Market conditions ripe for M&A; Bermuda under most pressure

The reinsurance sector is in the challenging later stages of a soft market, meaning conditions remain ripe for mergers and acquisitions (M&A), Robert DeRose, senior director of reinsurance at AM Best, told Monte Carlo Today.

AM Best believes the Bermuda market is under the most pressure, said DeRose, and he highlighted its market’s “anaemic” return on equity of 6.8 percent for 2016.

“Companies are flush with capital, borrowing is still relatively inexpensive, opportunities for organic growth are limited, and some companies are struggling to cover the cost of capital, which puts M&A on the table,” said DeRose.

“The trend for M&A appears to be towards finding a home in a larger organisation, where a company can have autonomy and be nimble but have some parental protection.”

The ratings agency continues to hold its negative outlook for the reinsurance sector, citing the significant market challenges that continue to hinder the potential for positive rating actions over time and may eventually translate to negative rating pressures.

Some of the bigger challenges, DeRose noted, include risk-adjusted returns being strained as pressures continues to bear down on underwriting margins, with investment yields offering little help.

He continued: “The market headwinds at this point present significant longer-term challenges that industry players need to work through. AM Best has said that companies that are not proactive will not lead their own destiny.”

He stated that M&A will continue to be part of the landscape over the next few years, but he added: “M&A is not a cure and has its own potential dangers.”

Risk-adjusted returns could also be adversely impacted over the longer term from declining rates, broader terms and conditions, unsustainable flows of net favourable loss reserve development, low investment yields and continued pressure from convergence capital, noted DeRose.

In terms of topics at the Monte Carlo Rendez-Vous, DeRose said there is no doubt that market participants and observers are thinking about potential disruption in the re/insurance industry, and about how to squeeze out more expense when calculating their costs.

“What will it take to break this cycle? At this point, it does not appear that the lack of underwriting profit in the current book or continued erosion in return on equity will break it,” said DeRose.

“Amid the considerable uncertainty as to the timing and what exactly it will take to turn the market, one certainty that remains is that reinsurers will have to continue to evolve, learning from their mistakes and successes.”

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