Deal or no deal

There has been intense speculation in the press recently that several major insurers may be takeover targets, including the big household names in the UK market. Indeed, last week, Aviva made a formal £17bn bid for rival Prudential (PM, 23 March, p3).

One of the big questions is what has changed to prompt this potential acquisition activity where there has been none in recent years? The answer lies in the excellent underwriting profits announced by many insurers in the latest round of results. This has been supplemented by a return to lower volatility in investment returns, which has stabilised many insurers' balance sheets and turned several such insurers into attractive acquisition propositions.

As the financial services industry looks to compete in an increasingly global market, merger and acquisition activity can yield a range of key competitive benefits, including product and geographic diversification, with the resultant capital efficiencies and access to new distribution lines.

Deloitte recently conducted a piece of research into the cross-border merger activity of European financial services institutions and found a strong emerging trend. Based on the analysis, Deloitte was able to predict that 700 financial institutions will be acquired during the next four years. While the lion share of this number is made up of retail banks, there is still plenty of opportunity for insurers to obtain the benefits of increased customer numbers and the ability to drive down costs through acquisitions.

There are various issues associated with how a potential acquirer approaches a listed company target. If a bid is recommended, the purchaser is usually given some limited access to company information but this then opens up the target to other approaches, under level playing field rules. On the other hand, companies also need to be wary of hostile targets. An inappropriate response to a hostile bid can damage share price, investor sentiment or management team credibility so it is important companies have an effective defence plan in place. Recent research, conducted by Cass Business School on behalf of Deloitte, has identified four key characteristics of a hostile target and it is interesting to see that many major insurers share these features.

Target characteristics

Key characteristics of a hostile takeover target include lower turnover growth; lower employee growth; the board owns fewer shares in their own company; and low ratio of tangible assets over market capitalisation.

Firstly, looking at lower turnover growth with reference to the insurance sector, it is apparent that premium levels are stable, at best, if not falling within the majority of insurance markets. The industry is on the verge of entering a softening stage of its underwriting cycle and prospects for future growth and profits are, therefore, on a downward trend.

Secondly, the industry is looking to cut the cost of transacting business so headcount reduction and offshoring mean there is the likelihood of lower numbers of employees. Based on recent research into offshoring, it is predicted that 180,000 financial services jobs will be offshored by 2010.

When it comes to the third characteristic, where the board owns fewer shares in their own company, most financial services institutions have diverse shareholdings with mainly institutional investors. Consequently, they have low board shareholdings. Notwithstanding, the level of shareholdings by the board is, in the main, low.

As for a low ratio of tangible assets over market capitalisation, insurance companies themselves do not usually have a significant level of tangible assets so would normally meet this characteristic.

Bearing in mind, however, that the majority of the key characteristics uncovered by the research tallies with the key features of many insurers, board members of listed insurers need to be wary of predatory acquirers. As mentioned previously, the ramifications of ill preparation can be costly.

Research shows that companies are most susceptible to a takeover bid 86 days after they have published their accounts. So, with the reporting season having come to a close, the listed insurance community should be aware that acquirers will be thoroughly investigating the latest publicly available information.

Code obligations

Once a bid is received, there is the added pressure of takeover code obligations, which require an initial response within 14 days. This is insufficient time to prepare a robust response; therefore, to protect price, investor sentiment and management team credibility, it is important that companies have a bid defence plan in place. The issue of responding to hostile takeovers is increasingly becoming part of large companies' corporate governance plans and insurance companies have even been seen to offer financial protection in this situation.

An increased number of hostile bids can be expected this year as banks look to invest the enormous levels of capital at their disposal. While there has been much media hype around the huge wall of money private equity has to invest, most bids are expected to come from the corporate market. Private equity houses tend to avoid making hostile takeover bids as a rule, although private equity 'bear hugs' are akin to a hostile takeover bid as management is under huge pressure to recommend the offer.

That said, from the private equity perspective, insurance companies are capital intensive and highly regulated and, therefore, unless something makes the opportunity stand out, the standard public to private route is not the first option considered.

Further speculation as to potential acquirers and targets in insurance in the coming months is anticipated as the industry feels the pressure of a global, changing market. Listed insurance companies should, however, take seriously the factors identified by research in order to prepare themselves for potential unwanted takeover attempts.

Ian Clark and Penny Avis are corporate finance partners at Deloitte.