Mergers and acquisitions are expected to rise in the Bermuda insurance market this year due to numerous factors, many observers say.
These factors include excess capital, investors’ desire to move their cash, the need to diversify geographically and by line of business, and the intent to increase scale and achieve organic growth in a soft market.
But some observers say there also are factors that could dampen, if not quash, M&A activity in Bermuda, including managements’ desire to retain their independence, low stock valuations and the possibility of a high-loss hurricane season that could remove excess capital from the market.
Recent M&A activity includes the Max Capital Group Ltd.-Harbor Point Ltd. merger and the IPC Holdings Ltd.-Validus Holdings Ltd. deal.
The Bermuda environment is ripe for M&As, said Cliff Gallant, an analyst with Keefe, Bruyette & Woods Inc. in New York.
“You don’t really have much in terms of organic growth” and managements “don’t like to stay static. If anything, a prolonged soft market might finally cause both buyers and sellers to be motivated to” move toward a merger or acquisition, Mr. Gallant said.
“The stars are aligned” in favor of Bermuda market consolidation, agreed John Wicher, principal of John Wicher & Associates Inc. in San Francisco. “Rates remain weak with no relief in sight, and internal growth depends on good luck or a reckless pricing policy,” with further pressures exerted by global regulation, U.K. tax policy and the cost of collateral, he said.
Smaller insurers and reinsurers are under pressure to bolster their capital base, said Joe Rego, president and chief operating officer of Aon Bermuda Ltd.
“To improve your counterparty credit rating, you need to grow, and M&A is obviously the proper way of doing that. So I think you’ll see more pressure on smaller companies” to merge, Mr. Rego said.
“There are many small and medium-sized Bermuda reinsurance companies that would benefit from size and scale and additional capital,” said David Simmons, Hartford, Conn.-based leader of insurance M&A services for Deloitte & Touche L.L.P. “Several years ago, a company with $1 billion was considered a well-capitalized company. Now many are looking at the $3 billion to $4 billion range as being really necessary” to be a market player, he said.
Meanwhile, some larger firms have excess capital, observers say.
“A number of firms are sitting on excess capital,” said Tony Ursano, New York-based CEO of Willis Capital Markets & Advisory. “The debt markets have been much more accessible to the insurance community over the last six months, and I think there are ways to structure these deals from a financial perspective that should work.”
Some private equity investors still have large stakes in companies “and there might be somewhat of an incentive” to exit those investments, said Mark Rouck, senior director at Fitch Ratings in Chicago.
Private equity is “looking to get out,” which is “understandable given the softening market environment,” said Robert DeRose, vp at Oldwick, N.J.-based A.M. Best Co. Inc. “Margins are eroding, investment returns are low. It’s just going to be very difficult for companies to sustain double-digit returns on equity, and certainly that isn’t sufficient to keep private equity content,” he said.
The desire for geographical and line diversity is another factor that will encourage M&As in Bermuda, observers say.
Some of the deals seen recently have been driven partially by companies’ desire to diversify and reduce volatility “or overreliance on any particular line,” said Laline Carvalho, a credit analyst with Standard & Poor’s Corp. in New York.
For deals that occur, there will be mergers, such as the Max Capital-Harbor Point deal, as well as acquisitions, with larger companies seeking to acquire specialty companies with complementary books of business, Mr. Rego said.
Mr. Wicher said transactions between Bermuda companies are “the logical transactions” that would have the “most synergy and address the fundamental issues,” and challenges of doing business in Bermuda.
But, said Mr. Ursano, while there will be an increased level of M&A activity in Bermuda, “the Bermuda guys continue to be very eager to find growth opportunities in other markets,” including the U.S. primary market and the London market.
Simon Clutterbuck, a London-based director of BMS Intermediaries, said it would be most natural for companies seeking growth to reach outside their business area, such as reinsurers acquiring insurers.
Such deals would be most likely to occur in the United States, where most firms’ premiums are generated. “I just don’t see there being masses of acquisitions within the island itself,” Mr. Clutterbuck said.
Deals between catastrophe writers are more likely than those involving casualty writers, some observers say.
Tony Bibbings, senior vp at ARTEX Intermediaries Ltd., a unit of Arthur J. Gallagher & Co., said, “Assessing reserves from catastrophe business is a lot easier than it is for long-tail casualty business.”
However, Kevin Lee, vp at Moody’s Investors Service in New York, had a slightly different perspective. “If there is going to be further M&A, I think the more sensible combination would be a property cat company merging with a nonproperty catastrophe company” because of the greater diversification that would result.
Among factors discouraging such deals are Bermuda company stocks that are trading at a discount to book value, which Mr. Simmons said is “the major impediment to getting deals done in the Bermuda marketplace” and one that will be “difficult to overcome in negotiating a deal.”
“Social issues” could be an impediment as well, observers say.
Managements are “fairly well entrenched and committed to making it on their own,” said Mr. DeRose. “Everyone wants to be the winner in the deal, which necessitates being the acquirer.”
Charles Dupplin, CEO of Hiscox Bermuda, said a bad catastrophe season also dampens M&A enthusiasm “because it generates tremendous uncertainty about the true position the companies find themselves in.” He also noted that, historically, high-loss catastrophe years have led to a hardening market and new entrants.
