Large acquisitions steal the headlines — but do they produce the biggest returns for insurance investors?
While the potential for a home-run deal is understandably alluring to management and M&A teams alike, the success rate of these deals is relatively low among property and casualty (P&C) and life insurance carriers. Smaller acquisitions more frequently deliver superior returns, yet they are less frequently pursued because the incremental improvement from each deal isn’t considered worthwhile.
Programmatic M&A — serially and systematically executing a larger number of smaller deals — optimizes returns for insurance companies, reports McKinsey. This is especially relevant for PE firms under the current macroeconomic conditions. Publicly traded carriers are less likely to finance acquisitions with equity, because their valuations are lagging other industries. Meanwhile, thanks to low interest rates, mutual insurers and PE-backed carriers are as prepared as ever to acquire the right targets.
Insurance M&A strategy has been misguided
An estimated 60% of life and P&C carrier transactions over the past 15 years were executed primarily to increase scale, according to a McKinsey analysis of 250 North American deals. The implicit goal of such deals is to improve returns through operating leverage. However, other deal types actually delivered more value, according to McKinsey’s data. Smaller acquisitions provided roughly 4.5% higher excess returns for life and P&C insurers. This was derived primarily from product diversification and capability enhancement, whereas geographical expansion and scale gains actually dragged on results. Unsurprisingly, clear synergies and efficient integration are the most reliable ways to augment returns through a business combination. The data also reveals a massive gap in excess returns between the best and worst performers, underlining the importance of getting your M&A strategy right.
The value of programmatic M&A is well-proven in other industries as well. The most stable major companies dedicate a disproportionate amount of their transaction dollars to a larger number of smaller deals, reducing their dependence on home-run swings. Smaller integrations are simpler and less risky, and diligence doesn’t consume the same level of resources. Smaller entities are naturally less diversified, so they are more likely to fit the acquirer’s core business. It also tends to be more difficult and expensive to finance a massive deal, regardless of the source of capital. All in all, the programmatic approach diversifies risk without incurring meaningfully higher expenses.
The current insurance M&A outlook
Difficult macro conditions (i.e., low rates) could lead to higher deal volumes, especially in life insurance, where some carriers are currently struggling to generate the cash flows they had previously projected. To overcome these challenges, adjacent businesses in industries like asset management or fintech are likely to become popular targets.
As long as the valuations for publicly-traded insurance carriers remain below those we are seeing across other industries, there are also likely to be fewer whole-company takeovers. Even with low rates, there’s still a cost and risk associated with funding larger acquisitions entirely with cash. Instead, expect to see segments or portions of books moving, which could be especially prevalent in PE-backed companies.
The above conditions also make it less likely that the large publicly traded carriers will be buyers. If that’s the case, then mutual and private insurance companies will have an opportunity to acquire business with fewer competing suitors, which should lead to some attractive pricing.
How to implement programmatic M&A successfully in today’s market
The first step for operators is to create a repeatable, strategically guided M&A strategy — and follow this blueprint rather than shooting for huge one-off deals. Top M&A teams identify gaps in their corporate capabilities, then look for opportunities to fill those. This could include new product lines or analytical capabilities that enhance the productivity of their existing book in addition to bolting on additional revenue.
Monitoring industry status and trends, and adapting the process to reflect those conditions, is of course an important part of the process. Contingency plans are absolutely necessary to take into account potential disruptions to either party or to the macro environment. Setting out and adhering to parameters for appropriate deal terms is key. A deal might seem sweet enough to compromise on scale, valuation, or strategic motivation, but those all represent violations of the programmatic approach that’s been proven effective.
Curate a target list and establish relationships with the prospective members of that list, even if they aren’t currently pursuing a specific transaction. This improves familiarity with the industry as a whole, and makes data collection far more efficient when a transaction is actually imminent. Such an approach might require a fundamental shift in the M&A process, especially for teams that have traditionally zeroed in on one large target for an extended period of time. This change won’t happen overnight. However, building a more comprehensive view of the competitive landscape and the decision-makers within it will provide significant value over the long haul.
Finally, acquirers may also want to consider alternative deal types, such as joint ventures and partnerships, especially if we take into account the likelihood of fewer whole-company takeovers. Improved data analytics can help identify such opportunities, so leaders in digital transformation will have an advantage here. These alternative deal types are especially relevant to smaller portfolio companies and lower middle market firms hoping to establish a programmatic approach, as they can really shrink the scale at which deals are done.
There’s substantial evidence that M&A delivers more reliable value when it’s comprised of a large number of smaller deals that are identified and executed in a systematic and repeatable way. With today’s fairly extreme macro environment impacting life and P&C insurance carriers, this information is extremely relevant for PE firms that are active in those industries.