In an intensely competitive environment, organic growth opportunities are limited and insurers are increasingly turning to merger and acquisition (M&A) activity in their search for profitable expansion, according to a new briefing by A.M. Best. With underwriting performance under pressure and investment returns persistently low, insurers are finding it difficult to meet target returns, fuelling the drive for market consolidation.

The Best’s Briefing, “M&A Drivers Set to Remain, Fuelling Further Insurance Deals,” notes the M&A market has been active in recent months – a trend which A.M. Best expects to continue. Drivers contributing to the recent M&A activity include the perceived need to build scale and relevance – particularly in the reinsurance sector, which remains under pressure from alternative capital. The soft market conditions are making it difficult to generate strong underwriting returns, and the low interest rate environment is hindering companies’ ability to obtain acceptable yields from investment portfolios.

Catherine Thomas, senior director, analytics, said: “Some insurers are taking advantage of relatively inexpensive borrowing to finance deals, while in other cases, M&A represents a means for cash rich buyers to deploy excess capital. A.M. Best notes private equity backed buyers are especially active as they have excess capital and fierce competition between these participants are driving price multiples higher.”

The briefing states that a number of different strategies are deployed post-acquisition. For example, when similar businesses merge the focus tends to be on realising expense synergies and economies of scale. In cases where the business of the acquired entity differs considerably to that currently underwritten by the buyer, the acquired management team is usually kept in place. This can allow the takeover target to retain some of the advantages of being a smaller organisation, whilst benefiting from parental protection and access to the parent’s often large capital base.

Although A.M. Best expects the drivers and market dynamics behind recent deals to remain and that consolidation will continue, it states buyers will seek to avoid potential unforeseen legacy issues and exposures that are outside their risk appetite.

Yvette Essen, director of research, said: “Challenges in the current M&A environment are diverse and include overpaying, which could erode shareholder value, as well as execution risk regarding the integration of staff and systems, potential loss of talent and the alignment of different cultures.”