Emergence of Acquisitions

For the better part of five years, insurance industry commentators have asserted the inevitability of consolidation in the Canadian property and casualty industry. Several observe the industry is fragmented, with many insurance companies competing for relatively small pieces of Canada’s premium pie. The conditions are right for market consolidation, they argue.

And yet, relative to these high expectations, very few market-changing mergers and acquisitions have happened in the Canadian P&C marketplace over the past three or four years. Some have described the lack of activity as a byproduct of high valuations and marketplace conditions that favoured sellers, not buyers.

In this context, it will be interesting to see whether RSA Canada’s recent $420-million acquisition of GCAN Insurance represents a break in the M&A logjam. In talking to Canadian Underwriter about the deal, the second-largest merger in the Canadian P&C marketplace over the past decade, RSA Canada president and CEO Rowan Saunders says he sees a confluence of market conditions that may portend more opportunities for companies to grow through mergers and acquisitions.

“If you have a clear strategy and you have a good balance sheet and access to capital, this is actually a good time to grow, both organically and by acquisitions, so I do think that there will be more acquisition opportunities coming,” Saunders says in a sit-down interview to discuss the GCAN merger specifically, as well as the more general topic of M&A activity in the Canadian marketplace.

TIME IS RIGHT FOR M&A ACTIVITY

Speaking generally about the Canadian P&C marketplace, Saunders said he sees a number of factors that, taken together, could create opportunities for increased M&A activity. First among them is an economic and soft market environment in which it is difficult for insurance companies to grow their business.

“I do think the economic downturn and the fact that the economy has been flat to negative has had an impact [on insurers],” he says. “In commercial lines, [business has] been very much impacted, because revenues are down and exposures are down. An example would be: there were 17 trucks on the road last year or a couple of years ago, and you’ve got 14 this year. A few years ago, your inventory was piled to the rafters; now you have just-in-time production. Revenues are down, etc. So that has actually taken some exposure out of the marketplace, which does make it difficult for [insurers] to grow.”

Secondly, this low-growth environment has played a part in suppressing valuations for some companies, which makes them more attractive targets for acquisition. This essentially enables potential buyers. “You’ve been in some pretty tough trading conditions,” Saunders observes. “It’s been hard to grow the top line because of the downturn. From a pricing perspective, there’s been very little rate over the last couple of years. In fact, rates have been down over much of the past five years. So that does make it a difficult environment in which to grow. We’ve also contended that with tough auto environments and a significant increase in severe weather, as a result. the industry earnings haven’t been good, and I do think that has suppressed some companies’ book value. So valuations, in aggregate, are actually more affordable than they have been for some time.”

And thirdly, despite the tough growth conditions, the industry is not lacking for available capital. In fact, the industry in commercial lines “is very well capitalized and it’s still profitable,” said Saunders.

“We’re at the stage now where the industry ROEs have not been great for the past couple of years, and there has been some very significant divergence in performance,” Saunders says. “Some insurers are growing, and doing so comfortably, with very attractive combined ratios. Other insurers really are in quite a state of distress — either they have difficulty holding their business, but mostly they have some very unprofitable portfolios. When you have had that situation in the past, normally the whole industry is under a bit of stress and there isn’t capital to take advantage of that. What’s different today is that you have that divergence [in company capital levels], and you actually have people who have capacity and capital to take advantage of the situation.”

Thus, three factors are conspiring to drive future M&A activity: a low-growth environment, suppressed company valuations and the presence of capital in the market.

Of course, there has been capital in the market for awhile now, and while companies such as Intact Financial Corporation have publicly declared their “war chest” of $1.1 billion in 2009, and their concomitant desire to entertain appropriate deals, not much has actually happened. But Saunders thinks the contemporary situation, which features an uneven distribution of capital between Canadian P&C companies, differentiates this period from others in which little M&A activity occurred.

RSA ACQUIRES GCAN

RSA Canada itself took advantage of this scenario when it made the move to acquire GCAN Insurance in October 2010. Pending the official closing of the acquisition, the Ontario Teachers’ Pension Plan Board owns GCAN. A commercial lines insurer, GCAN wrote annual premiums of approximately $255 million in 2009.The company employs 148 people in four locations across Canada, and partners with a network of 130 brokers. The company had a combined operating ratio (COR) of 81% in 2009 and an average COR of 77% over the past five years. Essentially, the transfer of GCAN’s ownership from the teachers to RSA Canada gives GCAN underwriters more capacity with which to operate.

For RSA Canada, the deal adds greater depth to its commercial lines segment. Prior to the deal, RSA Canada had about $500 million in commercial business, with a significant amount of presence in the small and mid-markets. The company focused on capability in certain segments, such as manufacturing and construction, as well as in specialty segments such as marine and boiler and machinery. GCAN, on the other hand, does more of its commercial business in the large and complex risk area, and writes more liability business than RSA.

“What GCAN does for us is that in some segments it adds more scale, it adds geographic diversification,” Saunders says of the deal. “GCAN has over half their business with the global brokers and large brokers, which is important because those are the brokers that really are in control of all of our large and complex specialty business. That was positive. Most of their business is either mid-market or large, complex industrial risk. They’ve got specialty lines that we were very interested to be able to add to our repertoire of products, such as errors and omissions [E&O], and for-profit directors and officers [D&O]. And then there’s some overlap in marine and EBI [equipment breakdown and boiler & machinery].We are now the market leader in both of those product lines. The large, complex business is really the interesting, complimentary piece that we get. What the GCAN acquisition does for us now is that it will put us in a unique position in commercial insurance in Canada in that RSA will now have propositions and significant presence in the entire spectrum of commercial, from small, to mid-size to large industrial, to the global risk-managed accounts.”

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What’s different today is that you have that divergence in company capital levels and you actually have people who have the capacity and capital to take advantage of the situation through mergers and acquisitions.