Hunting season

Could this be a big year in mergers and acquisitions for insurers? The year has barely begun, and Canopius has already made an offer for Lloyd’s rival Omega.

There are three reasons why this could be a start of a frenzy of M&A activity. First, Solvency II looms large on the horizon. For smaller insurers that would probably need to swell the capital on their balance sheets and spend money on getting ready for Solvency II, it may be easier to be taken over by a larger insurer.

Secondly, the soft market is still very much a reality, making organic growth tough. That leaves acquisitions as one of the few routes to achieving growth. Finally, some of the larger insurers have excess capital, especially in the Lloyd’s market, where catastrophe losses have not been big enough to erode their capital base.

Finally, let’s give a quick nod to private equity, which views insurance as a good bet for solid returns, as it has proved its durability following the financial crisis. So put your seatbelts on and get ready - 2011 is going to be quite a ride. In the second of a two-part series on M&A in the sector, Insurance Times looks at five potential insurer targets.

Novae

Novae is close to or at the top of many equity analysts’ lists of Lloyd’s insurers that are likely to be taken over. As with many of its peers, Novae has been through the mill in recent years. To an extent, it is still trying to shake off the hangover from its days as SVB Syndicates, when it wrote a lot more casualty business. This ties up capital for longer and is more susceptible to reserve deterioration than short-tail business.

The company’s structure is also still in flux, as it strives to realise its full potential. Novae completed the transfer of liabilities from its separate company regulated by the FSA to its Lloyd’s syndicate at the end of last year in a bid to free up excess capital and boost return on equity.

As a result, the market appears to be waiting for Novae to hit its stride. Its shares are trading at a discount to net tangible assets: 325p versus 429p. This discount presents an ideal opportunity for a suitor to pick up a much-improved company.

While Novae no longer has an insurance entity outside Lloyd’s, its new capital structure promises better returns. And while it has still not completely shed its past, it is making considerable headway in balancing the long- and short-tail portions of its book, under the watchful eye of chief executive Matthew Fosh.

The company is also growing its Novae Re operation, and there have been hints that it is considering setting up a sidecar reinsurer to capitalise on greater demand for reinsurance, sparked by forthcoming revisions to catastrophe models.

Hardy

The fact that Hardy was able to turn the head of one of the most discerning and disciplined Lloyd’s insurers should tell you all you need to know. Hardy is viewed as an extremely well-run company that became available at a knock-down price because of high exposure to first-half catastrophe losses. Little surprise, then, that Beazley chief executive Andrew Horton was excited at the prospect of getting his hands on the firm.

As Beazley’s recent attempt proves, however, mounting a takeover bid for Hardy is not for the faint-hearted. Shrewd, no-nonsense chief executive Barbara Merry has declared publicly that she will not let her company go for a song, and recent events show that shareholders are on her side. They were not taken in by Beazley’s arguments that it would take a long time for Hardy’s valuation to reach the £3.50 a share it eventually offered for the company.

Shareholders’ belief in Hardy’s inherent value has no doubt been boosted by the subsequent share buy-back scheme and the admission of Bahraini insurer Arig as a third-party capital provider, freeing up money to seek further growth. Hardy’s share price – 284p at the close of 17 January – is not trading at a premium to its first-half 2010 net tangible assets (NTA) per share of 257p.

However, this premium is wafer-thin at 1.1 times NTA. And while Hardy’s recent actions have arguably cemented shareholders’ views of the company’s valuation, they have also made an already appetising takeover target look even better. As Panmure Gordon analyst Barrie Cornes has said on Hardy’s rebuff of Beazley: “I don’t think this is necessarily the end of it.”

Chaucer

Chaucer just cannot stay out of the headlines, especially when figures like Vladimir Putin are sticking their noses into the company’s business. The Russian prime minister wants the FSA to allow Russian private equity firm Pamplona to raise its stake in Chaucer from 9.9% to 29.9%. That would give Pamplona considerable muscle in deciding any future takeovers.

Pamplona may have more success where others have failed. Brit’s £220m bid was rejected 18 months ago, and then a merger with Novae fell through over concerns surrounding Chaucer’s investment portfolio. Since then Chaucer has switched its portfolio to a much safer mix, and under new chief executive Bob Stuchbery (left), is focusing on energy and private motor to boost growth.

The change in direction might excite investors, although the Chaucer board is determined to maintain independence unless an irresistible offer is put on the table. Bidders would need to persuade minority shareholders BlackRock, Bank of America, AXA Group and Legal & General Group to sell up.

Beazley

As Shore Capital analyst Eamonn Flanagan says: “You often find that the predator becomes the target, and I wouldn’t rule out the possibility of that with regard to Beazley.” He points to banking group NatWest as a prime example of how this has happened before: after NatWest failed in its bid to take over Legal & General, it was snapped up by RBS.

By some analysts’ accounts, Beazley misjudged its approach for Hardy, potentially leaving it vulnerable itself. Beazley’s share price has improved since it withdrew its bid, but, like many of its peers, it is trading at a tiny premium of 1.01 times first-half 2010 NTA, judging by the closing price on 17 January.

Like the company it tried to take over, Beazley is one of the jewels in the crown of Lloyd’s. Its quick-witted chief executive, Andrew Horton, is well respected, and its first-half 2010 performance was held up by many analysts as the one for its peer group to beat. Some criticised its cautious investment strategy, but this was a small complaint compared with an otherwise stellar performance.

As such, Beazley would make an attractive target for a private equity firm, a Bermudian monoline catastrophe writer to gain a significant Lloyd’s presence, or a fellow Lloyd’s business looking to round itself out. Its strong US focus (it now reports its results in dollars) might prove an appealing diversification play.

NIG

Let’s get one thing straight: NIG is not for sale, according to RBS Insurance. Okay, but that doesn’t stop admiring glances from rival insurers with war chests. The bank must sell off its insurance arm – Direct Line, Churchill, NIG and UK Insurance, collectively run by chief executive Paul Geddes – by 2013 to comply with EU competition rules.

The bank wants NIG to be rolled up with larger sister companies Direct Line and Churchill for a flotation. But NIG, a broker-only insurer, sits incongruously alongside these private motor insurers. If the stock market suffers under tough economic conditions, and RBSI goes down the path of a trade sale, it might be easier to hive off the business pre-flotation.

NIG would make a good fit for insurers expanding their commercial book. Moneybags Ageas and LV= spring to mind, as does Arista, whose chief executive Charles Earle was a former managing director at NIG. Buyers may believe they could bring stability to a business that in the past six years has had five managing directors, closed regional eight offices and placed its personal lines arm into run-off. Despite these setbacks, there’s plenty of goodwill left in the brand. IT