For Europe’s insurers, M&A points the way

RSA’s ambitious £5bn ($7.8bn) bid for the pick of the non-life insurance businesses of its larger rival Aviva died as quickly as it appeared last month when it became apparent that a price that would make sense to both sides was going to be all but impossible to find.

However, the approach highlighted the shape of things to come in the insurance industry over the next few years.

The effects of new regulation, a higher cost of capital and disappointment over the performance of past acquisitions look set to bring about wholesale changes in the ownership of insurance businesses around the world.

The big question is how far these changes will go. While many bankers and investors would like to see transformation right through the sector, other observers expect changes to be limited to a sell-off of insurance assets by banks.

RSA’s aborted takeover followed the drawn-out saga of the $30bn-plus tilt at AIG’s Asian businesses by Prudential, a proposed deal that finally collapsed in June. But even without these huge deals, insurance M&A has risen by 60 per cent to $44.8bn so far in 2010, according to Bloomberg data, up from $28bn in the same period of 2009.

Further, more deals are expected as several banks look to spin off insurance businesses – either because of political demands where they have received state aid or because changes in capital rules make them less rewarding.

Regulators on the Basel Committee on Banking Supervision, which sets the guidelines for the amount of capital banks must hold, earlier this month confirmed that banks that own insurers would no longer get away with “double leverage” on their balance sheets. This allowed them to employ the same $1 of capital against both banking and insurance operations, up to a certain limit.

Starting from 2014, however, this will be phased out so that by 2018 any bank owning an insurer will have to hold as much capital as if they were two separate businesses.

In a slightly different form, the same privilege is enjoyed by Europe’s composite insurers, which benefit from running both life and non-life businesses. This includes some of the continent’s biggest names, such as Allianz, Axa, Aviva and Generali.

Some in the industry fear that regulators will use the Solvency II European capital rules that are due to be implemented by the end of 2012 to stamp out such financial alchemy.

Many insurers also face pressure to become more focused as investors grow weary of sprawling and complex business models. This could lead to the disposal of businesses that are more a flag in a territory than a strategic foothold. Several financial services groups are already pursuing sales or demergers of operations, including RBS, ING, Aegon and Old Mutual.

“The post-crisis world is not just about a higher cost of capital, but also about showing more clearly how that capital is going to be deployed,” says one banker who expects to see more deals like Axa’s recent sale of its UK life business.

However, breaking up large companies is more difficult in the financial services industry than in almost any other, says Clive Cowdery, the insurance entrepreneur whose Resolution bought Axa’s UK arm as part of a project to consolidate Britain’s life industry.

In a recent speech, Mr Cowdery warned that the opacity of the financial services industry overpowered current managements and made it much easier for them to resist public market pressure for change.

“The long-term, assumptions-based nature of much of their reporting makes it very difficult to hold management to account,” he said. “If Marks and Spencer bet the whole winter line on the idea that short skirts will be the fashion, you’ll know by Christmas whether they’ve got it right. For a life insurer selling different types of savings or pension products, it might be 14 years before you have any idea whether they made any money or not.”