Short memories and immediate pressures on growth and profit are among the factors that may explain the surge of M&A deals in the property/casualty insurance sector last year, an analyst said last week.

Although Tracy Dolin-Benguigui, a director for Standard & Poor’s, said deal flow will likely slow up some in 2016, she suggested that companies without executive succession plans and participants in the Lloyd’s market are likely candidates for activity going forward.

During a presentation at the New York conference of the International Association of Claims Professionals in June, Dolin-Benguigui reviewed key points of a report published by S&P in April, “Global Insurance M&A Trends Should Continue In 2016 Despite A Patchy Track Record Of Successful Deals,” highlighting deals that didn’t pan out particularly well for acquirers in the last few decades, including Munich Re’s combination with American Re in 1996 and PartnerRe’s acquisition of Paris Re in 2009.

Referring to an S&P analysis of the rating agency and shareholder actions following a group of the largest industry transactions since 2000, she noted that medium-term (50 deals studied) and long-term consequences (100 deals studied) were largely negative. In fact, 1-in-8 buyers ultimately announced a disposal of the target company or a portion of the target’s book of business.

“Then why do deals continue? Do companies just have no place else to put their capital?” an audience member asked Dolin-Benguigui.

“I talked about that with a CEO yesterday, and his response was, ‘Well, I have a better track record,'” she replied, also providing a brief recap of some of the often-cited deal drivers that took deal values up to $150 billion last year by S&P’s count. (Editor’s Note: Other counters have different tallies, depending on the type of insurance operation included. See, for example, “Asia Investment Grabs Big Chunk of Global P/C M&A Pie: Conning.”)

For reinsurers, she added “competitive distress” and the need for diversification and scale to remain relevant to the overflow of capital, as she listed drivers of 2015 deals. “On the primary side, it’s a lot more strategic, [with acquirers] looking particularly at specialty lines and different ways to gain greater distribution or access to lines of business where they don’t have expertise,” she said.

In addition, foreign buyers doing business in “negative- and 0-interest-rate environments” overseas are doing deals because “they have to get capital out of their homelands and insurance is a place to put it, particularly if you adopt a Berkshire-Hathaway model and treat insurance as float,” she said.

“In short, there might be some short memories, but there are some immediate pressures out there,” Dolin-Benguigui said.

Reflecting on the biggest deal announced last year—the ACE-Chubb tie-up completed in January—Dolin-Benguigui, who is the S&P analyst for Chubb, said that former Chubb CEO John Finnegan’s employment contract expired in 2016 and “there didn’t seem to be any announced successors for that.”

“So, companies can even do it among themselves. I would be even as bold to say that we’re seeing so much about the aging population [and] a lot of announcements on retirements that if a company doesn’t have a successful succession plan in place, they could be vulnerable to be bought.”

Further straying from the usual list of factors making up the strategic rationale for 2015 deals—like potential synergies and competitive pressures—Dolin-Benguigui offered another novel idea about an emerging situation that might drive deals in 2016.

“For the external buyers, London continues to be attractive…If Brexit were to happen, Lloyd’s could be an interesting target for a lot of purchasers,” she said, noting pressures in the London wholesale market. “That could be the next shoe to drop,” she added.

“Right now, they [Lloyd’s vehicles] have that EU passport out of the U.K.” But if they have to set up shop in more local countries under a Brexit scenario, then “maybe an easy way to accomplish that would be through an M&A deal,” she said.

While an audience member suggested that U.K. trading arrangements with EU countries would have to change if Britain leaves the EU, Dolin-Benguigui said that M&A could be a consequence of “a more extreme scenario” where an equivalency arrangement is not in place. “That would kind of be an operational nightmare,” she said.

Separately, a day after Dolin-Benguigui addressed the international claims professionals gathered at the IACP meeting, the International Underwriting Association of London (IUA), Lloyd’s and Richard Brindle, group chief executive officer of Fidelis, published a white paper warning of the dangers of Brexit. (See related article, “A British EU Exit Could Kill 34,000 London Jobs.”)

“London market companies would almost certainly be required to lodge large sums of money in EU member countries and make reports to local insurance supervisors (as is the case in the United States) at the cost of many millions of pounds each year. Similarly, the European companies that pump many millions of pounds (and euros) in the London market when they establish companies here are likely to seek less burdensome jurisdictions than post-Brexit Britain,” the white paper says.

The Industry’s Dismal M&A Record

After a busy 2015, S&P believes that insurance M&A will continue in 2016 but at a slower pace going forward. With last year’s deal flow prompting S&P to look back at the success of deals in the last two decades, “the general consensus of the study is that insurers are not that great at M&A deals…Both in terms of equity returns and ratings momentum, we’ve actually seen a negative bias,” Dolin-Benguigui said.

Focusing on the S&P ratings, she noted that five years out, over two-thirds of deals failed to improve the financial strength of the buyer. In other words, the deals “didn’t lead us to any kind of positive rating action,” she said.

The report breaks this down further, noting that by the fifth year, S&P had lowered 38 percent of ratings on acquirers by at least one notch, while another 30 percent of acquirers ended up having the same rating that they had at the acquisition date.

Ratings movements were actually not as negative as equity price performance. While S&P’s initial reactions to deals was generally positive—with five upgrades, two downgrades and 43 affirmations upon completion of the top 50 deals since 2000—share prices showed significant abnormal negative returns by the end of the year of the deal. While prices show a slight bump up in the first month and the first quarter (about 5 percent on average, according to a graph in the S&P report), they dropped materially—by more than 20 percent—by the end of the first year.

Examining the track records of specific deals at the conference, Dolin-Benguigui went through the four examples.

• After Munich Re acquired American Re in 1996, S&P subsequently dropped Munich Re’s AAA rating down to AA- over 2002 and 2003, following underperformance and reserve strengthening at American Re ($2 billion of strengthening in 2002 and $1.6 billion in 2005).
• Swiss Re acquired several U.S. life reinsurers in the 1990s, including M&G Re and Life Re. In 2012, they announced the underperformance of those books, which are still a drag on Swiss Re’s performance, she said.
• PartnerRe didn’t integrate Paris Re’s operations for at least a year or two, she said. In 2011, “they had that perfect storm,” referring to catastrophe losses in Japan. They “didn’t manage accumulations and ended up with some outsized losses. We originally viewed ERM as ‘excellent’ for PartnerRe but dropped [that] down to ‘adequate with strong risk controls’ and moved the rating from AA- to A+,” she said.
• Amlin bought Fortis Corporate Insurance in 2009, a deal that ultimately led to reunderwriting activities and one that has “proven to be a drag on earnings and a distraction to the management team for nearly five years.”

Dolin-Benguigui also shared a sort of scorecard summing up how S&P has evaluated deals since 2000.

Among the positives:

• 41 percent of the time, S&P has cited potential benefits of diversification as a positive rating attribute.
• 29 percent of the time, benefits of greater scale and improved competitive position positively factored into ratings.
• 20 percent had improvement in capital and earnings.

On the negative side, “we overwhelmingly cited integration and execution risk as a negative rating factor,” Dolin-Benguigui said.

• 44 percent of the time, S&P indicated that integration and execution risk was a negative ratings driver.
• 15 percent of the time, S&P cited increased leverage as a negative.
• 15 percent of the time, weakened capital was a negative factor.

In terms of execution, “basically we look at who on the senior management team is still around.” In addition to looking at key people, “S&P looks at the retention of clients and businesses and what is the game plan after completing the deal.”

Dolin-Benguigui noted several times that S&P rating rarely gives credit for cost savings synergies. While deal partners often list synergies in describing deal rationales, “we’re a little bit skeptical when companies talk about synergies because often it’s something that companies don’t achieve or it’s forgotten.”

Just after deals were announced, target ratings saw more positive movements than acquirers, according to the study. For the 50 largest M&A deals since 2000, from acquirer point of view: 64 percent were affirmed at time of acquisition, while 22 percent were put on negative outlook or CreditWatch negative, and only 14 percent on positive outlook or CreditWatch positive. For targets, more than half—54 percent—saw a positive outlook or CreditWatch positive attached to the rating, while 26 percent were negative and 20 percent affirmed.