Insurance carriers struggled to keep pace with a virtually impossible comparison in M&A activity during the first four months of 2019.
Various factors coalesced to drive historically high levels of deal-making involving U.S. and/or Bermuda-based buyers and/or targets at the start of 2018. And developments such as an increase in geopolitical instability, a widening in bid/ask spreads and the brightening of near-term organic growth prospects in certain business segments have helped limit activity year-to-date in 2019.
The $2.57 billion in aggregate deal value for transactions meeting certain specified criteria* announced between Jan. 1 and April 30 marked a decline from an inflation-adjusted $31.02 billion in the year-earlier period; it also fell short of the inflation-adjusted average of $3.71 billion for the comparable periods from 2011 through 2017.
S&P Global Market Intelligence previously projected a decline in insurance M&A activity in 2019 from the lofty 2018 levels to about $26.8 billion, not far from the 10-year inflation-adjusted annual tally of $27.77 billion. But the early sluggishness will require a significant pick-up for the industry to come anywhere close to either of those figures. Should insurance carrier M&A maintain its current pace through the balance of the year, 2019 would rank as the slowest year since 2004 with or without consideration of the impact of inflation.
With a number of key structural dynamics that fueled 2018's activity still in place, even if the immediate catalysts for pulling the trigger have been absent, we think the most likely scenario is for aggregate deal value to land closer to our original projection than the near-term run-rate. That a number of notable 2019 deals have not included public disclosure of the consideration to be paid to this point only adds to our confidence as the run-rate materially understates the level of activity that has occurred.
A hardening market softens M&A prospects
Four of the largest M&A transactions in the first quarter of 2018 involved targets in the property and casualty space, highlighted by Axa's $15.39 billion agreement to acquire XL Group Ltd. and American International Group Inc.'s $5.54 billion deal for Validus Holdings Ltd. Several other deals valued in excess of $1 billion occurred through the balance of the year as some carriers turned to inorganic efforts to add new specialties, geographies and/or capabilities.
Those deals occurred against a backdrop of mixed P&C pricing trends in the commercial lines, with workers' compensation and commercial auto serving as the outliers on the low and high ends of rate actions. One year later, management commentary about pricing has been decidedly more positive in a general sense, and with the continuing exception of workers' comp, more broad-based in its application. It is not a coincidence that 2004 represents the historical low point of insurance M&A activity as that year arguably served as the peak of the post-9/11 market hardening.
Better organic growth prospects can lead prospective buyers to drive a harder bargain at a time when prospective targets' demands reflect the sort of multiples that emerged in 2018. The resulting imbalance could keep some deals from getting done, at least in the near term.
Thomas Gayner, co-CEO at historically active acquirer Markel Corp., said during a recent conference call that his company has not been making outbound calls about potential M&A deals of late as a result of concerns that "prices are too high." Markel spent nearly $1 billion in both 2017 and 2018 on acquisitions of State National Cos. Inc. and Nephila Holdings Ltd.
Unique circumstances seem to be at the root of the notable activity in the P&C space that has occurred so far in 2019.
The largest P&C deal to date in 2019, American Family Mutual Insurance Co. S.I.'s agreement to acquire the auto and home business of Ameriprise Financial Inc. for $1.05 billion, was a culmination of the seller's strategic review process. Auto-Owners Insurance Co. Inc. agreed to acquire the group that includes California Capital Insurance Co., which suffered through two consecutive severe wildfire seasons in its namesake state. The formerly acquisitive AmTrust Financial Services Inc. accelerated its strategic repositioning as a privately held specialty commercial P&C insurer through a couple of divestitures.
Behind the numbers
None of those AmTrust sales, which included agreements to divest a Lloyd's business to Canopius AG, surety and trade credit businesses to Liberty Mutual Holding Co. Inc. and a crop insurance managing general agency to a U.S.-based unit of Tokio Marine Holdings Inc., included formal disclosures of deal values. Yet each of them is likely to have been significant. The same is likely true of the agreement Berkshire Hathaway Inc. entered in February to sell its 81% stake in Applied Underwriters Inc. to United Insurance Co. United will also acquire the 7.5% stake held by Applied Underwriters co-founder Sidney Ferenc, according to the most recent quarterly statement for Applied Underwriters subsidiary California Insurance Co.
AmTrust paid $88.7 million and $179.7 million for separate past acquisitions of the surety and trade credit business it intends to sell to Liberty Mutual. It paid $203.3 million in 2016 to materially boost its Lloyd's presence through the acquisition of ANV Holdings BV. The Applied Underwriters group as consolidated by S&P Global Market Intelligence had policyholders' surplus of $839.3 million as of Dec. 31, 2018.
Similarly, one of the most significant deals in the life sector, Protective Life Corp.'s January 2019 agreement to acquire the U.S. life and annuity business of Great-West Lifeco Inc., also shows no specific amount of consideration. But the buyer, which is one of the industry's most active consolidators, described it as its largest-ever transaction with an associated capital commitment of $1.2 billion.
To the extent the deal values eventually get disclosed — and assuming prices either in line with the historical valuations or the target's year-end surplus — the industry's tally for the first four months of 2019 would be nearly 2x its current level. Applying the resulting figure as a full-year run-rate suggests a total of approximately $15 billion. That would still represent a significant shortfall relative to the 2018 total and the 10-year annual result, but it would not have the same historical weakness as the hypothetical figures discussed earlier.
Prospective transactions involving a possible sale of Global Bankers Insurance Group LLC and certain annuity and structured settlement business of Allstate Corp. could provide a boost. Athene Holding Ltd. and Apollo Global Management LLC recently revealed a $4 billion facility to provide additional "firepower" for inorganic expansion, including block reinsurance transactions and M&A.
Generally attractive multiples may keep other sellers in the marketplace, creating the potential for additional deal flow to the extent that less price-sensitive buyers can be found.
No slowing broker/agency M&A
The combination of insatiable demand by private equity-backed brokers and continuing pursuit of inorganic opportunities by their publicly traded peers resulted in the number of announced deals involving U.S.-based targets hitting a new high for a first quarter at 168. The total count of 201 deals year-to-date through April marked an increase of 15.5% from the comparable period in 2018.
Private equity-backed brokers such as Hub International Ltd. and AssuredPartners Inc. have driven consolidation in the sector to new heights as they accounted for more than half of the announced transactions in each of the past three years. But a resurgence of activity among publicly traded brokers helped push deal counts even higher.
Arthur J. Gallagher & Co., Brown & Brown Inc. and Marsh & McLennan Cos. Inc. were collectively responsible for 53 broker/agency deals in 2018, which marked their highest level of activity since 2012. In the first four months of 2019, they conducted 18 broker/agency deals, up from only 10 in the year-earlier period.
"Our merger and acquisition pipeline is very full," said Arthur J. Gallagher CEO J. Patrick Gallagher during an April conference call. Gallagher said the pipeline included about 60 term sheets at various stages with targets that generate aggregate annual revenues of approximately $350 million.
While deal values for most of the transactions in the sector are not disclosed, advisory firm MarshBerry put price-to-earnings before interest, taxes, depreciation and amortization, or EBITDA, at a historical high of nearly 10.9x for the trailing-12-month period ended March 31, for the transactions to which it had access to underlying data.
The fee-based business models employed by broker/agency targets lack the balance sheet-related risks historically associated with carrier transactions, making those high multiples more palatable for acquirers. Still, the relentless pace of activity over an extended time frame raises doubts over how much longer the momentum can continue.