Industry the April 2019 issue

The Art of the Acquisition

Carriers are combining M&A and strategic investments to improve their access to new capital markets and digital transformation.
By Russ Banham

M&A deal value among both P&C and L&H insurers—$40.3 billion—more than doubled in 2018 compared with the prior year, although the number of deals (533 in all) declined by 13%, according to audit firm PwCMany transactions were based in part on dealmakers’ atypical interest in transforming their organization’s business and operating models, addressing technology (in the P&C sector) and more innovative customer service (in the L&H sector).

In a KPMG survey of 115 insurer CEOs, nearly 37% said they were looking to transform their business models through acquisitions, while 24% said they were looking to transform their operating models through acquisitions.

Other atypical M&A factors included deals to diversify topline income. (Diversification into traditional property-casualty markets has long been a driver of M&A.) Several acquisitions in the P&C sector, for example, involved target companies with reinsurance operations, third-party claims administration, program business and insurance-linked securities (ILS) operations. “Every insurer is looking for ways to grow the top line, which isn’t easy,” says John Andre, a managing director at insurer ratings agency A.M. Best. “What’s interesting is how they’re going about it.”

Pressure to Change

In “going about it,” insurers have no trouble digging deeply into their plentiful capital coffers. Tracy Dolin, director and insurance sector lead analyst at S&P Global Ratings, cites an S&P survey saying industry surplus reached $790.7 billion on Sept. 30, 2018, up from $726.7 billion one year earlier. Net income also climbed to $50.7 billion, compared to $23.6 billion during the same period in 2017.

Overcapitalization comes with a price. “When you have too much money in the system, it ends up artificially depressing prices, commoditizing certain products and creating a need to compete differently,” says Mark Purowitz, leader of Deloitte’s insurance M&A and insurtech advisory teams. “Companies in both the property-casualty and life and health sectors are struggling with growth and pressured into figuring out how best to use their money.”

Many of the M&A deals we’ve seen indicate insurers are looking for deals that help transform their business and operating models. One way to do that is to gain access to other companies’ innovation initiatives and emerging technologies.
Ram Menon, partner and global head, KPMG

It seems they are diverting less of it toward stock buybacks, which fell from $11.7 billion in the first nine months of 2017 to $4.8 billion in the same period last year, according to S&P Global Ratings. “As capital for the sector keeps climbing and reaching record highs,” Dolin says, “there may be more compelling ways to deploy this capital that adds more value than just sitting on it or buying back shares.”

At the same time, organic growth has been limited in the industry, particularly among more mature insurance companies, says Ram Menon, a partner and global head of KPMG’s insurance deal advisory organization. Since the beginning of this decade, global GDP has increased by more than 20%, Menon says, while global premium volume has risen by a meager 9%.

The industry is also challenged by new competitors like reinsurers and investors in insurance-linked securities, in addition to market disruptions from emerging technologies. “Maintaining the status quo in such an environment is not a solution for sustainable growth,” Menon concedes. “Many insurers have come to realize that the traditional strategy of doing more of the same is simply not the best strategy. Many of the M&A deals we’ve seen indicate insurers are looking for deals that help transform their business and operating models. One way to do that is to gain access to other companies’ innovation initiatives and emerging technologies.”

Reaching New Markets

In all industries, M&A transactions can provide ample front-office and back-office benefits—reducing operating expenses, eliminating redundancies and increasing revenues. The thinking is that the combined organization will be greater than the sum of the individual parts, although these hoped-for synergies often look better on paper than in reality.

“History shows that synergies are often difficult to achieve,” Dolin says. “In our research, we have only identified synergies as a proven strength to an announced deal 5% of the time since 2000. Quite often the goalposts move or are forgotten in the years after the deals are done.”

While insurers certainly gave high regard to perceived synergies in their 2018 deal making, many acquisitions also departed from more traditional aims. Markel acquired Nephila, an ILS manager that generates fee-based revenue through its management of more than $12 billion in insurance risk-bearing capital from 300 geographically diverse investors. “Platforms with ILS capabilities are attracting M&A attention, which may increase in the future,” Dolin says.

A decade ago, the ILS market was a novel way for carriers to cede risks to third-party investors. This is no longer the case; the market has cemented its role as an additional source of risk-bearing capital. “We’re not even calling ILS ‘alternative capital’ anymore, because we believe it’s here to stay,” Dolin says. “Certainly, this is a factor in reinsurance consolidation and may reduce the number of independent reinsurers standing down the road.”

When you have too much money in the system, it ends up artificially depressing prices, commoditizing certain products and creating a need to compete differently. Companies in both the property-casualty and life and health sectors are struggling with growth and pressured into figuring out how best to use their money.
Mark Purowitz, leader of insurance M&A and insurtech advisory teams, Deloitte

AIG’s $5.5 billion acquisition of Validus, a Bermuda reinsurer and specialist insurer, also reflects interest in new revenue opportunities. Validus further diversifies AIG business to include a reinsurance platform and an ILS asset manager (AlphaCat).

Even giant M&A transactions like French insurer AXA’s $15.3 billion acquisition of commercial lines insurer and reinsurer XL Catlin (forming new carrier AXA XL) had elements of this trend. While the acquisition complements and diversifies AXA’s existing commercial lines insurance portfolio, it also delivers reinsurance capabilities and access to alternative capital. “The acquisition of XL rebalances AXA’s portfolio,” Purowitz says, “but it also gets them into new businesses, giving them a greater spread of risk and access to revenue through a different customer base.”

Reaching the Customer

Another way some insurers are trying to grow the top line is by gaining access and to new distribution markets and getting closer to the customer. The Hartford’s $1.45 billion acquisition of Aetna’s U.S.-based group benefits business (short-term disability, long-term disability, group life, and lead management) was driven by traditional M&A factors, such as larger market share, although the deal also involves an innovative distribution strategy. “The acquisition makes us bigger and stronger, significantly increasing our market presence,” says Mike Concannon, head of group benefits at The Hartford. “But the transaction also provided a new way to expand our distribution, selling group benefits through Aetna’s medical products sales team.”

On the life and health side of the industry, the bigger financial transactions were primarily in the health sector, where transformative objectives were similar to those seen in the property-casualty industry.

Cigna’s $67 billion acquisition of Express Scripts, for example, gives Cigna the opportunity to offer a more integrated package of benefits to its customers. Likewise, pharmacy chain CVS Health’s $69 billion acquisition of Aetna’s insurance business creates a new type of healthcare entity expected to have greater appeal to consumers. Goals include simplifying how consumers access care by making it local, accessible and less costly.

History shows that synergies are often difficult to achieve. In our research, we have only identified synergies as a proven strength to an announced deal 5% of the time since 2000.
Tracy Dolin, director and insurance sector lead analyst, S&P Global Ratings

“Everyone is looking for the silver bullet,” says Deep Banerjee, S&P Global Ratings’ director and lead life and health insurance analyst. “In this quest, we’re seeing all sorts of post-transaction combinations of traditional and non-traditional players. The mindset in these deals is to better assist the needs of consumers through novel concepts like onsite doctors or nurses in a retail environment.”

Activity in the life sector, while fairly substantial, followed more traditional M&A aims, such as a focus on core competencies or building market share. Liberty Mutual’s two-part sale of Liberty Life Assurance to Lincoln National and Protective Associates for nearly $5 billion in capital and other financial components was one of the sector’s largest deals of 2018. (Lincoln Financial cited the development of a more powerful group benefits operation as a primary factor in the acquisition.) Other major transactions included the acquisition of National Teachers Associates Life Insurance by Horace Mann Educators and Resolution Life’s agreement to acquire the life insurance arm of Australia’s AMP Ltd.

Tech Targets

The desire to harness the potential of emerging technologies like robotics, machine learning and predictive data analytics is also showing up as an M&A trend. (See sidebar: “Eyes on the Upstarts.”) “More than 60% of insurers now see disruption as an opportunity for growth rather than a threat,” Menon says, “with more than seven in 10 looking to M&A to help transform their organization in some way.”

All businesses and consumers nowadays expect efficient, fast and frictionless transactions. People don’t have the time or inclination to read and understand a booklet-thick insurance policy. They just want to know the basics from their broker or agent and trust in the product’s financial security. If insurers don’t satisfy these expectations, the fear is that some other entity—such as a big-tech company—will. “To bolster their competitive positions,” Dolin says, “we’re seeing carriers making technology-targeted bets in their M&A decisions.”

She points to the AXA XL Catlin deal and the addition of XL Catlin’s data analytics organization, led by chief data officer Henna Karna, to the AXA team. “Getting that data analytics team may have been a deal sweetener,” Dolin says. “It’s often cheaper to poach a top team than build one up from scratch.”

KPMG’s survey affirms this opinion, noting that one in 10 insurer CEOs are looking to acquire “new innovation capabilities” and “emerging technologies” via their M&A transactions. The Hartford’s acquisition of Aetna’s U.S.-based group benefits business fits this paradigm. “The deal gave us access to Aetna’s strong digital capabilities, helping to accelerate our technology strategy while reducing the costs we had anticipated were needed to upgrade our legacy systems,” Concannon says.

Technology is now another “key area of focus” for insurers in their M&A decision making,” Concannon says, and one that is “quickly becoming a competitive differentiator.”

“It’s an arms race out there,” he says. “All insurers are looking for ways to serve their customers with products closer to their needs at less cost. Technology is a way for us to process our transactions more efficiently, at less cost, with higher quality, and less friction for customers. Basically, you have three choices—you build it, rent it or buy it.”

Purowitz agreed the hunt is on among carriers to upgrade their legacy systems—and fast. “Few carriers are holistically using advanced technologies,” he says. “I’ve honestly encountered only a small handful on the front side using these tools to reach the marketplace and on the back side to reach into the plumbing. In today’s competitive environment, timing is essential.”

Nevertheless, Purowitz cautions insurers to be careful when considering technology assets in their M&A deal making. “Too many carriers rush into a deal without fundamentally knowing the problems they’re looking to solve with technology,” he says. “They’re pressured by FOMO”—the fear of missing out—“into feeling they have to do something. Their boards see competitors doing it, and that ratchets up the stress.”

He advises insurers to do “far more R&D” before acquiring a company for its technology capabilities. “The challenge is that the industry historically has not done this type of R&D all that well,” Purowitz says.

The Import for Brokers

As insurers combine in atypical ways to transform their business and operating models, brokers must prepare for the new competitive landscape that emerges. For the most part, observers are sanguine that brokers will continue to play important intermediary and consultative roles.

“The theory is that all these new technologies will disintermediate the middleman,” Menon says, “but the fact remains that the industry structurally has been built around insurance brokers for centuries. Newer generations may want to access insurance directly, but most of us will still prefer to deal with a broker or agent. And it’s not like brokers aren’t innovating. Many of the larger ones in particular are developing very innovative ecosystems to connect their clients with themselves and different carriers.”

Michael Brosnan, a partner and insurance transactions leader at Ernst & Young, has a similar view. “Some commodity stuff may fall off the edges for the brokers, but there will still be a need for the expertise they provide in different classes and for particular products needed in different industry sectors,” he says.

While Dolin agrees the likelihood of broker disintermediation is small at the moment, she is less sure how the different pieces of the insurance business will fit together in the future. “Generally speaking, every participant in the insurance value chain is dipping into each other’s territory, as we’ve seen in the recent M&A activity,” she says. “They’re all trying to protect their competitive position and value proposition, driving them into the offerings of others.”

“Where this will lead will be very interesting,” she acknowledges, “but it’s still too early to tell.”

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