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Valuation of Insurance Organizations

Mergers and Acquisitions Market for Property and Casualty Insurers

Jeff Balcombe | December 1, 2010

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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 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.

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.

Figure 1: Average Forward P/E Multiples for Publicly Traded P&C Insurers

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.

Figure 2: Implied P/E Multiples for Acquired P&C Insurers

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.

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.

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.


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 those already discussed, 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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2 Susanne Sclafane, "P&C Insurers Suffered on All Fronts in 2008," National Underwriter Property & Casualty—P&C Insurance News, July 20, 2009.
3 "On the Road Again," 22.
4 Ibid., 21.
5 Ibid., 22.
6 Zachary R. Mider and Brett Foley, "Insurance Deals Head for Biggest Year Since Peak of M&A Boom," Bloomberg—Business & Financial News, Aug. 27, 2010.
7 Anne Steinberg, "Property-Casualty Forecast and Analysis by Line of Insurance," 2010–2012," Conning & Company, July 21, 2010.
9 Mider and Foley, p. 3.
10 Ibid.
11 Ernst & Young, "Impact on Insurers of Dodd Frank Legislation," August 2010, 2.
12 PriceWaterhouseCoopers, 24.
13 Jim Campbell, "Whatever Happened to the M&A Recovery?", National Underwriter Property & Casualty—P&C Insurance News, Aug. 2, 2010.
14 Brenton Cordeiro and Archana Shankar. "DEALTALK—P&C Insurers Eye Deals To Boost Rev Growth," Business & Financial News, Aug. 2, 2010.
15 PriceWaterhouseCoopers, 22.
16 Gloria Vogel, "Could Cash Levels Drive M&A in the Property-Casualty Insurance Industry?," Seeking Alpha, Sept. 28, 2010.
17 PriceWaterhouseCoopers, 22–23.
18 Cordeiro and Shankar.