Big Questions: M&A
Do you expect we will see further divestment of reinsurance arms, in the same vein as AIG’s sale of Validus Re?
Kathleen Monaghan, head of corporate finance, Aon Capital Advisory: The capital-intensive and highly brokered nature of reinsurance, especially property cat reinsurance, will benefit scaled players with sophisticated strategies around capital management. Purely on an efficient frontier basis, we expect hybrid (re)insurance carriers to deploy capital towards lines of business with higher ROEs and less volatility. We believe the unit cost of reinsurance has improved for reinsurers, and many hybrid (re)insurers may explore opportunities to divest in the near-to-long term while taking advantage of the current market environment. We expect buyers of reinsurance companies to be strategic in nature; sellers will need to prove their technical capabilities to advocate for their value and talent.
Andy Beecroft, head of M&A advisory, GC Securities: There are not too many similar examples in terms of the scale and (relative) independence of Validus Re, but there is speculation that at least one large insurance/reinsurance group has been exploring options. The biggest question here is “where is the capital going to come from to acquire the business?”. There are significant attempts to raise balance-sheet capital for reinsurance businesses at the moment, but there have only been a limited number of successful capital raises.
GC Securities is in regular contact with private capital in relation to investment opportunities in the sector, but there is still some scepticism from investors around reinsurance due to climate change, inflation and historic performance etc, and so someone committing to acquiring a large reinsurance book requires a significant amount of conviction. Capital allocating to the sector might want to participate in a more passive/short-term way while rates remain hard with the option to exit if rates soften significantly.
Jean-Paul Conoscente, CEO, Scor P&C: The value of reinsurers has improved compared with two years ago thanks to the current hard reinsurance market. However, on the buyer side, the increase in interest rates does not facilitate M&A: increasing cost of debt and preference to use cash for fixed income (offering more yield certainty than M&A transaction) complicates the financing. Players that can rely on equity issuance will be the most likely buyers.
Consolidation has always been a part of the insurance brokerage story
Rob Bredahl, CEO, Howden Tiger: The stated rationale behind divesting Validus Re was a reduction in earnings volatility. It is logical that primary insurers will continue to prioritise core portfolios. Where this involves non-core reinsurance arms, this may involve divestment as seen in the case of AIG with Validus Re. On the other hand, improving reinsurance profitability metrics are making reinsurance businesses more appealing. This is arguably a great time to be allocating more – rather than less – capital towards reinsurance activity, so it depends heavily on company strategy.
Jason Howard, president, Acrisure International; chairman, Acrisure Re: AIG's sale of Validus Re was driven by a variety of factors, such as changes in their capital allocation priorities and desire to focus on core businesses. Further divestment will be driven by companies looking to streamline their business model and manage their volatility of their portfolio. Further divestment is likely driven by a range of issues including liquidity needs and capital efficiencies, among other factors.
Hannah Watkins, managing director, BMS Re: A properly managed reinsurance business can make great returns, but it does involve carefully managing your way through the cycle. Reinsurers’ roles may develop further to become a portal to the broader capital markets. They are perfectly positioned for this – modelling tools, proximity to clients etc. While the exit from reinsurance has been mainly driven by cat risk performance, it is still possible to construct a balanced and diversified portfolio of business.
One of the main issues the industry has faced has been the over-concentration of cat risk in portfolios. However, it is always the responsibility of C-suites and boards to measure stakeholder returns. So, with all this in mind, my view is that, yes, there will be further divestment.
Kevin Fisher, president, IQUW: Everything has a price. However, I don’t think we will see many other transactions as acquisitions are very hard to do given reinsurance is a people business and integration is key. A requirement for scale may overcome this hurdle and could be a compelling rationale for mergers. AIG’s sale of Validus Re had a very strategic rationale for both buyer and seller and deals need these synergies. It was a very specific sale that benefited both parties – for vastly different reasons.
We have seen the arrival of a number of challenger reinsurance brokers in the last few years. At what point will they have to consolidate to truly challenge the biggest three players?
Conoscente: The reinsurance broker world is in a transition period. In the journey from the union of single brokers under the same banner to a coordinated and consolidated organisation, challengers are not halfway yet. They need to add a layer of consistency, which is essential for both regional to global insurers and the top 10 reinsurance players.
Sven Althoff, board member, Hannover Re: Hannover Re has always worked closely and successfully together with brokers of various sizes. While size will always play a role for a broker in order to offer the full service required by many clients, there will always be a raison d'être for specialists – be it in local markets or lines of business.
We expect a gradual return to increased IPO levels, although the market remains sluggish
Monaghan: Consolidation has always been a part of the insurance brokerage story. Due to the cashflow-driven nature of distribution, economies of scale can be more impactful than in balance-sheet businesses. It’s not size or access to customers alone that matters; the biggest players have the ability to leverage data, see breadth and depth across markets, and advise on issues beyond the distribution-focused transactions.
Watkins: It depends on whether the goal is to challenge the Big Three. The landscape has changed considerably over the past five years. Given the pace of acquisition of certain broking houses, it is inevitable that others will look to scale via acquisition to ensure relevance. However, not all are looking to take on the biggest three players.
Do you expect more IPO activity this year following the successful listing of Skyward Specialty and also Fidelis’ balance-sheet business?
Beecroft: This can be considered from two angles: listings in the UK vs US stock markets. It seems unlikely that there will be UK listings. Interest in listing on the UK markets remains relatively limited, and Conduit’s perhaps unjust share-price journey post-IPO is not likely to change investor appetite. The US markets present a more attractive opportunity. The Skyward IPO, for example, has been viewed to date as a success. In terms of Fidelis, this is a very different entity and the IPO provided liquidity to the selling shareholders who have primarily benefited from the value created in the Fidelis MGU. In the current subdued M&A market, an IPO may be seen as the most realistic exit route for existing shareholders looking for near-term liquidity. US markets are trading at attractive levels, but the question for some will be whether IPO investors buy into a sufficiently high TNAV multiple based on future profitability without a clear historic track record.
Conoscente: Other names in the sector seem to be sounding the market around optionality – e.g. Axa/XL Re – with “dual track” (M&A or IPO) perceived as the main road. However, the current macro uncertainty and high interest rates have made IPO a less conducive option, as evidenced by the low volume in H1 2023.
Bredahl: We expect a gradual return to increased IPO levels, although the market remains sluggish. This is broadly a reflection of a normalised inflation and interest rate environment, increasing investor discount rates and resulting in divergence between private market valuations and investor expectations. Alongside this, insurance profitability will be improved by rate increases, which should make IPOs more appealing. We would expect that businesses cannot remain in an indefinite holding pattern, and there will be some increased activity this year, although it will likely remain muted compared to longer-term average levels.
Monaghan: IPO activity has been relatively stable in our industry. The likely IPO candidates are typically private-equity-backed or spin-offs from existing companies. We have seen PE focus its attention more on distribution than on balance-sheet companies in recent years, with the exception of a few notable buyouts. Generally, we expect companies will want to show a strong two or three years of growth and profitability to maximise their IPO success. Recent market conditions, particularly for E&S and specialty lines, should have yielded strong results, albeit against increasing reinsurance costs and increasing property losses.
Howard: Skyward Specialty's principal purposes of the offering are to increase its capitalisation and financial flexibility. In addition, Skyward Specialty utilised IPO proceeds to make capital contributions to its insurance company subsidiaries to support the growth of its business. Market conditions will continue to impact further IPO activity but, as companies look for liquidity and financial flexibility, it is not unlikely that there could be further IPOs.
Do you think we have seen a topping-out of MGA multiples?
Conoscente: MGAs remain attractive acquisition targets, with leaner operations and lower overheads tending to mean higher margins compared to retail agencies. However, the MGA space is made up of roughly two types of companies: niche MGAs that either write very specialised business or who have specific distribution channels, and MGAs that write standard business using the MGA form to provide better remuneration to the underwriters.
Current reinsurance markets dynamics are set to challenge the second type of MGAs, which rely heavily on fronting carriers and abundant reinsurance capacity. In addition, fading inflation coupled with slow waning of rate rises may lead to lower income and cash generation, while increasing cost of debt and wage inflation may weigh on profitability. It sets the stage for a slow squeeze of the MGA sector and a likely deflation of valuations.
Fisher: Currently investors generally assign higher multiples to fee-generating business than they do to balance-sheet businesses. After years of anaemic underwriting returns, the current strong underwriting returns that are likely to persist into the medium term, coupled with improved investment yields, may well change this dynamic.
Monaghan: The acceleration in MGA valuations has been aided by trading among PE buyers and sellers invoking roll-up strategies to scale the businesses. For valuations to decelerate and/or decline, we believe two things would need to happen: (1) dry powder dries up, and/or (2) MGA growth becomes limited due to reinsurance/fronting capacity constraints. There appears to be slow-downs in fundraising from PE, and we are in the midst of a hardening, or hardened, reinsurance market. We expect the winners will be those that are niche and best-in-class underwriters.
It sets the stage for a slow squeeze of the MGA sector and a likely deflation of valuations
Howard: MGA multiples have followed a similar trajectory to retail assets where YoY pricing has continued to what is an all-time high in pricing today. MGAs have been key to many brokerage companies, including Acrisure, as they look to execute on their value-chain compression strategies. While external market influences and rising cost of capital exist, we have not yet witnessed declining pricing on MGA assets.
Why do you think there hasn’t been more acquisitions of Lloyd’s businesses despite the turnaround in performance and prevailing market conditions?
Althoff: During the years 2015-2019, Lloyd’s saw an uptick in M&A. Given the poorer performance of the market between 2018 and 2020 in general, and the fact that capital has become a tighter resource than in the past, in addition to investment alternatives due to the rise in interest rates, we think the M&A market is in a waiting position. This said, it is fair to assume that eventually investors will look for attractive targets given that Lloyd’s remains a successful and profitable marketplace.
Bredahl: Although reported CORs have notably improved over the past two years, (FY22 COR 91.4%), Lloyd’s five-year average COR is still about 5 points higher than its cohort’s. Additionally, there may be a valuation gap between businesses and potential acquirers, owing to more expensive capital in a higher-interest-rate world.
Fisher: Investors will want to see evidence of sustained underwriting profit. We are currently seeing price adequacy in multiple lines of business which we expect to continue. Headwinds exist, M&A volumes are down significantly year on year and, while we strongly believe in the Lloyd’s model and the multiple advantages it provides, there simply aren’t that many Lloyd’s platforms that would be available for acquisition.
Beecroft: There haven’t been many recent transactions primarily because we are still in the hard phase of the market cycle. Shareholders are reluctant to sell when underwriting conditions are still strong or strengthening. Also, many transactions happened in 2020/21 (Inigo, Ark, Beat, Mosaic, Blenheim, Apollo, IQUW etc.), and so for those companies, there needs to be sufficient time for capital to be deployed, and demonstrable profitability and capital appreciation achieved before justifying a significant premium-to-book valuation that will be needed for shareholders to truly achieve their desired goal. We might not be far off the first few transactions, but we are not there just yet.
Watkins: Market conditions and results have improved but we must remember that we are only just starting to see such results. If we are honest, Lloyd’s businesses had to endure tough results for several years. Investors might want to see these positive results successively before any strategic decisions are made. There are many factors to consider when entering Lloyd’s, namely the differing regulatory requirements compared to most other domiciles – for every turnaround success there have been more that have failed – and that makes investors wary.