After 2015's bumper year for transactions, which brought the return of megadeals and a number of transformational acquisitions, both the volume of deals and their total value declined in 2016. The lower level of deal activity reflected both high levels of political uncertainty, as the US election and the Brexit vote prompted caution among dealmakers, as well as a pause in the pace of transactions as the market absorbed the previous year's big-ticket transactions.

But the underlying factors supporting M&A remain strong. The fundamental drivers pushing insurers to focus on how to generate growth have not changed, and if anything they have become more pressing. Premium rates are under pressure and the underwriting environment is challenging. Interest rates remain at very low levels and investment returns are weak, while the ability of insurers to draw on past reserves to support performance is diminishing. These drivers will continue to underpin the industry's appetite for M&A and the pick-up in activity in the last quarter of 2016 points to an active year ahead in 2017.

Low growth drives consolidation and diversification

Strategic re-positioning has been an important investment theme in M&A activity during 2016. Against a low growth backdrop, achieving scale through acquisition has clear advantages, both in expanding revenues and in offering scope for streamlining costs. The year's largest deal between two insurers the USD 28.5 billion acquisition of Chubb by ACE, which was announced in 2015 and completed in early 2016 is a clear illustration of this consolidation rationale. The merger creates the world's largest publicly traded property and casualty insurance company, increases the combined group's diversification and offers the potential for significant cost reduction.

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In the current market environment, the question is how to maintain margins. Companies can't control pricing and broker costs, so they are looking at the only line on the balance sheet they can control: expense ratios. Merging businesses can deliver millions of dollars in savings while underwriting the same volume of business, which means the combined bottom line should improve.

Andrew Holderness, London

The role of insurance within an overall portfolio was a theme underpinning two of the top three completed deals in 2016. Diversification was the rationale behind the USD 6.9 billion purchase of Bermuda-based PartnerRe by Italy's Exor, the investment company controlled by the Agnelli family, which completed in March 2016. During 2015, Exor won a three-way battle for the reinsurer, seeing off a proposed merger with Bermuda rival Axis Capital Holdings. Exor is seeking to diversify its investments, which include carmaker Fiat, away from the industrial sector.

Focus on core activities prompting on-going disposals

The flipside to achieving scale through acquisitions is the disposal of businesses deemed to be non-essential as insurers focus on their core activities and geographies. On the last day of the year, American International Group (AIG) completed the USD 3.4 billion sale of United Guaranty Corp., its mortgage guaranty unit, to Arch Capital Group, in what was a major move into a growth area for the acquirer. AIG described the deal as "another step in simplifying our organization to become a leaner, more focused insurance company". During the year, AIG also sold Ascot Underwriting, a Lloyd's of London platform, to the Canada Pension Plan Investment Board for around USD 1.1 billion.

Following a similar rationale, AXA sold operations in the UK and Hungary, while making an acquisition in the Philippines, and Zurich Insurance continued its sell-off strategy with the sale of its South African and Botswanan operations to Fairfax Financial Holdings. RSA completed the GBP 403 milion disposal of its operations in Brazil to Suramericana SA, the insurance subsidiary of Grupo de Inversiones Suramericana, and is in the process of disposing of its remaining Latin American operations in Chile, Argentina, Mexico, Colombia and Uruguay.

Looking ahead, on a similar theme, in the fourth quarter of 2016, Generali announced its intention to raise at least EUR 1 billion by 2018 from disposals of operations in less profitable and sub-scale markets, while making targeted investments in growth markets. The process is already underway with the disposal of businesses in Liechtenstein and Guatemala.

49%

of insurers expect to make an acquisition over the next three years to acquire digital technologies

Digitalisation will spur M&A

Generali also provided a further example of insurers' efforts to remain competitive in a low growth environment through investment in digital technology. The company is aiming to reduce its combined ratio in non-life business through digital initiatives including data analytics and automated profiling in motor.

Insurers have lagged behind other areas of the financial services sector in adopting digital technology, but a survey in January 2017 by Willis Towers Watson in conjunction with Mergermarket found that an increasing number of insurers now regard investment in digitalisation a priority. Nearly all survey respondents (94%) expect digital transformation to have the greatest impact in distribution over the next five years, but as the scope of digitalisation broadens, insurers are expected to buy-in external innovation through acquisitions, leading to a wave of new M&A activity. Almost half the respondents to the survey (49%) expect to make an acquisition over the next three years directly driven by the desire to acquire digital technologies.

Bermuda in focus

Exor's success in the battle for PartnerRe brought the future of Bermuda's other insurers into the limelight. Low growth, deteriorating margins and cost pressures underpinned expectations of further M&A activity, which culminated in two further deal announcements in the fourth quarter of 2016.

In October, Sompo Holdings agreed to pay USD 6.3 billion for Endurance Specialty Holdings, a value equivalent to close to 1.4 times trailing book value and in December Fairfax Financial paid USD 4.9 billion for Allied World, equivalent to 1.3 times book value.

M&A involving smaller to midsized Bermuda-based insurers and groups has been expected for years, and now those expectations have been translating into deal activity. Many Bermuda-based companies remain targets for deals and will have to diversify in order to grow and compete. Bermuda-based companies are of interest to global players, but many Bermuda insurers focus their business on the US so a tie-up with US parties can provide a natural synergy.

Vikram Sidhu, New York

Looking ahead, Bermuda-based insurers could face further competitive pressures if potential corporate tax cuts by US President Trump become a reality, undermining their tax advantage. In addition, the US administration may again consider essentially penalising premiums paid for affiliate reinsurance obtained from Bermuda reinsurers.

Entering new markets

Sompo's move on Endurance, which comes on the back of a record 10 trillion yen of outbound deals by Japanese companies in 2015, shows that Japanese insurers' appetite to internationalise their portfolios remains strong.

The Japanese insurance industry has been among the first to feel the impact of Japan's adverse demographics more than a quarter of the population is aged over 65 and the birth rate is among the lowest in the OECD. As a result Japanese insurers have been active purchasers of overseas assets. Whilst, in the short-term, Japan's acquisition spree could slow to allow time to absorb the purchases made over the last two years, further deals are likely. Sompo told investors that prior to deciding to buy Endurance it had considered 45 acquisition targets around the world.

Percentage of outbound M&A deals by region

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Outbound deal activity by Japanese insurers continued to be one of 2016's dominant themes, as is the high level of M&A activity generally among Asian insurers. In 2016, 60% of the top 20 completed deals involved an Asian-based acquirer, predominantly from Japan and China.

Last year's Chinese insurance deals include Shenzhen Qianhai Financial Holdings and Shenzhen Investment

Holdings' agreement in October to buy Singaporean carrier Asia Capital Re for USD 1 billion, and China Minsheng's USD 2.6 billion purchase of Bermuda-based White Mountains' reinsurance arm Sirius, which closed in April. However, the majority of the China-led deals were domestic transactions and the outlook for further international acquisitions in the near term is currently unclear.

China applies the brakes

Worried about the depreciation of the yuan and slowing economic growth, the China Insurance Regulatory Commission (CIRC) has imposed stricter controls on insurance investments, including companies' foreign assets, which could make it more difficult for Chinese insurers to gain domestic approval for foreign acquisitions. To help stem currency outflows, the People's Bank of China closed the Renminbi Qualified Domestic Institutional Investor scheme back in 2015, which had allowed domestic investors to buy offshore assets. Transactions that count as overseas direct investments (ODIs) by insurers remain possible, but are likely to be more difficult than in the past.

33%

the biggest stake a single shareholder can take in an insurance firm in China, down from 51%

Regulatory oversight of the activities of Chinese insurers in the domestic market has also recently been tightened. CIRC has introduced new rules aimed at limiting risk, by tightening the shareholding structure at insurance firms and limiting how insurance assets are invested. The biggest stake a single shareholder can take in an insurance firm has been reduced from 51% to 33%. To control their risk exposure, the amount investable by Chinese insurers in a single stock has been capped at no more than 5% of total assets, and an insurer's total equity investment is now limited to no more than 30% of its total assets at the end of the previous quarter.

The changes are the regulator's latest attempt to strengthen supervision of the industry amid concerns over opaque ownership structures and insurers' use of premium capital to speculate in domestic equity markets.

The regulator wants the insurance market to be more disciplined and, in the short-term, there may be less M&A activity, particularly outbound transactions. But the new regulations won't change the longer-term appetite among Chinese companies for international expansion and ultimately the new rules will help create a healthier market environment.

Michael Cripps, Shanghai

Protectionism is on the rise but regulation is driving M&A activity

Restrictions on the investment activities of Chinese insurers are not the only way in which China's government is shaping the insurance industry. At the start of 2016, the new C-ROSS solvency regime came into effect a regime that CIRC established from conceptual framework to implementation in less than three years. Under the new regime, offshore reinsurers are subject to greater capital requirements than onshore competitors, which is likely to force companies that want to do business in China to establish a presence on the ground.

Germany and South Africa cautious

China is not alone in using regulations to protect its domestic insurance industry. A new German Insurance Supervision Act came into force at the start of 2016, under which third country insurers must obtain a licence and establish a local branch office unless they are domiciled in a country with a Solvency II equivalent regime (the EU, Bermuda, Switzerland and Japan).

Similar changes are occurring in South Africa, with the introduction of the Solvency Assessment and Management (SAM) regime and a new Insurance Bill, likely to come into effect later in 2017. Under the new regulations re/ insurance companies will find it difficult to operate in this market without establishing a physical presence in South Africa. The new solvency regime increases capital requirements for insurers, which may be difficult for smaller companies to comply with, leading to an increase in domestic and international M&A activity. While some companies may choose to exit the market Zurich disposed of its interest in South Africa last year others will want to establish a presence.

Lloyd's spearheads globalisation

Further internationalisation of the market is underway. Lloyd's, the specialist insurance and reinsurance market, has received final regulatory approval from the Insurance Regulatory Development Authority of India to open a reinsurance branch in the country, in time for the April 2017 major reinsurance renewals. With a population of more than 1.25 billion, a rapidly emerging middle class and comparatively low insurance market penetration India is an attractive region.

In the Indian life insurance market, which remains dominated by the government-owned Life Insurance Corporation, consolidation among the fragmented private players has begun. In 2016, Max Financial Services and HDFC Standard Life Insurance agreed to a merger that will create India's largest private sector insurer, if it can overcome objections from the regulator regarding the deal's structure.

The biggest two deals in the last 12 months in Australia have both been driven by the desire to access new distribution channels; to help get closer to customers and propel growth.

Dean Carrigan, Sydney

Run-off moves up the agenda

The run-off market is continuing to attract significant attention in the Americas and Europe from both a disposal and acquisition perspective. In the US the main players have been active with the Berkshire Hathaway National Indemnity Company taking a USD 1.5 billion asbestos book from Hartford. The deal came in December 2016, shortly after ratings agency AM Best warned that insurers face an additional USD 15 billion of losses from asbestos in the coming years.

Zurich, QBE, RSA and Allianz among others have all been selling books such as catastrophic injury and asbestos and, with plenty of liquidity in the system, there is no shortage of buyers in what has become a very competitive market.

Meanwhile, in the US, Arch unveiled a new USD 500 million+ Bermudian run-off vehicle with majority backing from private equity firm Kelso & Co. The vehicle is expected to target the middle market legacy arena currently dominated by Enstar and Catalina.

Also in the US, following the amendment of run-off regulations in Rhode Island in 2015 to encourage more UKstyle transfers of run-off books of business, the market has been waiting for successful transactions to close under the new rules. In 2016 Pro Global Insurance Solutions announced that it has become the first company to file an application to form the first Rhode Island carrier established specifically to accept run-off portfolios, subject to regulatory approval. The new entity will be called ProTucket.

European run-off market expected to reach EUR 8 billion in 2017, up from EUR 4.4 billion last year

Targeting teams

Given that acquiring or merging with another business can be a lengthy, complicated and expensive process, assuming of course that it is possible to persuade the intended target to sell in the first place, the insurance industry has always been characterised by high degree of workforce mobility. However, over the last decade, a consistent trend has been the poaching of whole teams underwriting specific books of business.

The appeal of this approach is clear. It is possible to acquire teams relatively cheaply and without any of the legacy issues that buying a whole business may bring. This can be a good way of entering into a new part of the market or to strengthen an existing position by attaining business that otherwise would not be for sale at a competitive price. Poaching one team can sometimes be a springboard for more and it's quite often the case that we see teams moving in the aftermath of a merger or acquisition. For example, following the mega Ace-Chubb deal last year, Berkeley in Singapore moved quickly to snap up a number of unsettled teams. Also in Asia, Berkshire Hathaway recruited a team from AIG after it had established its specialty business in Singapore. In the Middle East, this is also a popular tactic that was employed by Zurich when it entered the market and now that it's leaving we are seeing a number of its component parts being snapped up by competitors. In the same region, Qatar Re has bought teams from Bermuda, London and Switzerland.

Targeting teams has been a consistent trend over the last 10 years, although cases tend to go in spikes. While it can be a means to side-step the complexities of acquiring a business, there are legal and financial risks to be navigated, as well as the potential for reputational damage.

Robert Hill, London

However, this is not an entirely trouble-free process. There are legal and financial risks, potential damage to a company's reputation, and employers may litigate against exiting employees for breach of contract. Employers who have lost a team may look at how they can claim for damages. One example where this proved to be an expensive process was in the broking space where a recent case saw JLT make a considerable out-of-court settlement, according to media reports, in a dispute relating to the poaching of 32 members of Willis' fine art, jewellery and specie team. In another case, this time in the US, in December 2016 Lockton announced that its Texas division was suing two of its former employees after they allegedly led a team defection to rival broker Marsh. Lockton has asked the court to rule that the departing staff owe a fiduciary duty and loyalty to their former employer.

As the soft market continues and insurance businesses continue to chase market share, they will continue to look at all available options. However, there has certainly been a shift in this area in the last few years with employers drafting tighter contracts and more likely to start legal proceedings against those who break them. Companies that have been burned in the past, or have registered the fallout of the JLT and Lockton cases, may be more cautious in the future.

Looking ahead

Uncertainty characterised 2016 and the full implications of last year's unexpected political decisions have yet to be realised. In the US, uncertainty about the trade policies of the new Trump administration could cool foreign investors' appetite for insurance M&A in the US in the short-term. Hopes remain high for a pro-business agenda and while the devil will be in the detail that is yet to be determined, a positive policy outcome would be encouraging for the economy and the insurance sector.

In Europe, the introduction of Solvency II has been a significant factor for the last few years, and now Brexit and its potential knock-on impact on other European countries brings further potential challenges. Uncertainty remains over how insurers' business would be affected should they lose passporting rights between the UK and Europe as a result of Brexit, which may lead to the postponement of some potential M&A activity. However, the combination of the effect of solvency requirements, tough market conditions and low investment returns added to Brexit uncertainty provide compelling reasons for insurers to continue to take a hard look at rationalising their portfolios and disposing of non-core assets.

For some, the decision may be taken out of their hands by acquirers seeking scale and cost efficiencies. Years of difficult market conditions have drained reserves, leaving some operators vulnerable to takeover. Expectations are for more M&A activity among the Bermuda-based re-insurers, while the near 25% plunge in Novae's share price after it issued a profit warning in December shows that investors are very aware of the challenges insurers face.

Other factors, which supported M&A in 2015 and 2016 are likely to continue to underpin deal activity. Driven by a weak domestic market and a shrinking population, the appetite among Japanese insurers for overseas assets looks set to continue and while regulatory pressure may prompt a pause in overseas expansion by Chinese insurers, the longer-term trend for internationalisation remains intact.