Where Warren Buffett treads others follow. His backing of Equitas early last year was right at the heart of a booming market for dealmakers. Mark Dunne reports on the trend
Warren Buffett didn’t become the world’s richest man by closing small deals. Last year the legendary investor spent US$5.7 billion (£3.6 billion) covering the liabilities of insurance claims specialist Equitas, through his Berkshire Hathaway conglomerate. This may have been just another investment to Buffett, but it was also the largest deal in the run-off industry in the past few years.
When an insurance company decides to pull out of a particular region or line of business, the liabilities of those portfolios still need to be managed on behalf of its policyholders. When this occurs, the investment is put into run-off and a legacy management specialist takes over.
“It’s not like a factory, where can you turn off the conveyor belt and things stop coming off the end. There are policies that remain in force for many, many years,” says Philip Grant, outgoing chairman of the Association of Run-off Companies (ARC).
ARC is the trade body for insurance and reinsurance legacy management professionals. It keeps members informed of industry developments and represents their views to regulators and the government.
One of the changes that Grant has seen in the market during his seven years on its board is an increase in M&A activity.
He says the run-off market has attracted increasing levels of capital, as there is a perception among investors that there are high margins to be made. “If you acquire an insurance interest in run-off, it’s basically a parcel of liabilities, which are matched by corresponding assets,” he says. “When you buy it, the acquirer often tends to discharge these liabilities for less than the amount provided against them, thereby releasing surplus from the assets.”
A growing interest
Another professional who has witnessed a rise in M&A work in the past few years is Dan Schwarzmann. The partner at accountancy firm PwC claims that the market was buoyant on the dealmaking front until recently.
“About three months ago, somebody asked me how the credit crunch was affecting the run-off market and my response was ‘what credit crunch?’ I just hadn’t seen it affecting the run-off M&A market.”
The market has since suffered the same problems as many other industries, as it has become tougher for buyers to access debt. Prior to the global financial problems hitting the market, Schwarzmann says he was speaking to several third parties that were interested in entering the market.
The increasing number of players investing in the market in recent years has driven up prices, according to Grant: “Historically you would have seen acquisitions of businesses in run-off or legacy companies agreed at a discount to its asset value. Now we are getting to the point where the acquisitions are at, or even above, asset value.”
He says that this has produced some “reasonably chunky deals”, such as Enstar’s acquisition of Unionamerica from Travelers in October, for a reported $343.4 million (£217.6 million).
At the other end of the deal spectrum, transactions range from £5 million and £10 million, as there are a lot of small portfolios that are pushed out into the market and bought by larger businesses.
Deal highlights in the industry have included Guernsey-based insurance fund manager Audley Gilroy Capital buying Scottish Lion in June, and run-off management service provider Randall & Quilter snapping up KMS in September, for £1.78 million.
Grant believes that while the current economic conditions have led to a drop in deal flow, it follows that more portfolios will be put on the market. “Insurance entities are looking more closely at their balance sheets to assess where their underperforming portfolios are. There will be more of a tendency to place these businesses in run-off, as they look to dispose of them as quickly as possible. It’s easier these days to dispose of discrete portfolios of business because of the various transfer mechanisms that European legislation now allows.”
Schwarzmann agrees that we have yet to see the full extent of the credit crunch on the market, but wonders if an increase of businesses on the market will drive dealmaking. “It has been deeper than anyone could have predicted. My hunch is that it will impact the number of parties that have actually got the liquidity to invest, not just in this market, but any market,” he says.
Whatever the outcome, Grant believes the sector will be more acquisitive next year as strong vendor appetite emerges. “More companies will want to dispose of these old portfolios because they represent a potential liability and tie up capital that could be deployed elsewhere. The question is whether investor appetite will be there, or indeed if they have the funds to make these deals happen,” he adds. “Obviously, at a time when cash is tight, it may be harder to raise the capital to invest in these sorts of deals.”