Fitch Ratings: intense competition and scale benefits fuel reinsurance M&A
Marginalized companies are increasingly incentivized to explore M&A, as they face the challenges of operating in a difficult market environment. These factors, coupled with the impact of US tax reforms and the record 2017 catastrophe losses, should support M&A activity for the sector up to 2019.
The potential benefits of consolidation for reinsurers include revenue diversification, economies of scale, improved return on capital and an enhanced competitive position. However, acquirers in a competitive bid situation run the increased risk of dilutive rather than accretive acquisitions, particularly when assessing the reserve adequacy of a target company and the potential complications in execution and efficient integration. Reinsurers are also focusing on cost efficiencies and expanding penetration in developing markets. Recent reinsurance acquisition multiples have ranged from 1.1x - 1.6x book value, with revenue multiples ranging from 0.7x - 1.9x.
Acquisitions providing alternative capital platforms in order to diversify revenue streams have grown tremendously in recent years. Aon Securities estimates that alternative capital deployment has increased by 10% from end-2017 to USD 98 billion at end-1H18, which is nearly double the USD 50 billion amount at end-2013. Markel's acquisition of Nephila (terms not disclosed) allows it to further expand into the more fee-based insurance-linked securities (ILS) sector, solidifying its position as the leading manager of ILS funds. It follows Markel's December 2015 purchase of CatCo, a retrocession and reinsurance investment specialist, demonstrating the further convergence of traditional (re)insurance and alternative capital market reinsurance.
Larger deals, while more difficult to justify on a cost-saving basis, highlight the trend of gaining scale and diversification to stay relevant in a competitive marketplace. AXA's sizeable acquisition of XL Group for USD 15.2 billion (1.5x book value) is expected to close by year-end. XL will become part of a very strong, larger multi-line organization in combination with AXA, the largest insurer in Europe by gross premiums written. This acquisition follows AIG's July 2018 purchase of Bermuda-based Validus for USD 5.4 billion (1.6x book value), providing AIG with a profitable reinsurance and Lloyd's market platform. Furthermore, both deals provide access to established alternative capital platforms that neither company has currently.
The acquisition of smaller, capital-constrained businesses is reflected in lower acquisition multiples. Apollo Funds' USD 2.6 billion acquisition of Aspen Insurance (1.1x book value) reflects the distressed nature of its reinsurance business, and its outsized catastrophe losses in 2H17. Maiden Re was also being marginalized, which forced its break-up and sale to run-off specialist Enstar Group Limited for USD 308 million, with the renewal rights on this reinsurance business being sold to Transatlantic Re. This effectively puts Maiden Re out of business, as it will only serve as a captive reinsurer for AmTrust, which has been dealing with financial difficulties of its own.