Capital Markets Flash Perspectives on Insurance M&A Volume 5, Issue 10

www.pwc.com/ca/deals
May 25, 2012
Capital Markets
Flash
Perspectives on Insurance M&A
Volume 5, Issue 10
Insurance M&A activity
increases in 2011,
but will the momentum continue?
Consistent with our expectations,
mergers and acquisition (M&A) activity
in Canada’s insurance industry continued
to increase in 2011 as more carriers
and brokers sought to expand market
share, drive premium growth, and seek
economies of scale. A continued lowinterest rate environment and sluggish
improvements in soft premium rates
continued to squeeze margins and drive
many players to seek scale. If more deals
could be found, chances are more deals
could have taken place.
2
However, the story of the year for
Canadian insurance M&A in 2011 has
to be the exit of AXA from the Canadian
marketplace. Beginning with the sale of
multi-line operations to Intact Financial
(formerly ING Canada) in May for $2.7
billion and continuing with the sale
of its life insurance operations to SSQ
Insurance in September, the departure
of AXA drove substantially all of the $3
billion announced deal value for Canadian
insurance M&A in 2011.
The activity (and pricing) surrounding the
departure of AXA is indicative of the pentup demand for quality insurance targets
in Canada. Strong balance sheets, surplus
capital and capacity and a desire, if not
necessity, to build scale is driving demand
for premium volume from domestic
carriers. However, there continues to be
a lack of willing sellers among carriers.
Indeed, 2011 saw carriers perusing
transactions along the value chain,
driving activity in the brokerage sector as
they sought to capture premium volume
from the acquired distribution platforms.
This was recently seen again with the
announcement of Intact’s agreement to
acquire Jevco Insurance Company from
Westaim Corp. for $530 million.
Deals in the insurance brokerage and
MGA space continue to get done as
entrepreneurs and aging owner-managers
seek an opportunistic exit to benefit from
the strong current demand and pricing.
Valuation trends
The demand for quality insurance
targets has driven both competition
and pricing to new heights. While
typical valuation metrics differ among
Figure 2:
Canadian insurance transactions
Source: S&P Capital IQ
Canadian insurance transactions totals
Source: S&P Capital IQ
Number of deals
Figure 1:
35
3,031
30
4
2,000
1,339
7
15
5
2,500
4
20
10
3,000
2
25
3
1,500
23
3
11
1,000
329
500
6
2009
Life and health
2010
Brokerage and other
3,500
2011
2009
Announced deal value $m
Deals in the insurance brokerage
and MGA space continue to
get done as entrepreneurs and
aging owner-managers seek
an opportunistic exit to benefit
from the strong current demand
and pricing.
According to data obtained from
S&P Capital IQ, there were 29 deals
announced in 2011 involving a Canadian
insurance target, compared to 21 in
2010 and just 12 deals in 2009. The
vast majority of announced Canadian
insurance deal activity in 2011 was
driven by the brokerage and managing
general agents (MGAs) sector, with
transactions to acquire 23 insurance
brokerage and MGA targets announced
in 2011 compared to 11 in 2010. Given
the size of many broker-to-broker deals,
typically there are many other deals
that go unannounced. Interestingly,
this spark in activity was ignited by the
acquisition of Western Financial Group
(“Western”) by Desjardins in December
2010, following which, Western went on
to announce a further six acquisitions in
2011. Another serial acquirer in Canada,
Hub International, drove a further three
brokerage transactions in 2011.
2010
2011
P&C and multi-line
3
insurance sub-sectors, there has been a
general trend towards higher valuation
multiples over the last five years. Pricing
is partially a function of the nature of
the acquirer and its ability to drive value
and collaboration from the deal. For
example, a carrier can generally derive
greater synergies from the acquisition
of an MGA than another broker or MGA
could. Therefore, it is often able to offer
a higher valuation as a result of these
stronger synergies. Due to the demand
for premium volume and scale from both
brokers and carriers, valuation multiples
for insurance brokers are at an all-time
high, and many brokers are being priced
out of broker-to-broker acquisitions due to
competition from large domestic carriers.
Other company-specific, controllable
factors will also impact the marketability
and valuation of a company in an
insurance transaction, including:
Insurance M&A outlook –
What to expect from 2012
value during a sale, or enhance those
factors that will drive premium pricing
and strong demand.
Buy Canadian
Interestingly, five of the top six announced
Canadian insurance deals by value in 2010
and 2011 were to Canadian buyers, with
the sale of the reinsurance operations
of Sun Life to Berkshire Hathaway, in
October 2010, being the outlier (while
RSA Canada’s parent company is
domiciled in the United Kingdom, given
that RSA Canada is a major player in the
Canadian marketplace, this has been
considered as a Canadian acquisition).
The relative strength of the balance sheets
of Canadian financial services companies
and strong Canadian dollar appears to
have kept foreign buyers from pursuing
many of the large deals.
We expect M&A deal volume in the
Canadian insurance sector to continue
to strengthen into 2012. Generally, there
appears to be more buyers looking to add
scale and diversify into new markets and
geographies than there are willing sellers.
With investment yields likely to remain
low (and therefore asset values relatively
high), and premium rates stagnating
and continuing to squeeze margins, this
phenomenon is likely to continue into
2012. Outside of potentially market
changing events, such as demutualization
of property and casualty (P&C) carriers
(see below), activity is expected to
continue to be driven by the brokerage
sectors where willing sellers seeking an
exit at historically high multiples can
continue to be found.
•Quality of historical earnings
•Strong underwriting results
• Consistent loss ratio trends
•Critical mass
•Strong niche
•Proprietary technology or analytics
Vendor due diligence, if performed early,
can help a seller identify and mitigate
factors that could otherwise deteriorate
Figure 3:
Figure 4:
Average transaction multiples
Top six insurance deals involving Canadian targets
Source: S&P Capital IQ (deals involving a foreign buyer highlighted)
1.5 - 2.0 x
Book value
Insurance
carriers
4
2.0 - 3.0 x
Revenue
MGAs
3.0 - 4.0 x
Revenue
Insurance
brokers
Sector
Seller / Target
Buyer
Value
($ millions)
Date
Multi-line
AXA Canada, Inc.
Intact Financial
Corporation
2,700
5/31/2011
P&C
GCAN Insurance
Company
RSA Canada
420
10/4/2010
Brokerage
Western Financial
Group (Network) Inc.
Desjardins Financial
Corp.
415
12/23/2010
Life and Health
AXA Canada, Inc.
SSQ, Life Insurance
Company Inc.
300
9/26/2011
P&C
JEVCO Insurance
Company
Kingsway Financial
Services
259
1/25/2010
Life Reinsurance
Reinsurance
business of Sun Life
Berkshire Hathaway
Life Insurance
240
10/27/2010
While insurance M&A activity may
strengthen in 2012, we expect a
number of issues will impact deal
activity in the insurance industry,
including:
•Solvency II - Solvency II may increase
the amount of capital European insurers
and reinsurers are required to hold,
making it more challenging for them
to compete in the Canadian market.
Interest in the Canadian M&A market
by European investors appears to be on
the decline partially as a result of the
uncertainty around whether Solvency
II will impact the capital they will
be required to hold at their foreign
subsidiaries and also as a result of the
strong Canadian dollar compared to the
euro.
•Yields likely will remain low in 2012
- The low-interest rate environment will
likely continue through 2012. Low yields
will likely impact pricing considerations
for many insurers that rely on
investment returns to drive returns,
and likely priced policies assuming a
greater investment yield. Insurers are
evaluating the realistic yields they can
earn in the current environment and
will likely be evaluating their pricing
and growth strategies. This may lead
some insurers to exit certain lowermargin or capital-intensive businesses
making more properties or blocks of
business available to the market.
•Significant catastrophe-related
losses may result in a stabilization of
market pricing - P&C rates have been
softening over the last few years as a
result of excess capacity and relatively
low catastrophe-related losses. In 2011,
the P&C insurance industry experienced
significant catastrophe-related losses as
a result of various floods, hurricanes,
earthquakes, and tsunamis around the
world. Market observers believe that
these catastrophe losses will lead to a
general stabilization in market pricing.
However, the level of the catastrophe
losses may not be signifnicant enough
to shock the market into price increases.
They also believe that a real rate
change will not take place until adverse
development on reserves from the
catastrophic events of 2011 are realized,
which is likely to occur over the next few
quarters and into 2013.
•Demutualization of the Canadian P&C
insurers - Pioneered by Economical
Insurance Group (“Economical”),
proposed demutualization could lead to
opportunities for private equity players
to deploy capital. In 2010, Economical,
one of Canada’s largest P&C insurance
providers, announced its intention
to demutualize. Its announcement
provided two options for demutualizing,
either through an initial public offering
or a sponsored demutualization, with a
financial sponsor providing the required
financing and acquiring a significant
proportion of the company. Although
there have been many life insurance
demutualizations in Canada in the past
20 years, there is currently no legislative
framework for the demutualization
of a P&C writer. Economical is in
consultation with the Office of the
Superintendent of Financial Institutions
(OSFI) and the Department of Finance
on the construct of such a process. Other
large mutual P&C writers are on the
sidelines waiting for the Economical
demutualization – expected to be
completed in 2012 – to pave the way. As
the regulatory framework is finalized,
and others follow Economical on the
path to demutualization, there could
potentially be increased demand for
financial sponsors’ capital and increased
consolidation in the Canadian P&C
market as demutualized companies with
new found access to capital look to build
scale and efficiency.
•US insurance companies have
largely recovered from the financial
crisis and are looking to put their
excess capital to use - Many US and
foreign insurance companies have
recapitalized over the last several
years and have begun to return some
of the excess capital to shareholders
through stock buybacks and, to a lesser
extent, through dividend increases.
Insurers will be evaluating whether to
continue returning their excess capital
to shareholders or to put their capital
to use by expanding their core business
though M&A.
•Uncertainty surrounding legislation
and federal regulation in the US
will continue to create hesitancy in
2012 for US buyers - This uncertainty
could also have a significant impact on
offshore property-casualty reinsurance
strategies and offshore reinsurers.
Further US health care reform could
have a big impact on accident, health,
and life insurers, and other writers
of related workers’ compensation,
long-term disability, or long-term care
products. The impact of health care
reform is far from over and the oversight
of the Federal Insurance Office is
expected to have further implications
on life insurance operations and costs
in the US.
5
Top considerations for
insurance dealmakers
Below are key considerations dealmakers should consider in deciding whether
a transaction is the best vehicle to meet the organization’s objectives.
6
1.
Be mindful of valuation gaps.
What can be done to build confidence
on both sides of the negotiating table
so that any valuation gap can be
closed? This is particularly important
in the insurance industry where
interest rates are likely to remain low,
impacting investment returns and
potential profitability. Valuation gaps
due to differences in expectations of
future profitability can be sizeable
and can make it hard to agree not
only on pricing but also on how the
deal should be structured.
4.Carefully consider potential
implications of anticipated and
recently implemented regulatory
reforms. Regulatory changes in
the US and Europe could have a
dramatic effect on valuation. How
might a transaction affect the capital
ratios of European insurers and
their Canadian subsidiaries under
Solvency II? Will acquirers have to
increase the amount of capital they
are required to hold, tying up so
much that a deal becomes financially
unworkable?
2.
Consider the impact of mediumterm interest rate trends on
projected earnings. With interest
rates likely to remain low for the
foreseeable future, insurers cannot
count on squeezing returns out of
a bad deal from rising rates. They
have to make certain that their
assumptions accurately project
margins and interest rate spreads,
the latter of which is a strong
contributor to earnings in the
P&C sector.
5.
Anticipate points of resistance. An
acquiring firm needs to understand
what impact a transaction would
have on the insurer’s relationships
with regulators, rating agencies,
bondholders, shareholders,
and other stakeholders. Some
transactions simply may not be worth
the price a company has to pay in
reputational or relationship damage.
3.
Consider the effects of recent and
expected legislation. Especially
with the upcoming presidential
election in the US, there is increased
uncertainty about both legislation
that has already been enacted in
the US and bills that might still be
introduced. Changes to US health
care reform could affect future
partnerships, alliances and joint
ventures in the health, life, workers’
compensation, disability, and longterm care sectors. A proposal in
President Barack Obama’s budget
to eliminate the tax ductibility of
some reinsurance premiums could
affect offshore property and casualty
reinsurance strategies.
6.
Evaluate transaction alternatives.
An insurer may be able to more
efficiently diversify its distribution
and revenue stream through other
measures which may organically
generate desired growth –
engaging in loss portfolio transfers,
participating in renewal rights
transactions, or simply hiring highperforming employees. Insurers
might also want to consider
deploying capital through avenues
that provide greater likelihood in
improving return on equity such as
stock buybacks or increasing the
dividend, rather than entering into
what may result in a risky transaction
which may not result in the intended
increase in return on equity.
7.Identify both strategic and
financial advantages. The best
deals not only generate incremental
returns but also strategic advantages.
Good partners have distinct
competitive advantages, expertise,
or product niches that cannot
quickly and efficiently be developed
internally or economically obtained
through other strategic alternatives.
For example, some distressed firms
are seeking to sell off non-core
businesses and assets, which would
make a deal a win-win. If this is not
the case, then the deal may result
in higher costs for little additional
business or financial gain, especially
if it means entering a new area when
the market outlook is still ambiguous
or an area where the buyer has little
or no experience or the ability to
drive synergies.
8.Assess the impact on the insurer’s
risk profile. If the risk profile
changes, an acquirer should make
certain that there are business
methods, controls, and processes
in place that can be used to identify
and mitigate the new risks posed by
a transaction. In particular, it needs
to make certain that its enterprise
risk management system is up to the
task of evaluating and addressing the
added risk.
Key industry findings from the
PwC 15th Annual Global CEO Survey
9. Look for a good fit in people,
culture and systems. Buyers need
to ascertain whether they can easily
integrate a prospect’s operational
technology and human assets.
Companies sometimes will buy a firm
while falling to realize how difficult
it can be to absorb. Differing business
cultures, back-office systems, and
infrastructure can result in much
higher integration costs than
expected or even cause a deal to fail
outright.
10.Evaluate how industry trends may
affect the viability of the deal.
Trends in premium rates, combined
ratios, excess capacity, and a residual
soft market could force industry
consolidation of underwriters. These
trends might increase interest in
vertical acquisitions of managing
general agents, managing general
underwriters, or captive agents or
might make certain horizontally
structured deals more or less
attractive.
For the 15th Annual Global CEO Survey, PwC surveyed 121 insurance
leaders in 42 countries. Some of the findings from the survey include:
•CEOs are optimistic about future prospects, with 90% confident
about improving company revenues over the next 12 months
•CEOs see economic uncertainty as the greatest threat
to growth in the short term and over-regulation
as the second biggest threat to growth
•Only 15% of CEOs are planning a cross border acquisition in the
coming year. Uncertainty with respect to capital demands and
valuation means bolt-on deals are the likely transaction of choice
•More than 80% of insurance CEOs expect to build
up operations in East Asia, South-East Asia, Africa
and Latin America over the next 12 months.
•Even with continued increases in climatic volatility, only
10% of insurance CEOs are planning to significantly step up
investment in addressing the issue of climate change
To explore the full results of the PwC 15th Annual Global CEO Survey, visit
www.pwc.com/ceosurvey
Properly performed, initial due diligence
of the considerations above could curtail a
poorly conceived deal early in the process,
saving time and money. For transactions
that make sense, working through these
scenarios offers advantages in meeting
the complex integration of operational,
valuation, accounting, and technology
requirements after the deal closes.
7
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Source: Kennedy; “Business Advisory Services Marketplace 2009-2011”; © BNA Subsidiaries, LLC. Reproduced under license.
In addition to the endnotes, sources may include: The Associated Press, Barrons, Bloomberg, BMO Capital Markets, Business Standard,
Canada Stockwatch, S&P Capital IQ, CIBC World Markets, Conference Board of Canada, The Economist, Eurasia Group, The Financial
Post, The Financial Times, FT Alphaville, The Globe and Mail, Goldman Sachs, International Monetary Fund, International Trade Suite,
Marketwatch, McKinsey Quarterly, Moodys, mergermarket, National Bank, National Post, New York Times, PR Newswire, RBC Capital
Markets, Reuters Loan Connector, S&P LCD, Scotiabank, Seeking Alpha, Standard & Poors, Stikeman Elliot, TD Newcrest, TD Securities,
TMX Group, The TMX MiG Report, Toronto Dominion Bank, Torys LLP, United Nations, VC Circle, Wall Street Journal, The Washington
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