For the third year in a row, insurance industry analysts are calling for a rebound in merger and acquisition activity. Too bad nobody’s listening.
In both 1999 and 2000, the forecasts of a pickup in merger activity proved to be more speculation than substance, according to Conning & Co., which this week released the 2001 edition of its study Mergers & Acquisitions and Public Equity Offerings.
An investment company that specializes in the insurance industry, Conning notes that the 293 deals in 2000 represent a 37 percent decrease from 1999, which in turn showed a 17 percent decline from 1998. The drops occurred despite high expectations for major insurer consolidation and cross-industry transactions for both years.
Worse yet, there’s no likely event to reverse the trend. “Will 2001 be different? No one really knows,” says Clint Harris, vice president of insurance research and publication at Conning, and author of the study. Also in decline are transaction prices and valuation metrics.
Neither the industry’s bargain prices in early 2000, nor deregulation from the passage of the Gramm-Leach-Bliley Act generated the wave of big combinations among financial service providers that many expected, particularly between insurers and banks. The only U.S. megamerger of that sort came with the 1998 merger of Citicorp and Travelers, but that deal was announced before the passage of Gramm-Leach-Bliley, which repealed the New Deal Glass-Steagall Act that had separated commercial and investment banks.
“A great deal of uncertainty exists in the marketplace whether that’s a good model to follow,” Harris tells CFO.com. Specific deal hindrances, he says, include the high recent profits at U.S. banks, which were presumed to be the most likely buyers of insurers. Insurance companies have been less profitable than banks in recent years, and unattractive as acquisition targets. The two industries also have different cultures, not to mention unresolved privacy and other regulatory issues.
Europe is far more comfortable with the convergence. On Thursday, The Wall Street Journal said German insurance giant Allianz AG is in talks to buy Dresdner Bank AG, Germany’s third largest bank, for $19.5 billion in stock and cash.
U.S. banks are content mating with insurance agencies to gain distribution or doing a strategic alliance. In early 2001, for instance, Wells Fargo agreed to buy ACO Brokerage Holdings.
“Perhaps a clarification of privacy requirements or a few large M&A transactions could spur the substantial market consolidation that has been anticipated,” Harris says in the study.
For now, small-scale acquisitions are the norm. If not for Citigroup Inc.’s $31.1 billion convergence-driven acquisition of Associates First Capital Corp., the aggregate value of the transactions — $55.7 billion — would have dropped in 2000 to the lowest value since 1994. Just six transactions reported last year had values in excess of $1 billion, versus 14 in 1999 and 23 in 1998.
Moreover, price ratios have dropped significantly:
- Property-casualty transactions decreased from 2.1 times (GAAP) book value in 1999 to 1.7 times in 2000; Life insurer transactions fell from 2.1 times book value to 1.9 times; Services fell the most, from 4 times book to 2.3 times book.
On a transactional basis, services sector saw a whopping 68 percent decline in transactions last year — likely a reflection of the overall technology turndown and the pressure on potential acquirers to deliver immediate profits, Harris notes in the study.
Purchase prices relative to the statutory book value also declined in 2000.
- Property-casualty decreased from 2.4 times statutory book value in 1999 to 1.5 times in 2000; Life declined slightly from 2.7 times statutory book to 2.4 times.
Results varied by sector on a price-to-GAAP earnings basis:
- Property-casualty transactions expanded from 11.8 times earnings in 1999 to 18.5 times in 2000, while Life decreased from 26.1 times earnings in 1999 to 19.3 times.
Conning’s database does not record price-per-member, the reasonable valuation metric for the health/managed care sector. And pricing information often is not disclosed for many of the transactions in the services and distribution sectors because they involve private companies.
Where the prices and valuation metrics go in 2001 largely depends in part on which of the two current trends win out in the end.
On one hand, with the greater economic uncertainty and deteriorating financial results of some insurers and subsequent defaults by giants like Reliance Group in 2000, some companies have decided to refocus the business around core competencies, acquire more of that type, and jettisoning weaker operations.
Distressed sellers, however, logically offer little incentive for the buyer to pay a premium. “Some industry experts suggest that lower prices point to the lesser quality of the business being sold/acquired,” Harris notes in the report.
Others insurers, seeking to create scale and/or broaden product lines to compete globally, have opted for consolidation and convergence. This path, which Conning expects to see more of for the industry, yielded the largest insurance-related M&A transactions last year.
Fundamental improvements stemming from the price increases for services are helping to boost the buying power for several companies as the market rewards the best performers, Harris says.
One issue that the Conning people did not address is the favorable impact of the FASB’s anticipated elimination of goodwill amortization.
Under the proposed rule changes–expected on July 1–many insurance companies might be willing to pay higher prices than they otherwise would have because they won’t need to worry about earnings dilution resulting from amortizing goodwill, according to a recent Merrill Lynch report entitled “No Accounting For… Goodwill.”
“The more lenient accounting treatment could give management reason to relax their acquisition pricing hurdles,” the Merrill report says.