H OULIHAN L OKEY H OWARD & Z UKIN
Mergers & Acquisitions in the
Property/Casualty Insurance
Market
Casualty Actuaries of Greater New York
Spring 2004 Meeting
June 3, 2004
685 Third Avenue • New York, New York 10017 • (212) 497-4100 • www.hlhz.com
Los Angeles • New York • Chicago • San Francisco • Washington D.C. • Minneapolis • Dallas • Atlanta • London

Agenda – Property & Casualty Insurance
• Industry Fundamentals
• Historical M&A Trends
• Recent M&A Trends
• M&A Outlook
2

Overview
• P&C consolidation has declined markedly and relatively steadily over the past five years
• Transformational deals are out of favor
– St. Paul / Travelers is the exception, not the rule
• Going forward, P&C acquisition activity should increase as rates soften and organic growth is more challenging
– However, M&A activity will be more thoughtful, as quality insurers consolidate and diversify with smaller niche acquisitions
3

Industry Fundamentals

Story of 2000 – 2004
The Race Between Premium Prices and Development
5

Decelerating Hard Market
• Property & Casualty companies enjoyed an extended run of rate increases beginning in 2000
• Overall rates have begun to fall back to the levels last seen in late
1999, the end of the last soft market cycle
– Increases began to decelerate in 2003
– Property has softened (large account)
– D&O and Med Mal still rising
• Question is whether the casualty lines have caught up after years of under-reserving
6

Decelerating Hard Market
Average Commercial and Personal Lines Rate Changes
30.0%
25.0%
20.0%
15.0%
10.0%
5.0%
0.0%
Fall 98 Spring 99 Fall 99 Spring 00 Fall 00 Spring 01 Fall 01 Spring 02 Fall 02 Spring 03 Fall 03
-5.0%
-10.0%
-15.0%
Personal Auto Homeowners Commercial Lines
7

Adverse Reserve Development
• The rating agencies are skeptical of the capital position of many insurers
– Fitch estimates the reserving shortfall to be $77 billion
• Asbestos – no trust fund and no end in sight
•
M&A Impact: Given the magnitude of the downside, prudence has dictated caution among would-be acquirors given sellers’ natural information advantage
8

Capital Turning the Corner
• The tragedy of September 11th, adverse loss development and the equity markets devastated the P&C sector’s surplus
• Thanks to the hard market, the industry is now generating a torrent of cash flow and surplus has surpassed 1999 levels, assuming proper reserving
$375
$350
$325
$300
$275
$250
1.50 x
22%
1.25 x
1.00 x
0.75 x
1999 2000
Industry Surplus
2001 2002
Operating Leverage
2003
9

Capital Management
What to do with the build up of surplus?
•
Increase Dividends
– With the new tax laws, dividending is an attractive option
– Montpelier Re increased its dividend yield to nearly 4% in 2003
•
Growth through Acquisitions
– Buyers may be able to take advantage of smaller insurers which have been weakened by capital pressures and rating agency actions
– Many of the Bermuda players have picked off liability-free business from weakened peers
10

Historical M&A Trends

M&A Drivers
M&A Driver
Technological Change
Financial Markets
Management/Personality
Regulatory / Political
Focus / Diversification
P&C Insurance
Applicability





12

Fragmented P&C Insurance Market
3,600
3,500
3,400
3,300
3,200
3,100
3,000
2,900
2,800
2,700
13

Deal Volume – Relatively Cyclical
• Not surprisingly, P&C insurance M&A deal volume is reasonably cyclical
1 0 ,0 0 0 1 2 0
8 ,0 0 0
6 ,0 0 0
4 ,0 0 0
2 ,0 0 0
6 0
4 0
2 0
0
1 0 0
8 0
0
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
Y
TD
T ot al M & A Act ivit y P& C M & A Act ivit y
14

P&C M&A Activity
• Generally, deal volume is inversely correlated with P&C rates
6 0
4 0
2 0
0
1 2 0
1 0 0
8 0
1994 1995 1996 1997 1998 1999
P& C M & A Act ivit y
2000 2001
P&C rates
2002 2003
200
4
Y
TD
15
31-Jul-2000
31-Aug-2000
29-Sep-2000
31-Oct-2000
30-Nov-2000
29-Dec-2000
31-Jan-2001
28-Feb-2001
30-Mar-2001
30-Apr-2001
31-May-2001
29-Jun-2001
31-Jul-2001
31-Aug-2001
28-Sep-2001
31-Oct-2001
30-Nov-2001
31-Dec-2001
31-Jan-2002
28-Feb-2002
29-Mar-2002
30-Apr-2002
31-May-2002
28-Jun-2002
31-Jul-2002
30-Aug-2002

Valuations and the Cycle
• The interplay between interest rates and P&C rates impacts P&C company valuations as well as deal volume
2.40 x
2.20 x
2.00 x
1.80 x
1.60 x
1.40 x
1.20 x
1.00 x
Asbestos;
Product Liab.
Hurricane
Andrew
9/11
Price-to-Book US 10 Year Treasury Yield
P&C rates
10.00 %
9.00 %
8.00 %
7.00 %
6.00 %
5.00 %
4.00 %
3.00 %
2.00 %
16

Recent M&A Trends

Is Hank right?
“…[T]wo drunks helping one another home…”
Hank Greenberg on P&C acquisitions
18

Recent M&A Activity: A Look Back
• Large transactions on the decline
– Bifurcation – strong grow and weak pare back or run-off
– Renewal rights deals flourish as buyers have the upper hand
• Bermuda Class of 2001
– Filling the capacity shortfall
– Cash flowing and surplus spiking…
• Focus and rationalization
– Pendulum swings away from diversification
– Sponsored spin-offs rise in popularity
19

The Death of the Mega-Deal?
• There have been 44 P&C mergers valued at $500 million or more since 1997 but all but five occurred in the 1997 – 2001 period
120
100
20
0
80
60
40
7
71
15
83
11
52
5
45
1
48 40
3
43
Source: SNL DataSource
Deals less than $500 mm Deals greater than $500 mm Deal Value
2
$50
$45
$40
$35
$30
$25
$20
$15
$10
$5
$-
20

Deal Valuations Decline
• Median multiples have declined drastically over the last few years but may be on the rise again
2.00 x
1.50 x
1.00 x
0.50 x
--
20.0 x
15.0 x
10.0 x
5.0 x
--
Price-to-Book Price-to-Earnings
21

The Rise of Renewal Rights Transactions
• Renewal rights deals have become increasingly popular given market skepticism regarding the adequacy of reserves
• Competition for growth in soft cycle should cause a decline in renewal rights deals
10
0
30
20
50
40
Renewal Rights Deals Other Asset Deals
22

Bermuda: Consolidation?
• Newer Bermuda players focused on secondary offerings, providing original venture investors a chance to reduce positions
• To date in 2004, a total of 15 insurance offerings have priced, raising
$4.9 billion with selling shareholders receiving 77% of those proceeds.
• Starting in 2005, the Bermuda players will contend with slowing growth
• Some of the Bermuda insurers have already begun to participate on the
M&A front by purchasing the renewal rights of weaker competitors
Buyer
XL Capital
Transaction
Renewal rights of DPIC Companies from RSA
Endurance Specialty Renewal rights of HartRe
AXIS Capital Renewal rights of Kemper Insurance
Arch Capital Renewal rights of CNA's Liability Insurance Business
23

Past as Prelude: Bermuda Class of 1993
IPO Stage M&A Stage
4,000
Partner Re. Ltd.
IPO Nov. 1993
3,500
3,000
2,500
Global Capital Reinsurance Ltd.
IPO Dec. 1995
Global Capital Reinsurance Ltd.
Sold to Exel Ltd. Jun. 1997
LaSalle Re Merged with Trenwick Oct. 2000
LaSalle Re. Ltd.
IPO Nov. 1995 2,000
1,500
1,000
500
0
Mid Ocean Ltd.
IPO Aug. 1993
1994
Tempest Reinsurance Co.
Sold to Ace Ltd. Jul. 1996
IPC Holdings Ltd.
IPO Mar. 1996
RenaissanceRe Holdings Ltd.
IPO Jul. 1995
Centre Cat Ltd.
Sold to Ace Ltd. Apr. 1998
1993 1995 1996 1997
Mid Ocean Ltd.
Sold to Exel Ltd. 1998
1998
Companies that went public and later were acquired
Companies that went public and expanded beyond their original mandate
Companies that remained private until acquired
Source: A.M. Best, Bermudan Business, Aon Capital Markets
24

Rationalization
• Verdict: focus is the safe bet
– Management is heeding the Street and divesting
– Examples: Safeco, CNA, RSA and Zurich
• Contra-case
– Diversification: risky but necessary?
25

Divestiture Mechanism: The Spinoff
• As profitability and competition have become increasingly challenging, many insurers are focusing on core markets
• In addition to divestitures, insurers have taken advantage of the capital markets by spinning off more profitable businesses
Company
Assurant
IPO Amount
$1.76 billion
Genworth $3.8 billion
Affirmative Insurance $259 million
Travelers $4.3 billion
Parent
Fortis
General Electric
Vesta
Citigroup
26

M&A Outlook

Outlook
• Soft Cycle
 Spurs M&A activity
– Bermuda consolidates again…
– Diversification returns?
– New hybrid capital – prolonging the inevitable?
• Russian Roulette Returns?
– Sellers gain leverage and liabilities back on the table
• Specialty consolidation and the return of the roll-up
– WC, E&S and NSA
• Focus on expenses in downturn
– Outsourcing?
• Europeans bargain shoppers
– Weak dollar could tempt buyers
28