Twenty years ago a colleague said that pending consolidation would make the U.S. life insurance sector an exciting and dynamic place to build a career. His words proved to be prescient: there have been many mergers and acquisitions among U.S. life insurers. Looking forward, I expect that our industry will continue to consolidate even further.
On the surface, it appears that the U.S. life insurance industry has already been consolidated. After all, the 10 largest life insurers command 53 percent market share, up from just below 40 percent in 1994, according to a recent study.
But despite appearances, although the market share of the 10 largest insurers is significant, the U.S. market is still highly fragmented. It includes more than 1,100 life insurance companies.
Furthermore, since 1996 there has been a downward trend in the number of merger and acquisition transactions in the industry, with the pace slowing even further over the last three years.
One of the factors contributing to this slowing pace is the fact that general economic conditions have been favorable for life insurers. As a result, the overall financial strength of the industry has improved over the last decade, which naturally limits any additional mergers and acquisitions.
That said, there are several factors that tend to favor more transactions, if not now then in the medium term.
Of the base of more than 1,100 U.S. life insurance companies, many are attractive takeover targets.
Some life insurers find themselves in the crosshairs because of their specialized expertise in narrow segments. These would-be targets provide new opportunities for buyers looking to expand in new segments.
As larger companies seek to expand their offerings, these specialized insurers become more attractive acquisition targets. This may result from new product sales being down, causing larger companies to seek consolidation partners in an effort to diversify their potential sources of revenue and profits.
Others, because of their geographic location, offer buyers opportunities to grow in new regions of the country. Still others offer themselves as potential takeover targets because they don't operate as efficiently as they could. In either case, such factors should spur further consolidation.
Further driving this business strategy is the need for companies to meet the growth expectations of investors. These demands should lead to higher values for companies that are producing new sales in niche products.
Divestments of noncore businesses by large and small players will also fuel additional mergers and acquisitions activity. Such transactions involve either the sale of an entire company or part of a company's business. The sale can be attractive for both the seller and the acquirer. From the seller's perspective, the divestment unlocks the value of the noncore business that would otherwise take many years to accomplish. The funds derived from the sale, along with any capital that had been dedicated to the business that was sold, can be redeployed to support growth in the seller's core lines of business. Divestments of noncore operations also give the seller the opportunity to shut down legacy administrative systems and redeploy personnel.
From the buyer's perspective, these acquisitions allow the company to build critical mass in selected lines of business and generate administrative efficiencies. If new distribution channels are required to grow a company's business, a targeted purchase can be an efficient means to add knowledgeable and trained personnel and other resources.
This emphasis on diversification is not necessarily limited to acquirers of life companies and may very well be driven by property/casualty companies, as they seek to strengthen cyclical profit streams with more consistent earnings from life business.
In addition, traditional consolidation deals will continue in the life segment for other reasons. Some companies have clearly focused just on acquisitions as a way to grow their business and have been active in the market for a number of years. While we will see continued activity from these acquirers, they will have to compete with what were until now less acquisitive companies.
As the economy improves, companies will have more capital available that their shareholders will want them to deploy. This will inevitably lead to some companies seeking the benefits of consolidation as a way to utilize their excess capital. In addition to the positive benefits of consolidation, it is difficult to know if an unstated reason for some management teams is the fear that if they are not actively engaged in consolidation, their company may be "consolidated" out of existence.
Globalization will also drive consolidation of the U.S. life industry. While large foreign players and global companies have been active acquirers in other sectors of the U.S. economy, they have been less so in ours. The increasing internationalization of the insurance industry, nevertheless, will be seen in the U.S. life market.
THE EUROPEAN ONSLAUGHT
Recently, some prominent European companies have indicated their interest in acquiring U.S.-based life insurers to expand their product offerings and increase their access to the U.S. markets. The most likely matches will pair prominent European companies with U.S.-based life insurers. This global consolidation indicates that life risks, no matter where located, are substantially the same. Assuming risks in the broader markets allows a company to optimize its knowledge and expertise.
Though the benefits of consolidation can be diversification, focus on core competency, growth or simply economies of scale, there are also risks associated with consolidation, sometimes big ones.
Larger companies should be able to realize greater efficiencies in their operations, by moving to a common information-technology platform, combining back-office functions, and reducing marketing and distribution costs. In addition, consolidation should result in a reduction in management expenses as a percentage of revenue. A recent Swiss Re study confirms that larger companies tend to have lower expense ratios than smaller companies.
A more efficient cost structure, however, may not always be achieved. The integration of acquisitions can be complex, and must be carefully planned and executed. Sometimes the excitement over a new transaction can lead to companies overlooking the less glamorous, but strategically important, work of integration. Failure to understand and monitor the true cost of integration may result in any economies of scale being dwarfed by integration costs. In addition to the risks associated with achieving cost efficiencies, companies also must consider risks and challenges associated with integrating distribution systems, back-office infrastructures and corporate cultures.
Beyond seeking to achieve scale, acquisitions and mergers are a time-honored way to diversify the product portfolio and build out the geographic footprint, giving the new company access to faster growing segments and regions. Over the last two years, many companies have seen a reduction in revenue derived from traditional life products.
Predictably, as the demand for new product categories increases, so too will the values of the companies that effectively operate in these areas. This drive for diversification will not be limited to alliances within the life industry, though. Property/casualty insurers, seeking to strengthen cyclical profit streams with more consistent and predictable earnings, may begin to view life insurance carriers as takeover targets.
For the near term at least, consolidation will be a prominent feature of our landscape, providing great opportunities for the companies that strike the right deals, for the right reasons, and execute effectively to realize the benefits.
W. WELDON WILSON
is CEO of Swiss Re Life & Health America Inc. He previously worked for Life Re prior to its acquisition by Swiss Re. He is also a member of the Swiss Re Executive Board.
April 1, 2006
Copyright 2006© LRP Publications