Return of the M&A market

2009 was a quiet year for M&A in the UK insurance industry. This was driven by the continued uncertainty in the financial markets, leading to difficulties in valuations, coupled with the disruption in capital markets, leading to a scarcity of finance.

Nevertheless, a number of deals did complete, including Amlin’s purchase of Fortis Corporate Insurance and Beazley’s US acquisition of First State Management Group. On the broking front, the consolidators did continue to acquire, although on a much smaller basis than previous years.

As we move through 2010, there are clear signs that the market is starting to pick up again. The year started off with the sale of HSBC Insurance Brokers to Marsh, which was swiftly followed by the sale by Lloyds Banking Group of its majority stake in Esure to founder Peter Wood.

Other insurance assets owned by banks that are likely to be on the market include The Royal Bank of Scotland’s brands (including Direct Line and Churchill) and the commercial insurance businesses owned by ING and Fortis. In addition, the sell-off of some of AIG’s international business is likely to continue, which could include the UK arm, part of the recently rebranded Chartis.

The key for the success of these divestments will be managing the financial expectations of the vendors and securing the finance required for the acquisitions. These issues proved insurmountable in 2009 but the market has improved considerably and insurers are once again securing finance in the capital markets.

Away from the large insurance divestments, M&A is expected to continue in the UK general insurance space, but in a measured way. Many of the publically listed insurers are trading at historically low multiples to book value, driven by the softening market, declining investment returns and fears of recession-related claims.

This is, therefore, an opportune time for these businesses to be acquired at only a small premium to book value (compared to the 2x that a number were sold for at the height of the market in 2007). The natural buyers would be those international companies looking to gain a platform and presence in the UK market, as well as the licenses and distribution that could be acquired from those companies operating within Lloyd’s. We expect any approaches to come primarily from the Bermudian market or the large European and Asian reinsurers.

Aside from overseas predators, there is also the potential for some in-market consolidation. In the past few years, this has proved very difficult, primarily due to the entrepreneurial personalities of senior management, as well as the relatively hard market providing management teams with an alternative growth strategy to any potential bid. Looking forward, however, size and scale is likely to be given a premium valuation as Solvency II and associated regulatory requirements will put onerous capital requirements and resource constraints on smaller insurers.

Large-scale corporate activity has long been talked about in the UK broking industry but has failed to materialise, although the recent purchase of HSBC Insurance Brokers bucked the trend. Instead, the large UK commercial brokers have continued with a strategy of bolt-on deals, and these are likely to pick up in 2010. The majority of UK brokers are privately owned, and in recent years private equity has taken much larger stakes. As a consequence, there will need to be a natural exit point for the capital providers in these businesses.

While stock market flotations continue to be rumoured, the current market remains volatile and the investor base for small issues remains limited owing to a lack of liquidity in the stocks. While this strategic path will remain of interest to many market players, they are also likely to look at either courting new investors to extend their lifespan or look to be acquired in cash at a premium in order to provide liquidity for existing shareholders. Given the size of many of the mid-market players, any acquisition is likely to come either from the three global brokers (although all have recently engaged in acquisitions and are therefore resource constrained) or from the large composite insurers, which may be looking to acquire distribution. IT

Seb Kafetz is a relationship director for insurance clients at Lloyds Banking Group.