M&A Opportunities for Insurance Companies
With the current low-interest-rate environment, insurance companies are increasingly looking outside of traditional investment classes for additional returns and yield. Some are considering mergers and acquisitions (M&A) to achieve additional returns as well as access to additional capital from the target’s surplus.
Common obstacles that we’ve seen insurance companies encounter with potential M&A deals include the following:
Private Equity (PE) Firms – Insurance companies are not the only potential buyers of other carriers. While PE firms may have a large hurdle in understanding the regulatory environments, they are increasingly investing into this space and thus have increased the demand and multiples used to measure the values of companies.
Risk-Based Capital Requirements – There are multiple regulatory hurdles and milestones that occur in an insurance carrier deal, including approval by the department of insurance. One often overlooked requirement is that additional capital may have to be infused in the deal to meet minimum risk-based capital requirements. A pro forma analysis of the capital requirements should be performed during diligence and deal structuring. In addition, there are generally regulatory dividend and distribution limitations to consider.
Ownership Structure – Not all insurance company ownership structures are the same, and additional obstacles may appear and investment may be required if the company is currently a mutual or reciprocal insurance carrier. Buyers and sellers should understand the potential regulatory and ownership reporting requirements early in the diligence process. Perhaps the furthest extreme would be if the company were required to list on a public exchange, i.e., NASDAQ or NYSE, along with additional SEC regulatory oversight.
Goodwill Admissibility – While purchase accounting is generally simpler under statutory accounting than U.S. generally accepted accounting principles, there are other considerations under statutory accounting. Statement of Statutory Accounting Principles (SSAP) 68 can create some goodwill limitations based on the acquiring entity’s capital and surplus. In addition, the resulting goodwill will be subject to amortization and potential impairment in accordance with SSAP 68. The current and future impact on the acquiror’s surplus should be considered when reviewing the pro forma results of a deal.
The Importance of Due Diligence – When considering potential insurance company M&A activity, the importance of a strong due diligence team with industry expertise cannot be overstated. Beyond key areas for review such as investment portfolios, reserves and reinsurance treaties, and understanding the effect of taxes, both federal and state are critical for a successful deal. Certain insurance lines of business do not allow for immediate consolidation of tax returns upon an acquisition and could cause obstacles if appropriate planning is not considered. In addition, there can be limitations on the use of net operating losses that have accumulated.
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