Mergers and Acquisitions Market for Property and Casualty Insurers
December 2010
The focus of this article is to provide an
overview of recent trends in the mergers and acquisitions (M&A) market for property
and casualty (P&C) insurers. Over the past few years, a variety of factors,
both economic and political, have had an impact on and continue to influence
activity and valuations in the P&C M&A market, as will be discussed further
below.
by Jeff
Balcombe
The BVA Group LLC
As a preface to the discussion in this article, it is important to understand
that prevailing valuations in the market are generally influenced by earnings
levels, growth prospects, and a variety of risk factors. One metric that captures
the elements of growth and risk and is utilized by industry analysts in assessing
valuations in the P&C industry is the price-to-earnings (P/E) multiple. The
P/E multiple can be based on historical earnings, such as net income during
the latest 12 months, or forward earnings, such as net income expected in the
next 12 months. In considering the trends in the M&A market for P&C insurers,
both of these types of P/E multiples are referenced below.
Analysis of P/E Multiples
In assessing value for a potential acquisition, a buyer may review, among
other things, the multiples of publicly traded companies operating in the same
industry as the target company. Accordingly, below is an illustration of the
trend in forward P/E multiples for a sample of publicly traded P&C insurers.
Click here for
Figure 1: Average Forward P/E Multiples for Publically Traded P&C Insurers
Additionally, Figure 2 below exhibits the trend in M&A valuations over time
by comparing the average implied P/E multiples (using latest 12 months' earnings
since forward earnings were not available) based on mergers and acquisitions
observed in the market during the time periods shown.
Click here for
Figure 2: Implied P/E Multiples for Acquired P&C Insurers.
The trends in the multiples shown above are a function of several factors
and market developments that have occurred over the past couple of years, as
discussed below.
Overview of Recent History
In conjunction with the decline in the market in late 2008, many U.S. P&C
insurers experienced significant unrealized investment losses, which, in addition
to underwriting losses, left them with deflated capital positions as they entered
2009.1 According to one article:
2008 will stand out as a year when turmoil in global financial
markets cut the property and casualty insurance industry's investment gains
in half, pulling down net income and taking a 12 percent slice out of the industry's
aggregate surplus level.2
As illustrated in Figure 2 above, valuation multiples responded negatively
to the increased uncertainty generated by the events of late 2008.
Subsequently, in 2009, the P&C insurance industry benefitted from relatively
few catastrophic events, manageable pricing, and improved investment performance,3
allowing some P&C insurers to accumulate significant cash balances which would
potentially be available to fund acquisitions. However, despite the partial
balance sheet recovery, 2009 deal volume and value in the insurance sector were
at a 5-year low. Interestingly, according to one industry report, 5 deals constituted
approximately 90 percent of the disclosed $5.9 billion dollar deal value, and
deal volume in the insurance sector was down 46 percent from 2008.4
Although it would appear there was little interest in pursuing M&A transactions,
industry sources indicate that "significantly more activity took place behind
the scenes than the announced deals would suggest."5
One of the primary issues preventing transactions from being executed was valuation.
In general, sellers were not willing to accept the depressed valuations prevailing
in the market in 2009.
Since 2009, the outlook for M&A activity and valuations in the P&C insurance
industry has continued to improve, as many potential buyers are seeking ways
to deploy excess capital and potential sellers are considering sales in the
near-term as they weigh the costs and benefits of waiting for further improvements
in valuations. As one article notes:
Deals in the industry have jumped 60 percent to $44.8 billion
so far this year, up from $28 billion in the same period of 2009, according
to data compiled by Bloomberg.6
Although activity and multiples have increased thus far in 2010, the graphs
shown previously indicate that valuations remain below historical levels. There
are several economic and political factors that continue to impact valuation
multiples as well as activity in the M&A market for P&C insurers, as discussed
below.
Economic Factors
Several economic factors are currently influencing M&A activity and valuations
relative to recent periods. One such factor is the improved general economic
stability as compared to late 2008 and 2009. As one article notes:
Deals are happening because there is "a greater level of stability
in the system compared to where we were 6 or 12 months ago … That provides a
greater willingness on the part of both buyers and sellers to consider transactions."
Lower uncertainty has likely been a strong contributor to improved multiples
in the M&A market, which has yielded more willing sellers and less dilution
for those buyers choosing to finance acquisitions with stock.
Another relevant economic factor relates to expectations for premiums. While
general economic conditions appear to have improved, the outlook for premiums
in the P&C insurance industry remains soft for the near-term. Growth in insurance
exposure, which directly affects total premiums, tends to lag overall economic
recovery. As a result, while 2010 real GDP growth is expected to be approximately
3.3 percent according to one analyst, premiums are only anticipated to grow
at 1.4 percent in 2010.7 Given that growth potential
affects P/E multiples, expectations for low growth in premiums may be placing
downward pressure on current valuations.
Furthermore, in addition to stability and growth, the M&A market is also
being impacted by the desire of some companies to sell noncore businesses. Some
banks, in particular, are seeking to free up their capital by selling their
insurance subsidiaries.8 Also, some insurers that
were bailed out are being forced into deciding which markets they want to compete
in, as "they are seeking to repay some of that money by selling businesses that
are noncore."9 One article quotes an industry analyst
saying, "There's a lot of stuff on the market … For deep-pocketed buyers with
firm conviction, it's a great time to be making acquisitions."10
Political Factors
Two of the key political factors affecting the current P&C M&A market are
financial regulatory regulation and the expiration of tax cuts.
In the wake of the financial crisis, Congress passed a new financial regulation
bill in the summer of 2010. Currently, the magnitude of the bill's effects on
insurance companies is uncertain, although some impact is expected. Insurance
companies with depository institutions will be required to hold at least as
much, if not more, capital because of "minimum leverage and risk based capital
requirements."11 Insurance companies could also
potentially face additional capital charges and margin requirements on derivatives.
This could result in a need for more insurers to raise capital by shedding noncore
insurance operations. Furthermore, forced disentanglement of large financial
services organizations could increase assets in the market.12
The uncertainty surrounding the impact of regulation may be placing downward
pressure on P/E multiples as the eventual outcome of the bill could negatively
affect business going forward.
Another possible political impact relates to the pending change to tax law,
under which the long-term capital gains tax rate is projected to increase from
15 percent to 20 percent in 2011. Some analysts say this poses a threat to waiting
to sell since "maintaining value won't be enough. Instead it will be necessary
to grow value for 2011 after-tax proceeds to equal 2010 after-tax proceeds."13
The possible increase in capital tax rates is likely depressing multiples, as
after tax proceeds on investments could decrease, making targets less valuable.
Outlook
Going forward into 2011, the M&A outlook for P&C insurers is unclear. As
mentioned previously, some P&C insurers are sitting on large amounts of cash.14
After a generally mild year for catastrophes and the partial reversal of 2008
investment losses, higher profits were generated in 2009 compared to 2008. As
a result, some P&C insurers ended 2009 with excess capital ready to be deployed,15
and these companies may not be able to afford to sit on these cash balances
in the long run. Instead, excess capital may used to repurchase shares, pay
dividends, or, potentially, make acquisitions.16
These factors, as well as others discussed above, appear to indicate that the
P&C M&A market may be posed for an increase in activity in the near future.
Growth in M&A activity and the resulting increase in general confidence could
allow for improved valuations in the P&C insurance industry.
However, an increase in M&A activity and valuation is not a foregone conclusion,
as some previously distressed insurers have now reaped the benefit of improved
investment performance and are now facing little pressure to divest. As a result,
improved valuations will be required to persuade insurers to sell,17
so some potential sellers may wait to see how growth prospects and risk factors
pan out. Nevertheless, given the capital positions of many P&C insurers and
the somewhat improved valuation multiples in the market, many industry analysts
believe that, beyond a significant insured event, "the scene is ripe for consolidation."18
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