Fresh alliances

A notable trend in the insurance market during the past 12 months has been the upsurge in private equity activity. UK insurers had their busiest year for mergers and acquisitions (M&A) since 2007, with more than 60 deals totalling $14.4 billion completed, according to figures from Dealogic. 
Private equity investors were at the core of this deal-making activity, with the likes of Synova Capital, AnaCap, LDC and HG Capital spending significant sums to purchase insurance companies, brokers or existing blocks of insurance businesses divested from larger entities. 
Although private equity firms are no strangers to the insurance sector, commercial, economic and regulatory pressures have combined to make insurance assets more attractive and consequently drive M&A volumes. 

The macro-economic climate continues to be challenging for insurers, who struggle to make decent returns on the investments they hold to cover potential claims. With interest rates at record lows and bond yields in the doldrums, it has been difficult for insurers to raise enough capital to fund business improvements or make acquisitions on their own. 
What is more, falling premiums across many traditional product lines continue to hamper organic growth. This increases the need for insurers to actively target new sources of capital to achieve their commercial goals. 
The need for insurers to tap new sources of capital has been heightened by technological advances. During the past decade, the pace of technological change in the sector has been unprecedented, with new models, new technologies and new competitors such as price comparison sites changing the rules of the game. All signs indicate the pace of change is going to increase in the future. 
Insurers need to upskill in areas such as such as data analytics, intelligent pricing, anti-fraud and telematics. M&A could provide the quickest way to improve in-house capabilities and counter the threat posed by aggregators. This approach, though, often requires significant capital reserves – something that cash-rich private equity funds can offer. 

Private equity activity in the sector is also being driven by the capital pressures insurers face owing to the increased burden of regulation. Lingering questions about the effect of Solvency II rules is leading a number of firms to question the future of parts of their operation and we expect to see disposals of subsidiaries or portfolios of assets from a number of European insurers as they consolidate around stronger markets. In particular, this applies to firms whose ratings are under pressure from writedowns on Southern European government debt or investments in distressed real estate markets. 
The effect of regulation in the banking sector has also had a knock-on effect in the insurance market. Capital constraints imposed on UK and European banks through Basel III has encouraged many to reduce their exposure to insurance assets, which has created a market of bolt-on targets for acquirers and outside investors. 
These investors have been attracted by the relatively low valuations and possibility of decent returns from these businesses. Private equity firms believe they are well positioned to create value from unprofitable or non-core insurance operations by using their investment expertise. 

The broking sector in particular has proved attractive to private equity firms for a variety of reasons. The lack of underwriting risk on brokers' balance sheets appeals to investors, particularly those that are new to the sector. Another plus is that brokers can generate predictable revenues and are not capital-intensive businesses, which offers investors the opportunity to boost their returns. 
Although consolidation has been a feature of the broker market during the past 15 years, a recent shift in dynamics within the market has created new investment opportunities for private equity firms. 
For a variety of reasons, the large consolidators such as Towergate and Gallagher have stopped making acquisitions. This created a gap in the market that is increasingly being filled by ambitious mid-tiered firms such as Stackhouse Poland and Aston Scott, both of which have attracted private equity investment in recent months. 
Many of these firms are run by quality management teams who cut their teeth working in senior roles within the large consolidators. They are hungry for investment as they embark on their own build-and-buy journeys. Both of these characteristics appeal to private equity backers, who recognise these businesses could offer potential exit routes in the form of a trade sale or flotation at some point in the future.
What is more, despite consolidation at the top end of the market, a significant proportion of the sector remains under the control of independent and regional brokers. Many of these firms were established in the 1970s and 1980s and their owners are now approaching retirement age and trying to find a suitable home for their business. 
Others are disillusioned by the pressures created by the regulatory environment, rising technology costs and falling premium rates, making them more receptive to a potential offer. 
Potential investors in the broker market need to be mindful of the ever-increasing regulation in this sector. Financial backers will be reassured if a broker has well-established relationships with insurers relevant to their particular market. They will also want to see evidence of open and honest dialogue with the regulator. Without early indications of regulatory support, proposed M&A activity may not go much further. 

The nuances of the Lloyd's of London market continues to appeal to private equity investors and trade buyers and their appetite to acquire Lloyd's vehicles is unlikely to recede in the future. 
There are several reasons for this. The Lloyd's global licences, credit rating and internationally recognised brand make the platform attractive to potential investors. There is also a possibility for investors to make significant returns, with typical yields generated in the London market significantly higher than those generated in traditional corporate markets. 

One hurdle private equity firms must resolve when investing in insurance companies is overcoming reservations regulators may harbour about the potential deal. Regulators in many markets commonly take the view that private equity funds are unsuitable owners for insurance businesses, particularly in the long-term life sector. 
While political sensitivities mean that private equity ownership may remain a delicate issue in certain markets, the recent approval of deals in the general insurance and Lloyd's of London markets suggests that regulatory attitudes towards private equity ownership continue to soften. 
An increasingly competitive market will put pressure on brokers and insurers to differentiate and find a proposition that stands out from the crowd. More firms will undertake mergers and acquisitions to build out their capabilities and increase scale. 
Against this backdrop, private equity investors will continue to find opportunities across the sector to deploy their expertise and secure the returns they are looking for. ?

Bill Cooper is managing director and global head of insurance at Lloyds Bank Commercial Banking. Bill and his team advise global life and non-life insurers with a UK presence on capital raising, asset management and investment management strategies