Republic CEO: P/C mergers and acquisitions likely to ‘skyrocket’

The statutory surplus for property and casualty insurers is at a record $488 billion, according to the CEO of one Dallas-based regional carrier, and they are going to be looking for somewhere to put that cash to work. Mergers and acquisitions, bringing with them opportunities to create efficiencies and to enter new classes of business, are likely targets for that excess capital.

The property and casualty industry, especially reinsurers, enjoyed a favorable pricing environment during 2006, and catastrophe exposures were relatively light. As a result, “every carrier out there thinks they’re flush with cash,” said The Republic Group President and CEO Parker Rush, speaking at the May 15, 2007, meeting of the Independent Insurance Agents of San Antonio.

Rush said in 2005 more than $20 billion in new capital poured into the industry from Bermuda and in 2006 the industry’s combined ratio was — on the books at least — 92 percent. Now, there’s “a lot of pent up capital in a number of carriers,” he said.

Unfortunately, “our industry as you know does not handle prosperity well,” Rush noted. “Whenever everybody thinks they’re in times of prosperity typically everything heads South.” One indication? A slowdown in premium growth. Net premium increased only 3 percent in 2006 and expectations are that premium growth in 2007 will be about 1 percent.

With competitive pressures mounting, carriers will not only want to move into new business classes and perhaps employ their capital in new markets — some of which they may not have experience in — they will utilize mergers and acquisitions to make up for the lack of organic growth. In addition, the ease of borrowing money in the current market is another incentive for carriers to combine and purchase, Rush said.

“The merger and acquisition side of our business I believe is going to skyrocket,” he said. “I think we’re going to see unprecedented mergers for insurance companies, as well as for brokers and regional types of insurance agencies like we’ve never seen before. Why? There’s excess capital. You’ve got to do something with it and in our business we’re lousy at returning the money to the shareholders. That’s usually not choice number one.”

The amount carriers are willing to pay for acquisitions is going up dramatically, Rush said, and “the amount they are paying far exceeds what the net income projections are.”

He cited recent announcements regarding Liberty Mutual’s purchase of Ohio Casualty and QBE’s acquisition of Winterthur U.S.

Liberty Mutual announced it offered $44 per share for Ohio Casualty, but Ohio Casualty’s share price before the announcement was $36. “They went for 1.65 times book value, which is huge,” Rush said. He added that Liberty Mutual is “paying 15 times today’s earnings to acquire that company. That is a huge premium in our business. Typically you’d pay eight to nine times earnings.”

QBE meanwhile paid 1.35 times book value for Winterthur U.S., and its subsidiaries Unigard and General Casualty, which had been for sale for three years, Rush said.

Unprecedented reserve releases
Rush said reserve releases by insurance companies in 2006 at least partly contributed to the industry’s favorable bottom line and its lower combined ratio. However, he noted, while releasing reserves creates money in the short term, it also creates a strain on the company’s “rainy day fund” and it takes a long time to build the reserves back up again.

“So what’s happened in ’06 is, there have been reserve releases at an unprecedented level in the property/casualty insurance business,” he said. “So I would be willing to argue that even if everybody produces the exact same results this year on their operating business, we will get nowhere close to [a combined ratio of] 92. Because once you release the reserves you’ve got to earn them for a considerable period of time before you’re going to be able to release them again.”

For 2007, a combined ratio in the mid-90s is more likely, as long as it’s “a relatively average cat year. If it’s higher than that, the combined ratio will go a little higher,” Rush said.

Off to Bermuda?
Rush speculated that with the Democrats now in power in the U.S. Congress, one thing they will likely do is try and close tax loopholes to increase the amount of money flowing into the U.S. Treasury. One way to do that is to look to Bermuda and the U.S. companies that are re-forming themselves there and in the Cayman Islands, Rush said.

“I’m always fascinated by U.S. carriers that merge or acquire a Bermuda company, primarily solely for the reason of saving tax dollars,” he said. “The latest example of that is obviously Argonaut acquiring PXRE.”

With that acquisition, San Antonio-based Argonaut Group will redomicile and become a Bermuda company. The majority of Argonaut’s business is U.S.-related, Rush said, and “PXRE is in run off so the only reason to do that deal is to save taxes.”

Rush believes Congress will begin to look at the number of insurance carriers that have re-formed as Bermuda or Cayman Island companies.

“I think you’re going to see at least a discussion about, ‘Hey is this fair and equitable for all of the U.S. corporations that pay U.S. taxes.’ I don’t know if anything will come of it but I think ultimately that’s something that’s in danger,” he said.

Topics Mergers & Acquisitions USA Carriers Ohio Property Casualty Casualty