After a pandemic-driven pullback in mergers and acquisitions activity in the first half of 2020, acquisitions and dispositions have come back strongly in the second half of the year, and the higher pace of transactions will likely continue into 2021, Moody’s Investors Service reports.
The main force behind all the activity is a recognition among management teams of an increased likelihood of lower interest rates persisting for an extended period, accelerating the sector’s transition to lower-margin products, higher growth and capital-light businesses that require greater size or scale. In the lower-rate environment, insurers are evaluating which businesses will deliver the greatest return on capital, how to deploy excess capacity, identifying and exiting non-core or legacy businesses, and expanding the scope of new and existing businesses that include digital capabilities. Private capital is playing a key role in this industry transition, expanding its capabilities to manage a greater share of insurance assets, often through M&A and other partnerships or investments. Overall, Moody’s sees three themes emerging:
Pullback in M&A activity will lead to a larger offensive pipeline in 2021 as insurers seek growth and scale. The pandemic-driven economic disruption in 2020’s first half caused many life insurers to hit the pause button on M&A activity to focus on sustaining operations and building liquidity and capitalization. Faced with lower equity valuations, life insurers are taking a keen interest in shedding legacy blocks and acquiring new or enhancing existing capabilities in a low-growth, low interest rate environment through M&A, whether it is for digital capabilities or to expand their scope to strengthen existing businesses that fit with their longer-term strategy.
Private capital continues to expand into the life insurance sector, allowing primary insurers to shed legacy business. Investments from private capital continue despite a pandemic and uncertain macroeconomic conditions. Private capital seeks to participate in the life insurance sector’s consolidation, bringing resources to gather asset-intensive or capital-intensive businesses, or businesses that produce volatile GAAP earnings, but have attractive economics for patient investors at the right price.
Insurers investing in digital capabilities. Life insurers’ stock valuations and capital bases have been under significant pressure in 2020, reflecting uncertainty regarding the economic impact of the pandemic, dramatically lower interest rates, and investors’ concerns about interest rate assumptions and customer behavior. To deliver value in this market, Moody’s expects that life insurers will rationalize products offered and embrace the digital transformation of traditional distribution channels.
Pause In 2020 M&A Activity Will Lead To More Acquisitions, Dispositions In 2021
The pandemic-driven economic disruption in the first half of 2020 caused many life insurers to pause M&A and divestiture activity in order to focus on sustaining operations and building liquidity and capitalization. In addition, life insurers’ stock valuations have declined during the pandemic, raising the bar for M&A transactions given the increased benefit of share repurchases. However, as the recovery unfolds, life insurers are updating forecasts and assessing the implications of an economic landscape with even lower interest rates and increased asset volatility, and are considering how to position their products and businesses as they factor in interest rate sensitivity and the outlook for their capital positions. Moody’s expects insurers to refine their strategies, acquiring new capabilities and gaining scale, shedding blocks of capital intensive business, and investing in digital and other technological capabilities for the future.
Given lower investment income in a low-growth, low interest rate environment, paired with life insurers’ desire for increased profitability, some companies will likely consolidate in order to buy or build capabilities that will increase operating efficiencies. Life insurers will seek ways to optimize their business mix and free up capital, which should drive transaction activity as an alternative to increasing buybacks. As a result, life insurers will also accelerate commercial activity through divestitures to exit non-core businesses, and acquisitions by adding lines of business to strengthen existing market share, or to add digital capabilities, particularly as technology becomes more widely used and accepted by consumers for buying and using insurance.
As the economy recovers, Moody’s is starting to see a wave of deals, and expects a high level of M&A activity will continue into 2021. The recent acquisitions have been primarily aimed at improving businesses for future growth or building scale by acquiring blocks with predictable cashflows and strengthening capabilities. The latter are motivated by the sector’s transition to lower-margin products and capital-light businesses that require greater size or scale. For example, Moody’s has seen a few life insurers expand group benefits lines and supplemental insurance offerings to support existing platforms and networks, and create additional opportunities by cross-selling products to their large customer base.