Willis: Insurance M&A to increase in 2010

The insurance industry will see a pick up in mergers & acquisitions (M&A) activity in 2010, according to Tony Ursano, chief executive officer of Willis Capital Markets & Advisory. Speaking at an industry event at The Willis Building in London, Ursano said that the soft market is fuelling the search for growth, diversification and specialisation that can be achieved through M&A.

Citing the factors likely to drive future M&A activity, Ursano said that the size and scale of insurance companies was becoming increasingly important for rating agencies, investors and clients, and that M&A would satisfy the pent-up demand for liquidity from private equity owners. So far in 2009, insurance M&A volume has been light, with deals completed at an average price of 1.09 times book value. This is in contrast, he said, to specialty insurance M&A transactions that took place before the financial crisis in which the average price was 2.46 times book value.

“As markets stabilize, valuations boost confidence and acquisition financing capacity and terms improve, we expect to see a significant increase in M&A activity in the insurance space,” Ursano said. “While the outlook is positive, we must bear in mind that more than 50 percent of insurance deals have failed to create shareholder value due to a number of factors, including difficulty assessing the profitability of the target, the cyclical nature of the insurance market and the volatility of the financing markets.

“In order for an M&A deal to be successful, it needs to be financially and strategically compelling,” he said, citing Ace Limited’s successful M&A strategy as an example. “Insurance companies looking to acquire should first ensure that the deal is accretive to earnings, return on equity and book value per share. There should be clear, defensible strategic logic behind the acquisition, transparency of loss reserves and committed financing upfront. It’s also important that key management are given appropriate incentives to stay,” he said.

Ursano added: “We are one event away from a hard market. Profitability and returns are under tremendous pressure and there have been major investment losses and reduced investment income in the insurance world, with valuations at all-time lows; more than 50 insurance and reinsurance companies are trading at below their stated book value. Under these circumstances, a significant investment or catastrophic loss would catapult the industry into a hard market.”

Ursano also predicted an increase in sidecar and cat bond activity, and an increase in ILS fund formation in 2010 fuelled by the light catastrophe losses so far this year, which could drive strong investor returns in an attractive, uncorrelated asset class. This, coupled with financial market stability, could increase hedge fund participation, he said.