Posted on 23 Jun 2009
With many insurers and financial institutions looking to fund potential capital shortfalls by divesting non-core insurance businesses at attractive valuations, strategic buyers and sovereign wealth funds may be able to expand into new markets through acquisition, according to Deloitte's "The 2009 Insurance M&A Outlook: Opportunity in an Uncertain Environment," released today.
“As we entered 2009, the primary challenge for some life and property and casualty (P&C) insurance companies had shifted from finding ways to deploy excess capital to raising new capital. While both the life and P&C segments have experienced investment write-downs, the life segment has been hit the hardest. The volatility in the financial markets caused more stress in the system particularly for those life insurance companies with guarantees on their variable annuities,” said Rebecca Amoroso, head of Deloitte’s U.S. Insurance practice. “As a result, many life and P&C firms are experiencing significant losses of capital as well as downturns to their ratings. In this environment, raising capital, divesting non-performing or capital-consuming businesses or seeking protection from better capitalized firms emerges as a priority.”
“There is currently an imbalance in supply and demand, with more companies seeking to divest than companies seeking to acquire. In this situation, the question becomes who will buy and how will they finance an acquisition given the decline in corporate stock’s allure as an acquisition currency and tight credit market conditions. In the current environment, Chinese and Japanese companies with strong foreign currency positions, and those Bermuda and European insurers that avoided major investment losses, may be the strongest candidates to make acquisitions,” said Dave Simmons, Deloitte's Insurance Mergers and Acquisition leader.
“Sovereign wealth funds may also seek to invest in insurance companies as Middle Eastern and Asian governments strive to increase the sophistication of their financial sectors by gaining access to needed resources and skills. As financial and credit markets stabilize, we expect strategic buyers to re-enter the market, take advantage of the supply-demand imbalance and a new wave of consolidation to occur.”
Deloitte’s report covers the five key situations when insurance M&A is likely to increase, a strategic objectives checklist for insurance M&A, and a four-phased approach to planning and executing insurance M&A.
Deloitte also defines 10 key factors affecting insurance M&A with five factors falling in each of two categories — near-term impact and regulatory and financial reporting considerations:
* Evolving M&A strategic objectives Insurance companies should respond to M&A opportunities effectively and avoid an ad hoc execution approach. Defining a clear end-state vision for the company with an aligned M&A strategy, understanding a proposed deal’s long-term strategic implications and “stress testing” the economics of the deal against both positive and negative economic scenarios are all considerations
* Investment valuations and subprime exposures Turbulent equity and credit markets have made it increasingly difficult to value insurance company investment portfolios. As a result, it is important for potential buyers to place increased emphasis on investment portfolio due diligence to help mitigate post-closing investment losses
* Capital challenges Traditional capital management and deployment strategies will not have a significant impact on the historically high, industry-wide levels of excess capital. If the industry is to significantly reduce the historic cyclicality of the insurance business, it should consider finding better ways to access and subsequently redeploy capital
* Low valuations Reflecting weaker balance sheets and lower reserve levels, the valuations of many P&C firms are trading at discounts to book value and, in some cases, at all-time lows. Life companies have suffered sizeable investment losses as well as ratings downgrades and now find themselves in a similar position. As a result of these financial setbacks, a good number of P&C and life companies may consider merger options. For example, some companies may seek to divest in order to raise capital, other companies may seek to acquire in order to diversify risks
* Integration challenges Strategic players are taking more of an “all or nothing” approach to integration, a departure from the “merger of equals” mentality that had historically dominated. Regulatory scrutiny has also increased. In this environment, companies may use M&A “clean teams” to speed up the merger process by enabling intended merger partners to share proprietary information while awaiting regulatory approval.
Regulatory and Financial Reporting
* Changes in insurance company regulation From an insurance M&A perspective, it is too soon to assess the potential implications of the proposed federal regulatory framework. The widespread perception that some change is likely suggests that participants in the insurance M&A arena consider potential regulatory changes when evaluating transactions
* Push for IFRS A switch to IFRS would establish a globally accepted insurance accounting standard. It could also result in more consistent financial information and valuations — both key benefits to players in the insurance M&A arena
* Principles-based reserves The National Association of Insurance Commissioners is expected to adopt the Principles-Based Approach (PBA) to life reserve and capital requirements, which will require companies to “model all identifiable and material risks, benefits, and guarantees inherent to the product sold.” If adopted, PBA will have a significant impact on the due diligence associated with M&A transactions by requiring companies to test and understand the reasonableness of the assumptions used in the models
* Fair value reserving The underlying principle of fair value accounting is that an acquirer needs to evaluate loss-reserve obligations using valuation assumptions that are consistent with those used in a public market exchange. Two general approaches have emerged to determine the fair value of P&C loss reserves. The direct method involves discounting the expected value of loss reserves using a risk adjusted discount rate. The indirect method separately identifies the risk margin from the discount rate used in the fair value calculation
* Tax issues and legislation As the tax-reform debate moves forward and specific proposals emerge, it will be important from an M&A perspective for potential acquirers to determine their best- and worst-case tax scenarios and prepare valuation models under these scenarios. Potential changes in the tax system and tax rates can have a significant impact on the after-tax cash flows and value of a deal.
A copy of the report is available on Deloitte’s website at http://www.deloitte.com/us/insurance.