Gavin Davis and Adam McNestrie
This week Axa announced a $15.3bn agreement to purchase Bermudian (RE)insurer XL at close to 2x tangible book value, with the merged entity set to become the largest commercial lines insurer in the world.
In some ways, the transaction was not a total shock. XL has been touted as a potential takeout target for some weeks. And given the amount of consolidation in Bermuda over the past few years it is easy to dismiss the deal as just a "me too" transaction from yet another buyer with too much capital and not enough growth.
Yet in other ways the transaction is remarkable and suggests the specialty (RE)insurance market is only at the beginning of a seismic shift that will dramatically reshape the industry.
Elsewhere in this issue we analyse the deal specifics. But perhaps the most notable takeaway from the Axa-XL tie-up is that it brings another significant influx of capital into the specialty (RE)insurance sector, just weeks after AIG shocked markets with the $5.6bn takeover of Validus.
Adding AIG's and Axa's monster balance sheets and stated growth ambitions to the specialty (RE)insurance sector is hardly the type of dynamic that leads to a hard market.
Arguably, both transactions signify an important shift for the market. Both transactions highlight the emergence of a new dominant type of buyer for specialty (RE)insurance assets following changes to US corporate tax laws: the conglomerate insurer in low-growth developed economies.
With these deals Axa CEO Thomas Buberl and AIG CEO Brian Duperreault have shown that they are willing to make big bets that are predicated more on strategic objectives and long-term growth assumptions than cost-cutting.
Both deals seem to reflect, among other things, the search for streams of diversified earnings and the capital synergies that they bring.
This kind of deal-making - right down to the high multiples paid - bears resemblance to the internationalising deals pursued by the Japanese big three in which they deploy earnings to acquire diversifying specialty assets, while leveraging their low cost of capital.
Although foreshadowed by Tokio Marine's slew of international acquisitions and Sompo's takeover of Endurance, the Axa-XL and AIG-Validus deals are arguably far more significant given the sheer scale of the acquiring businesses.
These transactions also appear to confirm that earlier predictions that sector consolidation would take the form of deals driven by an industrial logic of scale - as well as the arrival of Chinese money - were misguided.
Following the latest deal announcement, the market's near-term focus is likely to be on the "scarcity value" of remaining platforms and a re-emergence of M&A fever, as observers try to match the remaining Bermudians with acquirers with a similar profile.
One of the features of frothy markets - not to mention full on speculative bubbles - is that decisions that individually make sense often aggregate into an irrational market.
A recent example is the argument that consolidation in Bermuda would improve returns due to increased scale - a presumption that relied upon the absence of a strategic response from competitors.
A similar case could be made for deals predicated on growth. Individually, the maths can work in a banker's spreadsheet. But too many companies with a growth imperative spoil the game for everyone.
Arguably recent transactions are suggestive of a frothy environment. Whatever the strategic rationale, it is hard to make good returns when paying a premium of 50 percent or more for a business with a long-term track record of single-digit returns.
Though growth and capital synergies can make a deal work in the long run, they can also be used to justify deals that do not make clear financial sense.
Buberl's decision to refer four times in his prepared remarks to the creation of the world's largest commercial lines insurer seems notable, documenting the pendulum swing from returns-driven to growth-oriented M&A.
Especially when the fact appears largely academic given that Axa will still not have the scale to dictate terms to its clients.
Ultimately, the greed phase of the cycle means the high multiples paid for low-return businesses will disappoint many buyers. Given the context of a long softening cycle and signs of a reflationary economy, there is also scope for some blow-ups if acquirers execute badly.
However, there are also some reasonable arguments to suggest large conglomerate companies like AIG and Axa might make better owners of specialty (RE)insurance companies than public shareholders when the targets are bought at the right price.
Among the secular pressures faced by Bermuda, and an under-appreciated driver of consolidation, is technology.
First, it is worth noting that technological limitations have historically played a significant role in preventing M&A.
The logistical challenge of combining insurance businesses onto a single platform has historically prevented firms from deriving easy returns from increased scale. This has allowed an inefficient industry structure to persist. This may change over time as the technology that supports big data improves.
However, a second factor highlighted by the Axa-XL deal is the indirect impact of technology on the insurance sector.
As Buberl noted more than once on the deal conference call, Axa's traditional P&C business faces threats from driverless cars and transportation network companies, which could lead to growth challenges as auto insurance premiums decline.
The natural response for these exposed companies is to try and shift along the risk curve and attain exposure to business with less obsolescence risk. Buberl described this as "one way for us to get out of the commoditisation trap".
This in turn has been aided by a third technological factor. The advance of big data is increasingly providing companies with ways of addressing markets even without historical loss data.
Here the closest analogy is catastrophe vendor models, but much progress has also been made in lines like small commercial and homeowners.
This will likely to lead in time to the migration of business from specialty underwriters to more mainstream carriers.
Industry executives often want to blame the decline of the small and independent specialty (RE)insurer on the increased costs of doing business, driven by regulation and technology.
However, there is a compelling case to be made which says that the industry has been too complacent and failed to respond to the commoditisation of its product either by decisively expanding into new geographies or emerging risk classes.
A common complaint is that emerging economies do not have comparable quality data to enable underwriting on similar terms to existing markets, or that emerging risks are too poorly understood in terms of aggregation exposures.
But ultimately, what makes a business truly a specialty carrier is to address those risks that others can't. If you can't do that, you have no reason to exist.