Conditions are coalescing for the kick-off of a new M&A cycle.
Earlier this week, this publication reported that Sompo and Generali are circling London-listed carrier Hiscox.
The development has underscored that there are a range of demand-side and sell-side factors that could spur a pick-up in carrier M&A that has been in the doldrums since 2018.
There is too much randomness in dealmaking to predict with certainty that a string of transactions will make it to the line in any given period. The last-minute whim of a CEO who decides he doesn’t want to retire could torpedo a deal. Or an external shock like a sharp drop in equity markets, or a seizing up of debt markets, could put talks on ice.
But conditions are starting to be more fruitful for carrier M&A, and the chances are it will pick up meaningfully in the second half of 2024, or in 2025.
Demand-side spurs to carrier M&A:
1. Growth is poised to become harder:
The 2019-24 firming market has been remarkably extended, but cycle overtime will ultimately end, with a mean reversion of growth towards the increase in nominal GDP. Carriers may do a little better than this due to structural loss-cost inflation in casualty providing some uplift as property and finpro pricing goes down – but still well short of what we have seen in recent years.
Growth will also be negatively impacted by the attenuation of other recent drivers of expansion. These include inflation, economic growth and property revaluations.
The industry is closely watching the Atlantic hurricane season, but there are fewer and fewer potential cycle extenders after a run of prolonging factors including the pandemic, macroeconomic after-effects and geopolitical instability.
2. Carriers will have to use or lose excess capital:
After a strong 2023, commercial lines-focused insurers and reinsurers are sitting on significant excess capital from retained earnings.
They will want to deploy this capital organically or inorganically, or return it to shareholders given its scope to drag on ROEs.
There are also two one-time effects that will throw off excess capital that can be deployed into M&A.
The most significant is the windfall that Japanese insurers will receive from the sale of cross-holdings in other companies. The Japanese regulator has encouraged insurers – including the Japanese big three – to sell out of the historic equity stakes they hold in domestic companies.
The numbers sound almost implausible. But, assuming the divestitures go ahead, tens of billions of dollars of capital will be thrown off over the next few years, with scope for this to fuel a round of dealmaking at scale.
Tokio Marine, for example, has said that it will sell 600bn yen ($3.7bn) of investments in fiscal 2024, and halve its 3.5tn yen ($22bn) holdings by the end of fiscal 2026.
Japanese international M&A could be heading into a period of hyperactivity.
In addition, changes to the way in which capital requirements for mortgage insurers are set will throw off excess capital – with Arch set to benefit here, alongside the dedicated mortgage insurers.
3. Multiples provide currency:
Better-performing insurers have positively re-rated through the firming cycle, leaving them with historically high price-to-book multiples.
These higher multiples provide strong currency for would-be acquirers to finance transactions, and create additional room for deals to be accretive.
Potential acquirers face time pressure on their trading multiples, just as with excess capital. Right now they are riding high, but there is no guarantee that will last – with investor sentiment on the sector well past its peak.
Supply-side spurs to carrier M&A:
1. Soft markets are a drag:
CEOs sometimes choose to resign either on the eve of soft markets, or in their early stages, rather than play defence for multiple years.
And even setting to one side retirements, boards and management teams may judge that investor interests will be better served by cashing out than trying to grind through.
2. The Class of 2020 is heading into its exit window:
On top of the cyclical push to sell, there are a raft of other businesses that are likely to look to sell over the next couple of years.
The Class of 2020, including the private businesses that scaled up, are three or four years old and starting to enter the window where liquidity events make sense. Bowhead Specialty and Beat Capital have already conducted events, via an IPO and a sale respectively. Other businesses like Core Specialty, Coaction, Vantage, Ark, Inigo, and IQUW will all need to trade.
In addition, there is essentially a pent-up pipeline of carriers that would ideally have traded in the last year or two still sitting with their prior owners.
This includes businesses like Ascot, Aspen, and Peak Re, as well as troubled businesses like James River.
With IPO markets not straightforward, some of the businesses from across these categories could sell out to trade.
The inhibiting effect of the elevated casualty fear index
While conditions look to be coalescing for a new M&A cycle to kick off, there is one important inhibiting factor.
Concerns around reserve adequacy on US casualty business in the underpriced 2016-19 years, and the lower degree of confidence around 2021-24 profitability, could delay the start of the M&A cycle, some banking sources believe.
Reserving risk is the number one challenge for carriers buying other carriers, and warrants a high degree of caution. And for targets with large exposure to general liability in the poor accident years with a history of adverse development, buyers will likely be scarce.
But, of course, not all carriers are equally exposed to the reserving challenges due to factors including their launch year, business mix, and legacy protections.
As such, the caution on casualty reserves may not delay the whole M&A cycle, but narrow the range of attractive targets.
Carriers may also be given pause by the mediocre record of value creation from carrier consolidation.
In the broker space, M&A has almost always been a winning strategy. Carriers have often stepped on landmines.
Issues include weak underwriting resulting from management distraction, cultural mismatches leading to talent flight, and buyers straying outside their circle of competence.
Of course, carrier M&A can be executed effectively. Successful exponents include those employing a confederated structure that leaves synergies on the table (e.g. Tokio Marine), and firms with%20strong culture and central management grip (e.g. Chubb).
Not everyone will get it right, and no doubt we will again see some value destructive deals when the M&A cycle does kick off.
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