Fitch Believes M&A Can Benefit Re/insurers by Increasing Resilience

The combination of continued competitive pressures, the effects of US tax reform, and catastrophe losses in 2017 is leading to speculation of more mergers and acquisitions (M&A) among re/insurers in 2018, especially in the Bermuda market, says Fitch Ratings. Increasing scale and diversification resulting from mergers could increase the resilience of firms to market challenges, including intense price competition and low investment yields. However, merger execution and integration risks could pose risks to profitability.

The $5.6 billion acquisition of Validus by American International Group (AIG), announced in January, could foreshadow additional re/insurer acquisitions for 2018. More recently, a media outlet reported that Allianz may be interested in acquiring XL (this had not been confirmed by the companies at time of publication), while Swiss Re confirmed that it was discussing a potential deal for SoftBank to invest a minority stake in the company.

Notably, several recent deals have involved international firms buying into Bermuda or London, providing the benefit of growth outside home markets. The AIG-Validus acquisition is a case in point, with AIG gaining access to a Bermuda re/insurance operation and London platform.

The sale of several typically smaller and less diversified re/insurers in recent years has largely been in response to a prolonged highly competitive market that has inhibited profitable capital deployment. The growth of alternative capital in the reinsurance market helped limit price increases at the January 2018 renewals, with the insurance-linked securities market reaching record size. Significant catastrophe losses in 2017 stemming from the particularly severe hurricane season in the United States and Caribbean more fully revealed the weaker reinsurance market profit fundamentals.

Fitch's global reinsurance sector outlook remains negative due to pricing concerns and constraining effects of protracted low investment yields on profitability.

In addition, recently enacted US tax reforms reduced the tax advantage that Bermuda and some other international re/insurers have over their US counterparts. This may encourage firms to move more business to the United States or enhance their geographic scope and competitive position through M&A.

Conversely, opportunities for better revenue growth and rate adequacy could reduce sellers' interest in finding a merger partner. A near-term shift toward property re/insurance rate increases in response to 2017 catastrophe losses and pricing stabilization in some other market segments will likely enable premium growth and modest underlying profit improvement in 2018. Stronger global economic growth is also leading to expansion in insured exposures and demand for coverage.

Fitch believes that M&A can benefit re/insurers through greater scale, an enhanced profile, diversification, and improved profitability. However, the operational risk associated with an unfocused or poorly controlled M&A strategy could outweigh the diversification benefits.