Rising interest rates could boost insurance M&A in Europe

Rising interest rates will not be an impediment to mergers and acquisitions in the European insurance market and could even spur them on, according to lawyers and advisers.

Persistently low interest rates have been one of the key drivers of insurance M&A, having pushed life insurers to restructure as they have made interest rate guarantees on traditional life insurance products more expensive. The potential for deals has attracted private equity investors struggling to make returns elsewhere, and the low interest rates have given such buyers access to cheap debt to fuel further growth at their newly acquired targets.

But a rise in interest rates would not necessarily put the brakes on life insurance M&A in the continent, specialists say. James Tye, insurance deals partner at PricewaterhouseCoopers, said in an interview that rising rates "will make the industry more attractive to invest in," because it would mean targets would make more money on the asset side of their balance sheets.

Germany is one country where insurers have historically offered high guaranteed interest rates, and, along with the Netherlands, is considered a market to watch for M&A activity. Richard Baddon, who heads Deloitte's insurance M&A proposition, said in an interview that "if anything in Germany, a rise in interest rates would be very beneficial" as it would make the guarantees less onerous and so the companies more attractive.

More generally, while noting that private equity buyers typically use debt in deals, Baddon said they have "very full war chests" and so "I think you will see transactions happening because capital is available, and I think that trade-off in funding costs won't actually stifle the market." He added that because of the negative interest rates in some European countries, "it is more valuable for people to keep things on their balance sheets than to distribute them," and so a reversal of this "would be very helpful."

U.S. 10-year Treasury notes were yielding 1.64% as of April 8, 2021, compared with 0.93% on Dec. 31, 2020, according to S&P Global Market Intelligence data. There are indications European interest rates are also heading upward, with German 10-year government bonds — typically seen as a proxy for the European market as a whole — yielding negative 0.33% on April 8, compared with negative 0.58% at the end of 2020.

Deals in waiting

As with the U.K., M&A advisers expect another busy year in 2021 after activity picked up in the second half of 2020 following a coronavirus-induced slump.

S&P Global Market Intelligence data shows there were 79 deals in the European insurance industry between July and December 2020, compared to 61 deals in the previous six-month period. The aggregate value for deals where data was available was €16.44 billion in the second half of 2020, compared with €3.37 billion­ in the previous half.

Charles Rix, a partner at law firm Hogan Lovells, said European insurance M&A activity is likely to remain high for the next 12 to 18 months driven by a range of factors including the effects of the coronavirus pandemic, Britain's exit from the EU, the requirements of the bloc's Solvency II insurance capital regime and the introduction of the new IFRS 17 global insurance accounting standard, which he said would make it easier to assess the performance of different insurance companies.

The evolving corporate strategies of large groups, including Aviva PLC, Assicurazioni Generali SpA and Aegon NV, have spurred a number of deals as these companies decide where they do and do not wish to play. There is also the potential for more deals from European life insurance consolidators such as Viridium Group GmbH & Co. KG, owned by private equity house Cinven Group Ltd. and Hannover Re, and Athora Holding Ltd.

Tye said deal volumes were between 25% and 30% higher than the previous year and that deal execution prices were between 10% and 20% higher.

There is also a growing interest from private equity in the European life market, with Tye saying private equity interest was "super-hot." He noted that while the quality of businesses coming to market in the mid-market in Europe was lower, "the number of bidders is probably triple, maybe even quadruple than what it was two years ago." One of the reasons for the high interest in such targets, Tye noted, was the opportunity to improve their capital structures, cost bases and operations to take them "from underperformers and middle performers to decent performers."

High hopes

There is a sense that the European M&A market has yet to show its full potential. Hugo Laing, a partner at law firm Eversheds Sutherland specializing in insurance transactions, said in an interview that although deals were getting done in Europe, "I haven't seen quite the volume I expected on the life side." He said that European life consolidators faced hurdles such as the diversity of regulatory regimes and products across the continent, meaning it is "probably a little bit slower than it can be in the U.S. and the U.K." to do deals. He added, however, that "the appetite is immense from those players."

Baddon said that while the U.K. M&A market has "really come back to life," dealmakers had been "very, very cautious up until now" in Europe. But he added: "I think that will start to pick up, particularly in Germany."

Laing said that while his expectations of European life M&A exploding had not been met in previous years, he was hopeful of seeing more deals in 2021. "There are definitely good reasons to think there will be more deals but we'll just have to watch this space."