NEW YORK - Mergers and acquisitions - as well as increased attention to enterprise risk management - will be among the key drivers of life insurer profitability and survival for the remainder of this year and beyond, according to research released this month.
"Stock performance for the [insurance] industry outperformed the [Standard & Poor's 500 stock index] from 2002 through 2005, increasing the likelihood of merger activity," said Stephan Christiansen, director of research for Conning Research and Consulting Inc. in Hartford, Conn. "While revenue growth is anemic, prospective profitability appears relatively solid."
Scale - the economic advantage of spreading fixed costs over a larger number of policies - will be an important driver of industry consolidation, according to the study, "Mergers & Acquisitions and Public Equity Offerings - Fasten Your Seatbelts," released last week.
Enterprise risk management, which is being given greater weight by agencies that rate financial strength, is receiving more attention from insurer chief financial officers, according to "The Life Insurance CFO Survey," released this month by Stamford, Conn.-based Tillinghast, a business unit of Towers Perrin.
M&A increase predicted
There were 324 consolidation-related transactions in the insurance industry last year - the most since 2001 - and even more may occur this year, Mr. Christiansen noted.
While Conning hasn't yet tabulated consolidation data for 2006, he predicted that "market forces" will cause consolidation to pick up during the second half of the year and continue into the first half of next year. Those forces include little opportunity for organic growth as well as the fact that capital is growing at a faster rate than premiums.
Private-equity firms will become more active in buying out insurance entities, though that might apply more to insurance brokers than companies, Mr. Christiansen added.
The higher costs of complying with new and potentially burdensome regulations will add to the need for scale and prompt more mergers and acquisitions, according to the Conning study. Complexity of the industry's product offerings and distribution systems also encourages consolidation, as scale is needed to provide the required infrastructure and support services.
Products that involve the behavior of customers - such as letting a policy lapse or invoking a return-of-premium rider - are costly to administer, Mr. Christiansen said.
"Insurers require the systems, investment capabilities and diversification to deal with those risks," he said. "For variable annuity companies, they need to adjust their products in order to better compete for retirement assets."
"Enterprise risk management includes all of an insurer's potential exposures to loss, including from improperly pricing and hedging annuity guarantees, and from maintaining inadequate reserves to pay claims," said Prakash Shimpi, Tillinghast's New York-based practice leader for enterprise risk management. "The insurer-rating agencies are now looking not just at capital adequacy but at how the company manages all of its risk."
About 60% of the 33 CFOs who participated in the survey said that increased rating agency scrutiny influenced their use of enterprise risk management. Moody's Investors Service and S&P, both based in New York, and Fitch Ratings Ltd. of New York and London, all rate insurers based at least partially on their risk management strategy and success, Mr. Shimpi said.
For instance, the rating agencies are interested in insurer liquidity and what would occur if annuity guarantees were triggered. That hasn't happened yet, but rating agencies are concerned about whether insurers would be able to comply with the guarantees, Mr. Shimpi noted.
"Good risk management is also seen by the rating agencies as something that reflects favorably on the insurer's culture, organizational ability and management," he added.
"While revenue growth is anemic, prospective profitability appears relatively solid."
Director of research
Conning Research and Consulting