Fitch Ratings has claimed that the combination of continued competitive pressures, the effects of US tax reform and catastrophe losses in 2017 is leading to increased talk of more M&A among (re)insurers in 2018, especially in the Bermuda market.
The rating agency said in a commentary that increasing scale and diversification resulting from mergers could increase the resilience of firms to market challenges, including intense price competition and low investment yields.
However, merger execution and integration risks could pose risks to profitability. Fitch pointed out that several recent deals have involved international firms buying into Bermuda or London, providing the benefit of growth outside home markets, with the AIG-Validus acquisition being a case in point, with AIG gaining access to a Bermuda (re)insurance operation and London platform.
The rating agency said that: “The sale of several typically smaller and less diversified (re)insurers in recent years has largely been in response to a prolonged highly competitive market that has inhibited profitable capital deployment. The growth of alternative capital in the reinsurance market helped limit price increases at the January 2018 renewals, with the insurance-linked securities market reaching record size. Significant catastrophe losses in 2017 stemming from the particularly severe hurricane season in the US and Caribbean more fully revealed the weaker reinsurance market profit fundamentals.”
Fitch's global reinsurance sector outlook remains negative due to pricing concerns and constraining effects of protracted low investment yields on profitability.
In addition the rating agency pointed out that recently enacted US tax reforms reduced the tax advantage that Bermuda and some other international (re)insurers have over their US counterparts. This may encourage firms to move more business to the US or enhance their geographic scope and competitive position through M&A.
On the other hand Fitch added that opportunities for better revenue growth and rate adequacy could reduce sellers' interest in finding a merger partner and that a near-term shift toward property (re)insurance rate increases in response to 2017 catastrophe losses and pricing stabilization in some other market segments will likely enable premium growth and modest underlying profit improvement in 2018. Stronger global economic growth is also leading to expansion in insured exposures and demand for coverage.
Fitch believes that M&A can benefit (re)insurers through greater scale, an enhanced profile, diversification and improved profitability. However, the operational risk associated with an unfocused or poorly controlled M&A strategy could outweigh the diversification benefits.
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