Reinsurance M&A Driven by Strong Competition and Scale Benefits

Consolidation of the global reinsurance industry will continue, as intense market competition and capital levels drive mergers and acquisitions (M&A), while smaller players lacking scale and diversification see further pressure on growth and profitability, Fitch Ratings said. 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 the US tax reforms and the record 2017 catastrophe losses, should support M&A activity for the sector into 2019, according to Fitch.

The rating agency said potential benefits of consolidation for reinsurers include the following.

• Revenue diversification
• Economies of scale
• Improved return on capital
• 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 1.1 times to 1.6 times the book value, with revenue multiples ranging from 0.7 times to 1.9 times.

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 percent from end of 2017 to $98 billion at the end of the first half of 2018, which is nearly double the $50 billion it was at the end of 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 in order to stay relevant in a competitive marketplace. AXA's sizeable acquisition of XL Group for $15.2 billion (1.5 times the book value) is expected to close by year-end. XL will become part of a very strong, larger multi-line organization in combining with AXA, the largest insurer in Europe by gross premiums written. This acquisition follows AIG's July 2018 purchase of Bermuda-based Validus for $5.4 billion (1.6 times the 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' $2.6 billion acquisition of Aspen Insurance (1.1 times the book value) reflects the distressed nature of its reinsurance business and its outsized catastrophe losses in 2017. Maiden Re was also being marginalized, which forced its breakup and sale to run-off specialist Enstar Group Limited for $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.