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Think Tank: The Geneva Association - Insurance M&A: Valuation effects

Source: Asia Insurance Review | Jan 2016

The mergers and acquisitions (M&A) market for insurance has been active as a result of low interest rates, capital availability and competition demands. It raises the question of whether the deals are value-adding and whether such considerations are conditioned by cross-border, industry sector and size considerations. In this extract from The Geneva Papers on Risk and Insurance, Dr J David CumminsDr Mary A Weiss from Temple University and Dr Paul Klumpes from Nottingham Trent University, endeavor to determine this. 
Two principal hypotheses have been developed concerning the effects of M&A on targets and acquirers—the value-enhancement or synergy hypothesis and the hypothesis that M&A are primarily driven by non-value-enhancing behaviour by managers. 
   Value-enhancing motivations include achieving economies of scale and scope, improving X-efficiency, gaining market power, achieving earnings diversification and improving other aspects of financial performance. Non-value-enhancing motivations include various agency theoretic explanations such as managerial hubris, empire-building, increasing manager compensation, and expense preference behaviour.
   Although M&A may arise from both value-maximising and non-value-maximising motives, on balance we argue that M&A are likely to create value for targets and acquirers. 
   Insurance is a competitive industry, and it is unlikely that firms with predominantly non-value-maximising behaviour will succeed or survive in the long run. In addition, the prior literature provides evidence that M&A are associated with efficiency gains in both life and P&C insurance. 
The analysis is based on M&A transactions that were obtained from the Thomson SDC database. In selecting the sample, we capture all change in control transactions during the sample period 1990 through 2006 where either the acquirer or target was an insurance company. 
   A change in control transaction is defined as an acquisition that increases the stake of the acquiring institution from less than 50% to 50% or more of the ownership shares of the target institution. 
   We decided to use the universe of transactions rather than a sample to improve the statistical results. The sample period was selected to bracket the introduction of the European Union’s third generation Insurance Directive and other deregulatory measures around the world in other countries such as Australia, Japan and the Netherlands. 
   Insurance companies were defined as all firms with four-digit Standard Industrial Classification (SIC) codes in the insurance industry. The stock price data for the event study are obtained from the Thomson Datastream database. 
   Because either the target or the acquirer had to be an insurer, transactions are included in the sample where insurers are acquired by non-insurance firms such as banks, other financial firms and industrials, and where insurance firms acquire non-insurers, as well as within the insurance industry (insurer-to-insurer) transactions. Countries were included in the study if they have well-developed insurance markets or have significant developing insurance markets. 
Computing the returns
The standard event study methodology is used. The analysis involves computing the returns for each of the transactions in our sample using stock price data. For each transaction included in the study, the event study methodology computes the abnormal return associated with a specified event, controlling for the predicted return on the stock on the same day.
   There are at least 150 “deals” in each year of the sample period with a total of 4,068 deals over the entire sample period. The number of deals peaked during the late-1990s with more than 300 transactions taking place each year from 1996 through 2000. Deal volume exceeded US$120 billion per year from 1997–2001 and exceeded $100 billion in 2003, 2005 and 2006. Total deal value for the entire period covered by the study is more than $1.3 trillion.
US has largest number of target transactions
As expected, the largest number of transactions in terms of targets was within North America (1,200), 1,073 in the US and 127 in Canada. 
   The US thus accounts for 54.5% of all transactions and North America for 61%. The next largest number, 668, involved European targets, with the largest number of targets in the UK (278) and France (75). Thirty-two transactions involved Bermuda targets, and there were only 57 target transactions in Asia. 
   Overall, there were 1,968 total transactions. There were 1,628 within-border and 340 cross-border transactions (17.3% cross-border). For the cross-border transactions, the vast majority were intra-region (eg within Europe, North America, or Asia-Pacific) rather than cross-region. 
   Overall, total deal value amounted to $729.7 billion for the sample period, an average of $42.9 billion per year. The US dominates with 52.6% of total worldwide deal value, measured by target transactions, followed by the UK (12.8%), Switzerland (9.6%) and the Netherlands (5%). Others with significant deal volume include France, Belgium and Italy. Cross-border deals dominate in Australia, Bermuda, Germany, the Netherlands and Switzerland. Overall, 78.5% of the deal volume ($572.9 billion) represented within-border transactions. 
M&A more likely in high penetration markets
There were a substantial number and volume of M&A deals involving insurance firms during our sample period (1990–2006). Considering all deals, there were 4,068 deals with a total deal value of more than $1.3 trillion. Approximately 45% of deals (41% of deal volume) were cross-industry, meaning that the acquirer was from the insurance industry and the target was from some other industry. 
   Focusing on change in control deals, the largest number of deals in terms of targets was in the US (1,073 deals), and the next largest number (668) involved European targets. There were only 57 target transactions in Asia. The high number of deals in the US and Europe supports the argument that M&A are more likely in markets with high insurance penetration. 
Findings and conclusion
The overall results indicate that there are small and statistically significant gains for acquirers in the (-1,+1) and (-2,+2) event windows. There are large and highly significant gains for targets based on the overall sample. The finding of small positive gains for acquirers is consistent with prior insurance research for the US but not consistent with prior literature showing that European M&A are value neutral for acquirers. The finding of large positive gains for M&A targets is consistent with results of prior research.
   Breaking the results out by country/region, we find small significant market value gains for acquirers in the US and Europe but not in Asia. We find significant market value gains for targets in the US, Europe and Asia. The gains for targets are larger in the US than they are in Europe or Asia. Thus, the US was a particularly fertile environment for M&A during our sample period, but targets achieved market value gains globally.
   Breaking down the results into cross-border and within-border (domestic) transactions, we find small positive gains in the shortest windows for acquirers and substantial gains for targets in both cross-border and within-border transactions. The gains are similar in magnitude for the cross-border and within-border transactions, suggesting cross-border deals do not create competitive or efficiency disadvantages.
   We also compare M&A transactions within the insurance industry with transactions where the acquirer is in the insurance industry and the target is in some other industry. The results show that acquirers realise small market value gains from within-industry transactions but that cross-industry gains are either value-neutral or lead to market value losses for acquirers. There are large and significant market value gains for targets in both within and cross-industry transactions, but the gains are larger for within-industry deals. Hence, the results provide further support for the strategic focus hypothesis—focusing deals are more likely to create value than diversifying deals.
Further research needed
Further research is needed to identify the longer-term effects of M&A transactions, to investigate the impact of the recent financial crisis on the global insurance M&A market generally, and to incorporate some information concerning the level of disclosure, regulation and corporate governance effectiveness in the period surrounding M&A deals. 
   Further analysis of cross-border transactions based on more detailed data would also be valuable. A more detailed analysis of the characteristics of targets and acquirers in general, such as their size and financial ratings, and efficiency effects, would help to elucidate the motivations for M&A.
Dr J David Cummins is the Boettner Professor of Risk Management and Insurance at Temple University; Dr Paul Klumpes is Professor of Accounting and Finance at Nottingham Trent University and Dr Mary A Weiss is the Deaver Professor of Risk Management and Insurance at Temple University. 
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