M&A A’ GO•GO

M&A Scoreboard, Q1’14

By Adam Cancryn and Jan Haider Kiani

The underwriter space logged a total of $4.4 billion in M&A transactions in the first three months of 2014, by far the highest first-quarter total in four years. The deals ranged across all sectors and specialties; private equity firms swooped in for a pair of billion-dollar-plus takeouts, while companies within the industry targeted rivals or distressed properties.

Yet the diverse deal-making was in large part motivated by a shared need to find new ways to fuel growth. The broader industry and economic trends that lifted the entire sector in 2013 are fragile or faltering, M&A specialists told SNL, leaving little guarantee that widespread improvements in stock prices and valuations will continue through this year. Indeed, the SNL U.S. Insurance Underwriter Index had underperformed the S&P 500’s 1.60% yearly gain as of May 16, as companies dealt with concerns around pricing, catastrophes and low interest rates. That leaves insurers increasingly under pressure to figure out how and whether they can remain top performers amid more settled conditions.

The answer for many will likely be in the M&A market, where a handful of companies have already jumped on opportunities to expand their reach or capabilities. Others have entered the market as sellers, in hopes of cashing out at peak prices. More are likely to follow suit, driving what some see as a resurgence of strategic tieups that could alter the industry’s competitive dynamics and usher in a new class of ambitious, high-growth players.

“There’s a continuing need for growth in enhancing ROE that’s not coming sufficiently from organic means,” Deloitte principal and U.S. Insurance M&A leader Boris Lukan told SNL. “These circumstances, I think, are pointing toward M&A as a solution to some of these core issues.”

Much of the deal activity so far has come from regional and midsize carriers, for which a well-executed deal can help it boost growth and stay ahead of its competition. Those insurers benefited in 2013 from an ideal combination of industry ingredients, especially in the property & casualty space. Pricing in most sectors continued to climb, disaster losses remained low and the broader economy strengthened. Life insurers got a boost from higher interest rates as well as gains in the stock market. The resulting jump in revenue and earnings pushed valuations in some cases to post-financial crisis highs.

To keep that momentum going now, companies have had to reinforce their existing business or move into brand new ones. American Financial Group, Inc., in the first quarter, struck two deals, the largest being a $250 million acquisition of Summit Holding Southeast, Inc. Adding Summit makes American Financial the top workers’ compensation writer in Florida, according to SNL data, moving it up from 39th place in 2012. The company’s Southeast-focused book also provides the California-centric American Financial with some needed balance in a business line that can be particularly volatile.

Another Florida company, meanwhile, used M&A to exploit a new profit source. Brown & Brown, Inc. in January said it would acquire Wright Insurance Group LLC, giving it the ability to service policies written through the National Flood Insurance Program. The insurance broker will be the largest NFIP servicer in five states, including Louisiana and Texas, when the deal closes.

“It is what is likely a targeting of organizations that bring core competency and underwriting for particular classes of risk,” Lukan said of acquirers’ current approachto M&A. “That’s what I see happening with American Financial, for example.”

Another, more counterintuitive approach to growing scale is through a sale. Burgeoning companies like Wilton Re Holdings Ltd. have shopped themselves to private equity and asset management firms, negotiating arrangements that infuse the insurer’s operations with cash while maintaining most of its independence.

Wilton Re’s partner is Canada Pension Plan Investment Board, which plans to use the company as a platform for insurance and reinsurance expansion in the U.S. Its financial backing gives Wilton Re the resources to pursue more large deals of its own, Chairman and CEO Chris Stroup said soon after the deal.

Wilton Re announced two deals in the first quarter prior to its agreement with Canada Pension Plan. CNA Financial Corp.’s Continental Assurance Co. and CNO Financial Group Inc.’s Conseco Life Insurance Co. are both set to become part of Wilton Re following agreements in February and March, respectively.

M&A experts said that market dynamics will force more sellers into the open. Some might decide that the tougher competitive landscape is not worth it and sell when demand is high. Other companies will likely be pushed into a sale, as the slowdown in industry and economic drivers exposes deep operational issues.

“M&A is a creature of the soft market,” Conning Research & Consulting Vice President Jerry Theodorou told SNL. “When rates are soft, companies are not growing organically.”

SPARTA Insurance Holdings Inc. was one of the year’s first distressed sellers, reaching a deal with runoff specialist Catalina Holdings (Bermuda) Ltd. following reserve charges and a damaging ratings downgrade. SPARTA took its sixth straight and largest underwriting loss in 2013, which included significant unfavorable development. Catalina plans to buy SPARTA and transfer the renewal rights to its alternative market business to Arch Capital Group Ltd.’s Arch Insurance Co.

The highest-profile deal of the first quarter also came as a consequence of reserve charges. ACP Re Ltd. in January agreed to take over Tower Group International Ltd., which was derailed by a host of internal issues that cropped up in 2013. The specialty insurer’s downfall was as spectacular as it was unexpected, Sandler O’Neill analyst Paul Newsome told SNL, coming after years of seemingly excellent results.

“The absolute worst reserve scenario is the one that looks exactly like the best company until it blows up,” he said. “They seemed to be fundamentally more profitable than every other company, and of course, they weren’t.”

Though reserve problems at individual companies are nearly impossible to predict, he added, there will likely be more deals involving both distressed and well-functioning insurers in the specialty P&C sectors. Companies that fill a small niche in the market have been particularly attractive in recent months due to better-thanaverage pricing and are valuable to bigger insurers as competition ramps up.

“Specialty lines tend to be what people are looking at because it’s a better business as far as commoditized pricing,” Mayer Brown LLP Partner Edward Best told SNL.

That strategic mindset is expected to permeate the industry over the rest of the year. After a 2013 largely dependent on improving conditions overall, insurers are looking to M&A to help them break away from the pack.

“I think we’re in a sort of separation,” Newsome said. “We’re in this period when we’re going to see people who really execute well separated from those that don’t.”