July 2017    |    By Indrani Nadarajah 

The insurance industry is facing unprecedented challenges -- climate change, tougher solvency capital requirements, more aggressive risk management procedures and additional enterprise risk controls are adding to the industry’s financial burden. The Insurance Bureau of Canada reports that regulatory compliance alone is estimated to cost the industry “hundreds of millions of dollars,”  These factors provide the backdrop for insurance mergers and acquisitions activity, as no sector is  exempt.

The number of insurance mergers and acquisitions (M&A) in Canada and globally has been ticking upwards since the 2008 financial crisis. This trend is continuing this year, despite a slight dip in 2016. According to a KPMG survey of 200 international insurance executives, 84% of insurers were planning up to three acquisitions each in 2017. Ninety-four percent of those polled said they would undertake at least one divestiture this year, which KPMG says suggests an “encouraging environment for deal-making overall.”

“Insurers took 2016 to understand how major events — particularly Brexit and the US election — will influence the business and investment climate around the world. And while there are still many unknowns, we expect insurers to return to the market and start to take advantage of the new realities that have been created as we move into the second half of 2017,” writes Ram Menon, Global Lead Partner, Insurance Deal Advisory with KPMG in the US.

Research houses Fitch and Conning also echoed the KPMG findings in their assessments of the insurance industry. Both reports were completed at the end of 2016. The firms noted that signs point to 2017 being another year of “robust” mergers and acquisitions.

Chris Waterman, EMEA head of insurance at Fitch, said that the key factors driving insurance M&A are the need for scale, expense management, constrained profitability and limited growth opportunities.

From Conning’s perspective, one of the biggest M&A drivers is the excess capital currently swishing around– insurers dealing with excess capital and low rates see acquisitions as their only way to grow.

Heading Overseas

Growth in global p&c premiums is forecast to dip from 2016’s 2.4% in real terms to 2.2% in 2017. It will, however, pick up to reach to 3.0% in 2018, Swiss Re reports. Emerging Asia, on the other hand, will have the strongest growth in p&c premiums, expected to hover around 8% in 2017 and 9% in 2018. This is based on the emerging Asian region’s economic growth rate, which is expected to record an estimated real growth of 7.3%, which is still lower than the 9% recorded in 2015.

Insurance regulators in emerging markets have also been liberalising insurance rules. In China, the China Insurance Regulatory Commission has expanded the commercial motor liberalisation to 18 additional locations, while in India, the Insurance Regulatory Development Authority of India has granted business approvals to 23 cross-border reinsurers. Malaysia has also implemented a gradual price liberalisation of motor and fire tariffs, and Thailand has raised the voting shares of foreign shareholders. The Thai government has also eased the foreign shareholding limits in p&c insurers. Thailand is also planning to deregulate premiums.

North American insurers (both life and p&c) are investing heavily in Asia’s growth opportunity  and some are fundamentally transforming their companies as a result. Canadian Manulife Financial Corp was recently described by Credit Suisse in a research note as a company that would become “a progressively more Asian company” with up to 50% of its earnings expected to be generated in Asia within 10 years.

KPMG’s data also suggests that insurers are more interested in finding potential acquisitions in Asia Pacific than North America as a region. Almost half of the respondents in the KPMG report cited above said they are most focused on Asia Pacific, more than twice the number that are highly focused on North America as a region.

Canada

According to the Insurance Bureau of Canada, in 2016, there were over 207 private p&c insurers in Canada. The Intact Group was the top insurer, with 15.59% of 2015’s direct written premium. The Aviva Group was the second largest with 8.05% of direct written premium. Desjardins was third largest (with 8.02%), and TD Insurance, with 6.02% of DWP, came in at fourth place.

While the majority of players in the P&C insurance sector in Canada are hoping to make substantial mergers and acquisitions, there is a lack of companies that can be sold.  2017 will see one to two notable acquisitions, KPMG Canada George Pigeon said, pointing out that this has been the pattern for the past 10 to 12 years.

Already, big deals have been announced – in May,  Intact Financial Corp. shelled out C$2.3 billion for U.S. specialty insurer, OneBeacon Insurance Group Ltd. Around the same time, Intact announced that its net operating income for the first quarter (Q1) of 2017 declined by more than one-third year-over-year.

“We’ve been looking to grow our business outside of Canada, and identified the U.S. small to mid-size commercial and specialty market as an attractive entry point,” said Charles Brindamour, CEO of Intact, during a conference call following the announcement.  The acquisition is expected to help the company compete more effectively against international insurers and bolster its business with new products and cross-border capabilities, explained Brindamour in a conference call.

Prem Watsa’s Fairfax Financial too, has been on a buying spree – last December, the company announced it was acquiring Switzerland’s P&C insurer Allied World (a P&C and specialty insurer/reinsurer) for $4.9 billion in cash and stock. At the time of writing, Fairfax had received all regulatory approvals in order to complete the acquisition. In February this year, Fairfax acquired New Zealand’s Tower Insurance for $197 million.

Also in February, Wawanesa Mutual Insurance Co. also struck a deal with Desjardins Group to buy its Western Canadian insurance businesses for $775 million. Chief executive officer Jeff Goy said the transaction supports the company’s plan to expand its network of independent insurance brokers in Canada.

M&A activity involving insurance brokerages is also expected to remain especially active as many of the principals that own these brokerages approach retirement.  In June, the Co-operators acquired Quebec City-based Assurance Auclair, a brokerage that handles personal and commercial insurance policies.   

Mergers and acquisitions of insurance agencies last year were the second-highest ever in 2016, according to OPTIS Partners' annual report. The OPTIS database recorded 449 deals in the United States and Canada in 2016, a slight dip from the all-time record of 456 in 2015. Sales of property-and-casualty-focused agencies headlined the list (54% of all sales). Sales of employee benefits agencies rose to become the second most popular category, accounting for 20%, up from 17% in 2015.

The actual number of sales was greater than the 449 reported, as many buyers and sellers do not report transactions, and some acquirers do not report small transactions.

According to the report’s data, Intact Financial acquired five agencies last year. Intact acquired a total of 14 agencies between 2012 and 2016.

Reinsurance Industry

Persistent pressures in the global reinsurance market also suggest the continuation of the merger and acquisition (M&A) trend for reinsurers, experts say.

Last December, the European Insurance and Occupational Pensions Authority (EIOPA ) warned that pressure on profits in the reinsurance market is increasing as excess capacity, declining demand and alternative capital reduce underwriting margins (PDF).

AM Best also maintains its outlook for the global reinsurance industry as negative.

Low rates, softer terms and conditions, low investment yields and alternative capital, which now comprises approximately 20% of the global reinsurance market capacity, are pressuring reinsurers.  Organic growth will be hard to achieve, leaving acquisitions as the main source of growth for larger firms with still-healthy balance sheets, writes Fitch.

However, Munich Re Chief financial officer, Jörg Schneider told a German publication there were hardly any worthwhile takeover opportunities in the primary insurance sector, because the asking prices currently were not reasonable. “There is a bubble when it comes to takeovers,” Schneider observed. He emphasized that Munich Re is not interested in making acquisitions in the reinsurance space. The group is reducing its traditional reinsurance business and is growing the primary insurance of industrial and commercial risks through its reinsurance arm, in addition to its primary company Ergo. The Ergo group operates in over 30 countries in Europe and Asia.

Bancassurance

The bancassurance sector is also experiencing M&A activity with banks selling their insurance businesses to existing insurers.

At the moment, Canadian banks are allowed to sell eight types of insurance products. They are: credit or charge card-related; creditors’ disability; creditors’ life; creditors’ loss of employment; creditors’ vehicle inventory; export credit; mortgage; and travel.

It is an uphill task for Canadian banks wanting to sell other types of insurance. For one thing, chartered banks are not allowed to offer insurance products like home and auto through their branches. While they can sell through subsidiaries, they cannot provide easy online access, from the banks’ web pages to other web pages through which other types of insurance are sold.

Some banks did try to circumvent these regulations that were established in 1991. Royal Bank opened its first insurance office near a Toronto bank branch in June 2005 and set a goal of opening 100 insurance offices adjacent to branches. The Financial Post reported that between 2005 and 2009, RBC opened 43 insurance offices beside their banking branches.

However, in 2015 Royal Bank CEO David McKay lamented that the bank’s p&c business was below scale, and said he was not sure if the bank would be in the insurance business for long, because of the difficulties caused by rules that ban banks from selling coverage in branches, leading to higher distribution costs.

The business was sold a few months later: Aviva Canada acquired RBC General Insurance Company for $582 million. Aviva also announced a 15-year strategic agreement with RBC Insurance in January 2016. Through this agreement, Aviva Canada would provide policy administration and claims services, and RBC Insurance customers would also be able to access Aviva Canada’s p&c products. RBC Insurance would continue to market and sell these products under the RBC Insurance brand. Approximately 575 RBC Insurance employees became part of Aviva Canada’s operations when the transaction closed.

The addition of the existing RBC Insurance home and auto business to Aviva increased Aviva Canada’s gross written premiums by approximately CA$800 million. The deal closed in the third quarter of 2016.

In early 2015, Canadian Western Bank also agreed to sell its p&c insurance unit, Canadian Direct Insurance, to Intact Financial Corp. for C$197 million. CWB CEO Chris Fowler said the “ongoing regulatory restrictions” that prohibited how the Edmonton-based lender could sell insurance products was one reason for the sale.

Going Forward

Coping With an Evolving Landscape

Depending on which side you are on, Deloitte’s vision of the Canadian p&c industry going forward can either be exhilarating, or dismal. The firm predicts that by 2025, “a few extremely well-capitalized giants” will dominate in a business characterized by intense competition, ongoing M&A activity and search for growth. Deloitte believes the Canadian p&c industry will break into two bands with the insurance giants cornering  both personal and commercial business, while expanding their direct channel capabilities. This process is already underway: over the past 10 years, approximately 12% of auto direct written payments (DWP) and 15% of personal property DWP has shifted ownership because of consolidation, Deloitte writes. There will still be a place for smaller carriers, which will have evolved into specialist niche players.

A principal driver for this change is disruptive technology. Published data show that global investment in fintech ventures tripled to US$12.21 billion in 2014 (the latest figures available) while insurtech saw global investment of US$1.7 billion last year.

One cannot over-state the impact of the digital challenge on the insurance industry. As the market changes and customers demand greater efficiency and digital options, many insurers will have to consider acquisitions, if only to make their offerings more consumer-friendly and to stay relevant, say industry commentators.

McKinsey Consulting goes further, hypothesizing that the most successful companies will become “digital insurers” (PDF). These companies will be “customer-centric” but such a shift will require a fundamental change in structuring operations and conducting business. At the moment, a full nine in 10 insurance companies report they are struggling to develop the technology infrastructure to support digitization, McKinsey says.

Willis Tower Watson’s international report into technology and insurers, notes that insurers’ appetite for traditional M&A may also wane in favour of smaller and more specialist activity, specifically targeting technological capability. However, “there isn’t a long track record in acquiring digital capability through fintech businesses,” observes Willis Towers Watson’s Fergal O’Shea. So far, relatively few insurers have made outright acquisitions that were directly driven by their desire to acquire digital technologies. Willis Tower Watson figures show that only 14% of companies have completed such a deal over the past three years – and most have undertaken just one transaction.

Willis Tower Watson’s figures are not isolated and therein lies the disconnect between statements and practice. In a 2016 report on insurtech (PDF), PWC bluntly commented on the discrepancy between the statements of perceived disruption posed by new technologies and the actual willingness of insurers to embrace insurtech and fintech innovation. Three in four insurers polled said they believed that some part of their business was at risk over the next five years because of fintech; yet, less than half (43%) of insurers claim that fintech is at the core of their corporate strategies. Only 28%, slightly over a quarter, actually explore relationships with fintech companies and less than 14% have participated in ventures or are supporting fintech incubators.

Some argue that Canadian companies have been relatively cushioned from the aggressive march of fintech, but the status quo is changing. “Globally, the rate of adoption of fintech products is about 15.5%,” reports EY Canada financial services advisory partner Gregory Smith. In Canada, the rate of adoption is only about 8%, the lowest of the countries that EY looked at. Hong Kong’s fintech adoption is about 30%, while the US is 16.5%. “We predict this is going to triple in the next 12 months. It’s a bit of a wakeup call on the subject of fintech [for Canadian companies].” EY’s investigation also shows that a lack of customer awareness is the main driver for the lower rate of adoption in Canada, not a lack of trust of the technology. Traditional players will really need to step back and evaluate the customer experience they are providing, Smith concluded.

Thus far, Canadian insurers have been primarily focused on core technology solutions like policy administration, claims processing and billing. These measures are just scratching the surface. Their peers in the U.S., U.K. and Australia, are far ahead with many innovative offerings to appeal to the customer.

Innovate or Go Bust

Technological developments can be a threat for some companies and could severely impact their bottom line or prove to be business opportunities. A case in point is automated cars. At the moment, auto insurance accounts for half of the premium revenue in the Canadian p&c industry. Some calculations point to driverless technology reducing the incidence of car crashes by up to 80% over the next 25 years, affecting risk rating and premium rates. This may not be the best news for some companies.

And yet, such a technology may be a boon and usher in new business for nimble companies. In the UK,  Adrian Flux Insurance launched what it describes as the world’s first driverless car policy in mid-2016. This new policy protects against the common risks that are found in the traditional human driver's policy such as damage, fire, and theft. The policy also covers against system malfunction in the vehicle. Tesla has also reportedly been quietly selling cars in Asia with insurance and maintenance included.