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Worth the price of admission?

With M&A valuations for carriers swelling, Anthony Baldo looks at what’s behind the frothy multiples for recent blockbuster deals and asks whether they are likely to continue

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In their separate ways, activist investor Carl Icahn and some insurance company chieftains have not been shrinking violets when it comes to valuations.

Icahn launched a crusade this spring to save AmTrust shareholders from what he believes is too low a price for a take-private deal, while several CEOs have begged off doing M&A deals because of valuations they believe to be too frothy.

Which camp is right?

Naturally, valuations are in the eye of the beholder. And what’s of value to one person – or company – can differ sharply from another.

In the insurance sector currently, several factors are affecting the calculus.

Carriers face a plethora of challenges. Coming off the worst year on record for catastrophe losses may have caused what has been a very soft pricing cycle to go astray a bit, but now the soft market has resumed its former leaden gait, and a hard market is still way off in the distance.

That circumstance means carriers have to be ever more mindful of their cost containment efforts and of new ways to grow, in order to keep their shareholders happy – especially since abundant capital exists in the insurance sector – to keep rivals fortified enough to keep their competitive juices flowing and, thus, keep pricing low.

“The success we are going to need in the future requires cheaper capital, more efficient systems, better access to data, far fewer people and a more diverse workforce,” said one reinsurance executive at The Insurance Insider’s London 100 roundtable in late May. “Those, I think, can be motivating factors of M&A which probably weren’t present five or 10 years ago.”

Lifting the bar

Two deals set the tone early in the year. Brian Duperreault continued to remake AIG, deciding to pay $5.56bn for Validus Holdings, in January. Then, in early March, Axa agreed to buy XL for $15.3bn. The Validus deal was done at 1.6x book value, or almost 1.8x tangible book, while the Axa deal for XL was for 1.5x book, or 2x tangible book.

All of a sudden, says one investment banker, “you had a couple of traditional alpha players out of the market come back, in AIG and Axa”.

At the start of the year, there was a clearer sense of the effects of tax reform, 1 January renewals and industry pricing, especially after 2017’s historic catastrophe experience. At that point, says Wells Fargo Securities senior property and casualty analyst Elyse Greenspan, companies on both sides of any M&A transaction would have a better understanding of what they’d need to pay “and what their franchise value would be”.

In that vein, deals of about $5bn to $6bn seemed like they would be the norm, she said.

So when Validus went for $5.56bn – right in the sweet spot – Greenspan was not taken aback.

“I was surprised it was AIG, though,” she added. “I get why because of the talent they acquired. But it surprised me they’d take on reinsurance exposure.”

Then Axa-XL lifted the bar – significantly.

But what was really eye-opening was the multiples the two deals were done for. Both Validus and XL went for the same or more than the 1.8x tangible book Ace paid for when closing its $29.5bn deal for Chubb in early 2016, when it also took the target company’s name.

Now 2.0x tangible book and $11bn – the market capitalisation of XL when Axa agreed to buy it, are the benchmarks, and high ones at that.

Under-valued

No wonder Icahn made noise at AmTrust. As of March 31, AmTrust’s book value was $3.9bn, yet Karfunkel and Zyskind families were to take it private for $2.7bn. Icahn eventually got them to increase it to $2.95bn, which won shareholder approval. But another AmTrust shareholder, Arca Capital, still believes the company is worth much more – perhaps $5bn to $6bn – and said it will take its fight to the Delaware courts.

But while Icahn and Arca have embraced the current state of valuations in the industry, many insurance CEOs have blanched at what it means for their own deal-making ambitions. Chubb’s Evan Greenberg, Markel’s Richard Whitt and Everest’s Dominic Addesso were among those disavowing any M&A aspirations. The Hartford CEO Christopher Swift said he was not interested in diversification into reinsurance.

Greenberg, in particular, was pointed in his comments, asserting after announcing Chubb’s first-quarter earnings that “prices paid for recent transactions may make sense to others, but they don’t for us”.

But Axa CEO Thomas Buberl, too, had discounted interest in a transformative deal roughly a year before he made one. Questioned in February 2017 about Axa’s possible interest in Generali, Buberl dismissed small and very large acquisitions being in the insurer’s future.

What may make Buberl’s reaction then more compelling is a belief he may have been bidding against himself for XL. Early on, Allianz was a rival for XL, but a proxy filed by XL noted that when it learnt the target’s board was pushing for more than $50 per share, it retired. Axa paid $57.60, or $2bn more than it may have had to.

…or over-valued?

Still, Greenspan believes that multiples for Validus and XL could have been higher. “If the reinsurance pricing opportunity had been better at 1 January, Validus and XL could have sold for more,” she explains.

The expectations set so early in the year, however, may have been overwrought. Some auctions started since the beginning of the year have not gotten real traction, though it is hard to say valuation is to blame.

For example, the auction for Aspen has rolled on but has disappointed. “Aspen is peculiar to Aspen and is not indicative of the rest of the insurance market,” said the investment banker.

And Greenspan notes that “there’s a difference between a company being shopped and someone making overtures.”

Nor is Aspen the only auction that has yet to produce a winner. The Hanover has been shopping its Lloyd’s business Chaucer, and Enstar and Stone Point have done the same with two companies they jointly own – Atrium and StarStone. Maiden Holdings retained Bank of America Merrill Lynch to review strategic options for its $800mn diversified reinsurance business, with no results yet.

Other possible linkups, meanwhile, collapsed. In late May, Swiss Re and SoftBank agreed to end discussions over the Japanese technology firm taking a minority investment in the reinsurer. After almost four months of talks, they reportedly could not agree on a price or the size of the stake.

Capital overhang

What makes M&A valuations and the state of play even more stark thus far this year is how they compare to what was a slumberous 2017 for insurance sector deal-making.

Uncertainty over what tax reform would mean was a major factor in 2017 being so quiet for M&A activity. A rough year for cats also led carriers to believe that organic growth, in the form of a harder pricing market, was in the offing. So M&A was not considered a must-do.

But the solid financial footing of the industry made the cat experience more than survivable. Problem was, it also meant that significant price increases were not going to stick.

As a result, said Morgan Stanley analysts in a May report, “the somewhat disappointing 1 January renewals may have contributed to a recent wave of reinsurance M&A” – namely the Validus and XL deals.

That the worst cat season in history did not alter the 1 January renewal season is largely attributable to the immense capital overhang in the insurance sector. Several Bermuda reinsurers were started in 2001 after the September 11 terror attacks in New York and the sector was able to raise rates. In 2005 came another opportunity, thanks to seven 2004-2005 cats, though the price jumps were not like those of 2001.

Yet property cat prices only rose 5 percent between the cat events of last year and the renewal season – the least ever – compared to the 65 percent after 1992’s Hurricane Andrew – the most ever, Wells Fargo’s Greenspan said, adding: “There’s just so much capital now.”

Faced with a pricing dilemma, insurance chiefs had to rationalise their businesses and increase their focus on cost-cutting. That trend will only continue. “Hanover is selling Chaucer because you have a CEO in Worcester, Massachusetts, asking: ‘Why should we have a London operation?’” says the investment banker.

Attacking the value chain

There are so many things attacking the insurance industry value chain, from too much capital to InsurTechs and managing general agents (MGAs) that are becoming increasingly efficient, that carriers just cannot put their heads in the sand.

“All those influences are converging,” according to Michael Halsband, a partner at Drinker Biddle & Reath. “Things will only heat up at the carrier level when it comes to M&A.”

Deals are often spurred by what carriers need most now – to cut costs and add or expand business lines.

“The ability to bring two companies together is one reason they are pursuing a deal and because of inorganic growth, one plus one equals more than two,” says Greenspan.

Most of the time the insurers are marrying because of “the ability to reduce headcount” and because they “are assuming complement businesses”, she adds.

Technology is having a big role in cost-containment efforts but its use has in no way peaked. Drinker Biddle’s Halsband underscores the point when it comes to small commercial business insurance applications that need to be filled out. Seven different carriers have seven different forms. With artificial intelligence today, technology may take over much of the task. “And that will take points off the expense ratio,” he says.

The same goes on the underwriting side, where data from sensors can help insurers better assess risks. “That efficiency will be felt, and all these components will drive M&A,” Halsband notes.

Certainly this is being seen in the world of MGAs, managing general underwriters (MGU) and specialty insurers. Technology is playing an increasing role, according to David Helms, managing director at Waller Helms, who advises mostly sellers in MGA and specialty insurer transactions. Expertise and relationships still drive his clients, he says, but “then they use technology to execute.”

The MGA/MGU route

To be sure, carriers are realising more and more that, when it comes to increasing its business lines, the better way to go is aligning with MGAs and MGUs. The reason is clear. At a time when keeping a lid on costs is paramount, a one- to two-year buy-in isn’t optimal, says Miles Wuller, the COO of RSG Underwriting Managers (RSGUM), a unit of Ryan Specialty that owns 22 MGUs that provide 80 lines of business.

As Wuller explains, a carrier has to hire top talent, put overhead on it, and then has to cover those costs until the books comes to scale. MGAs and MGUs offer a more efficient approach, by hiring people and operating more cheaply to enter lines of business and charging carriers a commission on the premiums brought in.

“We can be more nimble and react faster,” he says. “With carrier support, we can have a new product up and running within weeks.”

The augmented use of MGAs by carriers to help fill their efficiency and product gaps has, itself, contributed to a valuation burst for that segment of the insurance sector.

RSGUM, for example, acquired Irwin Siegel Agency, based in Rockhill, New York, the Johnstown, Pennsylvania-based Interstate Insurance Management this year, but it looks at 60 to 70 acquisition candidates a year. The process has become more complicated. “Now there’s an uptick in things going to auction,” Wuller says.

Valuations, as a result of the demand, have risen as much as 30 percent since 2010. “We’re paying fair prices, but we’ve won recently on cultural fit,” Wuller explains.

Because MGA and MGU deals are mostly private, industry participants reckon that large, multi-line entities with strong growth prospects now go for 12x to 14x Ebitda, or almost double the 6x to 8x eight years ago.

Sellers in the MGA and specialty space have a better understanding of the market because of the higher level of activity, according to Waller Helms’ Helms. In the past six months, the firm has run sale transactions one-on-one as well as broad auctions.

“It’s a much broader buyer universe,” Helms says, explaining that strategics, wholesalers, retail brokers and private equity firms are all in the MGA acquirer mix. “That creates a lot of demand.”

AmWins, Ryan Specialty and CRC Swett are larger national players known to the market to have boosted the profile of specialty distribution. From carriers, too, there’s been significant interest.

In general, when carriers buy MGAs, it’s been a single line. They try to capture a profitable book of business. With Ryan and AmWins, it’s a mix of things – MGAs and programmes. “That’s a different proposition,” Helms says.

Legacy surge

Carriers’ need to become more efficient has also led them to shed legacy assets and liabilities, which has sparked more deal-making for prospective buyers of those books of business.

Last year, Arch and Kelso & Co formed Premia Re, a Bermudian run-off vehicle. This year so far, Apollo Global Management and Renaissance Re have bought equity stakes in another Bermudian run-off buyer, Catalina. Legacy manager Armour was acquired by investors led by Aquiline Capital Partners. Arch, Validus, Axa and Allianz have all sought exposure to the space via joint ventures, investments, the creation of their own run-off vehicles or assumed reinsurance.

With more buyers, the legacy sector has seen a surge in run-off acquisitions. From June 2017 until the end of April, sister publication The Insurance Insider found the number of known large legacy deals at various stages stood at 23.

All the activity in the various corners of the sector has created some concern over where valuations now sit.

“Quite modest business which used to trade at 8x or 9x Ebitda are now regularly trading at 12x or even 14x Ebitda – personally I find that very worrying,” said one M&A adviser at London 100 roundtable. “We are at the top edge of pricing here.”

Even with those hefty multiples, the M&A script may still be far from complete. Morgan Stanley research shows that almost 60 percent of reinsurance deals since 2009 were announced during hurricane season, which started on 1 June.

Reinsurance underwriters and brokers have reported a “depressing” property catastrophe 1 June renewal as oversupply has held pricing close to flat.

While better than last year’s 1 June renewals, the rates have not met expectations.

That may make hurricane season a busy one for dealmakers, no matter where valuations are.

“A further deceleration at 1 June renewals could challenge the long-term property cat reinsurance business mode – reinsurers get payback in higher prices after losses,” said Morgan Stanley in a recent report. “This could push more boards and managements to rethink their long-term business strategy and lead to more industry M&A.”

This article was previously published in the Summer 2018 issue of Insider Quarterly