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Reinsurance M&A: bigger not necessarily better

Swiss Re’s incoming CEO Jacques Aigrain highlighted the “remarkable fit” between his company and the (re)insurance operations of GE as the companies announced the deal last month.

Aigrain, who takes the reins from John Coomber early next year, added: “It is one more transaction in a long line of successful acquisitions with Swiss Re now very experienced at delivering value to our shareholders so we are comfortable with our biggest acquisition yet.”

But a look at history raises concerns over the rationale behind large-scale reinsurance mergers and acquisitions, with genuine successes few and far between.

In the Autumn 2004 issue of our sister publication IQ, we looked at the widescale consolidation in the sector during the second half of the nineties. The deals, including GE Insurance Solutions (GEIS) subsidiary Employers Re’s acquisition of Frankona Re, Munich Re’s American Re buy, and Swiss Re’s October 2000 takeover of Underwriters Re, appear to have a poor record in the value they add to the buyer’s performance.

In a study conducted by rating agency Standard & Poor’s (S&P), only one deal out of 15 surveyed experienced a combined ratio better than the market average in the period since acquisitions were completed.

In its study, S&P spoke of the difficulties in integrating companies, so that even after consolidation, synergies may be difficult to achieve.

“The question has to be asked whether the strategic objectives of a reinsurer can be achieved without resorting to acquisitions. For instance some groups have demonstrated that new business can be accessed via existing channels. Similarly, diversity can be achieved by using innovative swap mechanisms,” the agency added.

David Collins, equity analyst at Morgan Stanley, said the GEIS deal had a “right place, right time” element to it, coinciding with significant rate rises.

However, he highlighted reserve adequacy as one area that may come to the fore as the deal pans out.

Drawing on Munich Re’s acquisition of American Re as an example, he noted “reserve adequacy in previous large reinsurance transactions has nearly always represented the ‘fly in the ointment’”.

Although before the announced $3.4bn reserve charge at GEIS, the company had already taken $7.7bn in reserve additions between 2000-4 boosting IBNR levels, Collins noted that the IBNR balances are still less than those of Swiss Re America on nearly all accident years.

GEIS IBNR levels are also lower than those at American Re at the end of 2004 on the troublesome 1997-2001 years.

“This is rather worrying given that American Re was known to be under-reserved at that time due to the $1.4bn reserving charge taken earlier in the year. Thus, it is clear to us that the $3.4bn reserving charge should not be viewed as being in addition to already adequate reserves,” he explained.

Despite commenting that Swiss Re’s move on GE Insurance Solutions “could prove to be the shrewdest reinsurance deal of the decade”, analyst William Hawkins from Keefe, Bruyette & Woods pointed to the time it would take before investors begin to feel any benefit.

He also warned that competitors – particularly Bermudians – will aim to win business from Swiss Re and GE Insurance Solutions as they remain in competition through the renewals season. Rivals may also look to poach teams, he suggested.

He described Swiss Re’s claims of $300mn of synergies as “superficially ambitious” as they represent a 26-36 percent of GE Insurance Solutions’ relevant cost base.

But he said that such a cut in expense would only require Swiss Re to match current non-life expense ratios.

Also on the positive side, Hawkins pointed to the gains to be made from the franchise of Employers Re in the US and Frankona in Europe.

“Swiss Re is paying a very small amount of goodwill for a major step-up in local market profile,” he explained.

The combined entity’s absolute size would make it “one of a very few one stop shops for all forms of risk cover. Assuming conservative asset/liability management, it also becomes a more stable long-term counterparty for its peers”, he said.

According to Hawkins, the imminent loss of one of the traditional “big 4” in the US will see Munich Re, Hannover Re and Berkshire Hathaway subsidiary General Re benefit.

“Hannover Re has been a good friend to the US brokers through this hard market, and we now expect them to reinforce this relationship. The group had previously been discussing cutting back its US casualty portfolio into the softening market. It may now be offered opportunities by brokers that are too good to pass up,” he commented.

“All three players will most likely view the 2007 renewal season as critical, hoping that the six months available for the combined Swiss Re/GE Insurance Solutions to integrate and prepare a strategy will still have left them in disarray,” continued Hawkins.

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