As mergers & acquisitions play out, all the attention is on the companies that are joining forces. But what about the cedants waiting to see what emerges from the deals? Bermuda:Re+ILS examines what happens behind the scenes.
When it comes to change in any type of relationship, it is never nice to be the last to find out. And so it is true with cedants: while they represent the single most important relationship any reinsurer has, they can also find themselves out of the loop all too often when it comes to hearing about new arrangements and marriages between their reinsurance partners.
Mergers or acquisitions (M&A) can go very smoothly when they’re planned well. But when they’re not, when doubt and uncertainty enter the equation, then cedants can, and do, get nervous. Cedants are obviously vital to any reinsurance business and it’s important to remember that mergers affect them as well. It all depends on when they’re told about such plans and if they become unsettled.
“Cedants can be informed of a merger at almost any point in the early to mid-stages,” says David Flandro, global head of analytics, JLT Re. “I wouldn’t say they become too unsettled during mergers—they simply take a close look at the reinsurers involved and make an assessment.
“This being said, merger situations do create uncertainty, and in this new world of smaller reinsurance panels, I would say it is best for reinsurers to resolve M&A activity as quickly and with as little drama as possible prior to renewals—even though that is, of course, easier said than done.”
Another issue is the possibility that a cedant might have ceded business to both the companies involved in the merger, leading to a combined increase in exposure in the merged entity.
"Retention of key colleagues in any merger is a very important part of a successful transaction, so that the client relationships are retained." Paul Schultz, Aon Benfield Securities
However, according to Flandro, this might not be a problem. “Even if cedants are using both reinsurance parties involved in a merger, the parties often or even usually operate separately at the subsequent renewal post-merger in my experience,” he tells Bermuda:Re+ILS.
“This makes it easier for cedants to continue with current reinsurance structures and counterparties for as long as possible with minimal disruption which is, I suppose, the point.
“Reinsurance buyers will, when possible, definitely work with reinsurance underwriters they best get on with and prefer, although there are institutional, credit risk, and strategic components as well which can affect decisions, even when a reinsurance underwriter with a strong client relationship leaves a company.”
Paul Schultz, chief executive officer of Aon Benfield Securities, agrees that this is an issue that can be easily solved. “Clients need to manage their exposures to their counterparties and these exposures can change in the event of a merger,” he says.
“Clients will to take into account considerations such as trading limits. They will take a look at their entire reinsurance programmes and their reinsurance relationships and the new combined entity and take a view on whether they should continue trading with them in the same way.
“Reinsurers and clients put a lot of thought into how they want to trade forward with each other. Both sides will let a merger develop, put a risk strategy in place, get that risk strategy communicated and then react and I think that in a relationship-driven market that makes sense.
“If two reinsurers merged and they were the two largest capacity providers for clients there may be some exposure management issues that just have to be addressed—the combined reinsurance company might have too large an exposure for a client to find it acceptable.”
The length of time it takes to negotiate any M&A activity will therefore play a part here—the more time to plan, the better, and the less contentious a deal is the more certainty can go into the planning. Pitfalls nevertheless still exist, as mergers will always have some degree of uncertainty when it comes to personnel.
The risk that a key underwriter might leave during a merger, possibly with his or her team, is a real one—when two companies merge then there is always a certain amount of duplication of efforts. This is an issue that executives have to address, as the links between reinsurers and cedants depend on underwriters.
According to Schultz, the reinsurance market is very much a relationship-based market and so trading relationships and partnerships that clients and reinsurers create are truly valuable.
“When clients hear of a potential merger involving one of their markets, the benefit of the doubt tends to favour the relationship and the length of that relationship,” he says.
“Generally I think that clients are supporters of mergers; if a merger is to happen, their principal focus is that it will protect the trading relationship and that they are informed about the nature of the transaction, so they can plan their business strategy accordingly.
“Retention of key colleagues in any merger is a very important part of a successful transaction, so that the client relationships are retained—there’s a lot of value to that. With the Aon-Benfield merger, and with some other recent reinsurance mergers, a large effort was put into communications with clients.
“When there’s a big merger happening people are cognisant that uncertainty is not a good outcome so everybody is trying to communicate in a way that gives clients ongoing updates on what’s happening and also reassuring messages about relationships—in other words, as much information as they can—before the entities combine.”
Taking everything into account one thing is very clear. When two re/insurers merge cedants obviously need to keep their eyes and ears open, but the nature of the market and the relationships it involves mean that they’ll be updated with as much information as possible by the merging companies. In an ideal world mergers should come from, and result in, smooth planning, not sudden shocks.
The road ahead
The recent M&A activity is changing the reinsurance industry quite a bit. What will it look like over the long term? Bermuda:Re+ILS asks what we might see 10 years from now.
“A decade from now we think that we’ll see fewer small reinsurers and more mid-to large reinsurers. Many reinsurers have set up third party capital arms to, among other things, enhance their competitive position and remain relevant in the market. Others have also expanded into primary insurance and morphed into a hybrid model that provides more flexibility in managing through soft cycles.
“We think we’ll see a further development of the hybrid model with companies allocating capital where there is a better return.”
Taoufik Gharib, analyst, S&P
“I have been saying now for a very long time that the number of Bermuda reinsurers will be lower in future. This has certainly been true of quoted reinsurers. The new question is: will the new, alternatively capitalised reinsurers now permanently fill the gap, or will capacity move in and out of Bermuda on a more temporary basis?”
David Flandro, global head of analytics, JLT Re
“There are some structural advantages to Bermuda, but what we seem to be seeing more often, and this relates to the entire market, is that the distribution chain—and that would be everything from broker to underwriter—is where we are all having to demonstrate our value propositions to our clients on a daily basis.
“If we’re adding value then we’ll trade on and we’ll trade in a good manner going forwards. If for some reason part of that chain isn’t adding value profitably enough then part of that chain will jump to make it more efficient. Each part of the chain needs to keep adding value, so the market, whether in Bermuda or London, needs to keep innovating to stay a part of that chain. It’s all about where underwriters will place the value.”
Paul Schultz, chief executive officer, Aon Benfield Securities
JLT Re, David Flandro, Paul Schultz, Aon Benfield Securities, Europe, S&P, Taoufik Gharib