Challenging business conditions and the availability of cheap debt financing will drive M&A among global reinsurers for the next few years, according to a new report from S&P Global Ratings.

The rating agency expects companies with narrow business profiles or limited geographic presence to consider buying companies or become targets themselves, and expects the insurance, reinsurance and insurance-linked securities, or ILS, markets to continue to converge through M&A.

It also said reinsurers that are less diversified or that have a higher expense base will struggle to compete with bigger, better-diversified players.

As a result, S&P expects more deals similar to French insurance group Axa SA's 2018 acquisition of Bermuda-based XL Group, and U.S. insurance group Markel Corp.'s acquisition of ILS manager Nephila Holdings, both completed in 2018. Geographic diversification will also continue to drive deals, S&P said, as shown by China Re's acquisition of The Hanover International Holdings and RenaissanceRe Holdings Ltd.'s purchase of Tokio Millennium Re.

It added, however, that it was not expecting any consolidation among the top 10 reinsurers, as they already command 70% of the roughly $210 billion of net reinsurance premium written by the top 25 reinsurers. It also said a merger among the top 10 would result in "significant" execution risk as well as meaning that buyers of reinsurance would be spreading their risk among fewer reinsurers, which could lead to the combined group losing business as buyers sought to diversify.

Fewer choices

S&P noted that although market conditions for global reinsurers had improved, with price increases in the first half of 2019, they remained "somewhat difficult." The rating agency said it was not expecting to see a significant change in conditions because "there is enough capital on the sidelines waiting to join the sector."

However the rating agency said that the number of attractive acquisition targets — small and midsize insurers or reinsurers with good books of business — had dwindled as a result of the recent spate of M&A deals.

S&P also noted that M&A deals are typically ratings-neutral. It said a well-executed deal can protect creditworthiness and improve shareholder value, but that there is execution risk inherent in M&A deals and they can dilute capital adequacy.