setting up of various new players in the region”.
And it looks like the trend is set to continue, particularly for the remaining firms left on the Lloyd’s market. Howden at Hyperion has already spoken publicly about his appetite to increase the strength of his group in this manner. Buying into Lloyd’s listed firms allows an insurer to write policies with less capital than they might otherwise require if they operated as a standalone company with a similar rating, according to Kamran Hossain, an insurance analyst at RBC Capital Markets.
Lloyd’s firms can operate with a premium of twice that of an insurer based in Bermuda, for instance, which clearly has a massive impact on returns.
“The Lloyd’s insurers have performed well in the period since the first M&A activity was reported in the space. In this note, we look at whether Lloyd’s insurers continue to be attractive M&A targets for suitors in the sector. We conclude that due to a number of advantages that Lloyd’s insurers possess by being part of the franchise, they will continue to be an attractive target,” says Hossain.
No two mergers are the same, and each will have their own drivers, but there are clear themes running through the industry, many of which will intensify as pressure on pricing continues and regulatory strain begins to take effect in earnest. So while some of the major deals may have already been done, expect the flurry of activity to persist, leaving a dwindling pool of operators in a market that is already unrecognisable from what it was a decade ago.