Expert Commentary

The M&A Market for P&C Insurers: 2017

This article provides an update regarding the mergers and acquisitions (M&A) environment for the property and casualty (P&C) insurance industry (prior article dated March 2016). It discusses the financial performance and M&A activity among P&C insurers, economic and political factors that heavily impact the industry, and the growth expectations for the P&C market in the next few years.


Valuation of Insurance Organizations
August 2017

A key driver of financial performance for P&C insurers is the health of the fixed income market. Insurers charge premiums to their policyholders and invest those funds in fixed income securities to earn investment income. Below is a graph (Figure 1) showing the investment yields for insurance companies from 2005 to 2015. As interest rates have declined, so have the yields.

Figure 1: P&C Insurer Portfolio Yields, 2005–20151

P&C Insurer Portfolio Yields 2005-2015 - Balcombe - August 2017

During June 2017, the Federal Reserve announced plans to raise the target range for the federal funds rate from 1 to 1.25 percent. Additionally, the Federal Reserve intends to remain accommodative to monetary policy by supporting further strengthening in the labor market conditions in an attempt to return to 2 percent inflation.2 While the increase in the federal funds rate has increased the yield on shorter term corporate bonds, the yield on longer term corporate bonds has remained relatively unchanged during the past 18 months.3

While the Federal Reserve's increase is a signal for additional increases, the prospect of continued slower long-term economic growth could result in increased M&A activity as organic growth opportunities remain limited. Rising interest rates could contribute to higher investment yields for insurers, potentially making it easier for companies considering a transaction to model a favorable economic scenario in their deal-pricing and make it easier to justify paying more for targeted companies.4

However, the P&C market will also continue to face economic challenges and uncertainty going forward. US economic growth is expected to rise from approximately 1.4 percent in 2016 to about 2.1 percent in 2017. Slow gross domestic product growth and greater uncertainty could lower expectations for premium growth in the P&C insurance market.5

Political Factors

Donald Trump's election as the US president has created uncertainty about the future of the US economy. Some analysts believe President Trump's goal of large tax cuts and increased infrastructure spending would boost US growth and drive up long-term interest rates. However, others feel President Trump's policies on other issues, such as trade, would have the opposite effect.6

Republicans, now in control of the White House and Congress, have promised and campaigned on a slew of deregulatory policies and reforms. The repeal of the Dodd-Frank Wall Street Reform and Consumer Protection Act and other reporting and compliance regulations could be beneficial to the P&C market. However, many of these deregulatory policies could be offset by other regulations and standards. For example, cyber security regulations are expected to be more robust. Many consumer protection regulations are also being considered by Congress. Finally, the Federal Reserve is preparing new standards for capital requirements for large insurers.7 Accordingly, insurers will need to manage the deployment of their excess capital with this looming regulatory change in mind.

Industry Trends

The P&C market is characterized by stable demand, as its products are required regardless of overall macroeconomic conditions, and the majority of industry revenues are generated from policy renewals from existing customers.8 Insurers charge a premium for their services that serves as an essential source of capital. Underwriting should continue to sustain profitability in 2017.9

The stable cash flows from underwriting allow P&C insurers to accumulate capital reserves to potentially deploy into the M&A market. However, rising interest rates could adversely impact the capital reserves of insurance companies. Although investment income grows, liabilities to policyholders also increase in concert with higher interest rates. Capital available for deployment in the M&A market could then become more scarce.

The frequency and severity of major catastrophic events are other key variables that impact the financial performance of M&A activity among P&C insurers. Increased frequency and severity of these events places stress on insurers by reducing the volume of premiums on which they can earn investment proceeds. The occurrence of catastrophic events in the United States has remained low in recent years, leaving P&C insurers with higher profit margins. However, catastrophic losses could expand in the future due to the increase in asset levels, especially in coastal regions where population density continues to grow.10

Nevertheless, many analysts believe that it will take a $100 billion event to move the market from its current environment.11 To put that into perspective, Hurricanes Sandy (2012), Ike (2008), and Andrew (1992) remain near the top of the list of costliest catastrophes with insured losses of roughly $30 billion, $19 billion, and $17 billion, respectively.12 This demonstrates the relatively strong foundation the industry is currently resting on. The financial position of the P&C industry mitigates many of the risks associated with M&A activity, creating synergies and economies of scale to be capitalized on.

Public Company Multiples

Valuation is a key driver of M&A activity. When considering an acquisition or sale of a business, it is common to assess the multiples of publicly traded companies operating within the business's industry. Figure 2, as shown below, graphically presents the average monthly forward price-to-earnings (P/E) multiples of domestic, publicly traded companies operating in the P&C industry. Data presented for 2017 in the graphs below is through July 31, 2017.

Figure 2: Average Forward P/E Multiples13

Average Forward P/E Multiples - Balcombe - August 2017

The forward P/E multiples dipped toward the end of 2013 and faced resistance between multiples of 14x and 18x through mid-2016. Volatility between 2013 and 2015 was the result of several factors, including economic and political uncertainty and instability in oil prices. Following the election of President Trump, the economic outlook turned positive, as more businesses and investors anticipate a higher growth environment driven by infrastructure spending and deregulation. This optimism is evidenced by the rise in forward P/E multiples toward the end of 2016 and onward.

However, it is important to note that the recent increase in P&C industry equity valuations could make the negotiation of successful deals more difficult in the near term. While rising valuations may benefit sellers, they can also make it more challenging for buyers to demonstrate that an acceptable return on investment is attainable. Continued growth in valuations through the second half of 2017 and into 2018 could make acquisition targets less attractive to potential buyers and drive overall M&A activity down.14

M&A Activity and Outlook

M&A activity for P&C insurers grew 18 percent in 2016 when comparing deal volume year over year. On the other hand, the aggregate deal value was down approximately 45 percent after adjusting for ACE Limited’s $28 billion acquisition of Chubb Limited, which was a significant outlier.15 The results of a recent market survey conducted by Mergermarket and published by KPMG indicated that 84 percent of respondents anticipated making between one and three acquisitions in 2017, and 94 percent planned on at least one divestiture.16 A recent example of a noncore divestiture is AmTrust Financial Services, Inc.’s agreement to sell a 9.9 percent stake in National General Holdings to unaffiliated third parties for approximately $210 million on June 9, 2017.17

Many industry sources are expecting the trend of higher deal volume and lower aggregate deal value to continue through the second half of 2017 and into 2018. According to one analyst, M&A activity will likely entail small- to midsized targets due to lower risks surrounding execution, regulatory approval, and integration. Additionally, these smaller acquisitions can be financed more easily with cash on hand and debt.18 Healthy insurers, with large reserves, experiencing a lag in organic growth as a result of low insurance rates may see M&A activity as a viable route to expansion.

Buying a smaller, more-specialized firm to tap into economies of scale can be an attractive alternative. A recent example is the merger of Intact Financial Corporation and OneBeacon Insurance Group. The transaction will "create a North American leader in specialty insurance, with over $1.5 billion of annual premiums. Furthermore, it bolsters Intact's Canadian business with new products and cross-border capabilities, and better positions the company to compete with North American insurers."19 However, this approach might face headwinds from the growing insurance company valuations, which, as previously discussed, could potentially make the M&A market too costly to consider as a viable option.

Finally, technology continues to play an important part in success for P&C insurance companies. Advanced technological systems are used to assist with audit, accounting, track policies, payments, and claims.20 However, large-scale technological advances require significant capital that a company might otherwise use pursuing a different objective. The M&A market could be the right place for a P&C insurer to consolidate and acquire new technology through an acquisition or a merger.

Conclusion

The M&A market for P&C insurers is strongly driven by weak organic growth prospects in a highly competitive environment and is coupled with the expectation of low returns on fixed income investments. However, as valuations rise, the ability for acquirers to achieve the required rate of return on its acquisition becomes more difficult, which could dampen the M&A market. While uncertainty from the change in administration regarding industry regulations and potential changes in tax policy and market volatility may limit activity in the near term, we expect M&A activity to continue to increase.


12017 US Property-Casualty Insurance Outlook, EY, 2016, page 3.

2Board of Governors of the Federal Reserve System, accessed July 13, 2017, https://www.federalreserve.gov/monetarypolicy/fomcminutes20170614.htm.

3Based on yield curve data obtained from Bloomberg for AA-rated corporate bonds.

42017 Insurance M&A Outlook, Deloitte Touche Tohmatsu Limited, 2017, page 7.

52017 US Property-Casualty Insurance Outlook, EY, page 2.

6Ibid.

72017 Insurance Regulatory Outlook 2017, Deloitte Touche Tohmatsu Limited, pages 6, 16.

8Report 52412—Property, Casualty and Direct Insurance in the US: Market Research Report, IBISWorld, June 2017, page 7.

92017 Insurance Market Outlook, Wells Fargo Insurance Services USA, Inc., 2016, page 4.

10Report 52412, pages 5, 11.

112017 Insurance Market Outlook, page 7.

12Sean Millard. "A Closer Look at the Costliest Catastrophes," Market Realist, April 2, 2015.

13Data obtained from S&P Capital IQ.

142017 Insurance M&A Outlook, page 10.

15Ibid, page 1.

16The New Deal: Driving Insurance Transformation with Strategy-Aligned M&A, KPMG, 2017, page 4.

17Obtained from S&P Capital IQ.

18P&C Insurance. Show Me the Money, 2017, UBS, 2017, page 1.

19OneBeacon Insurance Group, Ltd., "OneBeacon To Be Acquired by Intact Financial Corporation for $1.7 Billion," PR Newswire, May 2, 2017.

20Report 52412, page 32.


Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.

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