Small Insurance M&As Create More Value Than Large Deals: McKinsey

McKinsey analysts believe insurers focused on large one-off deals undertaken to scale their companies and those that stick to organic growth are both headed down unfruitful paths if outsized shareholder return is their success metric.

In a report published in late March, “A Better Approach to M&A in North American Insurance,” five members of McKinsey’s Financial Institutions practice, who are consultants and advisers in the insurance space, analyzed 250 life and property/casualty deals totaling more than $200 billion since 2007.

Although 60% of the transactions targeted greater scale as a goal, acquirers looking for product diversification and new capabilities did better in terms of excess total shareholder returns, they found.

The report defines excess TSR as the change in acquirer TSR (from 30 days prior to two years after the announcement date) in excess of the Dow Jones U.S. Life Insurance Index or Dow Jones US P/C Insurance Index.

Breaking down returns for the 173 P/C deals included in the analysis, the McKinsey researchers reveal that excess TSRs for acquirers targeting product diversification came in at 8% while excess TSRs for deals focused on scale averaged only 1%.

In addition, concentrating the analysis on absolute deal size, they found that excess TSRs for small deals were 3% higher than for large deals.

Later in the report, the authors define a large-deal approach as one in which a company makes at least one deal per year and the target’s market capitalization is equal to or greater than 30% of the acquirer’s market capitalization.

The differences by size and by deal strategy were starker for life insurance.

McKinsey researchers reviewed 76 life insurance deals during the same period dating back to 2007, finding TSR outperformance for product diversification coming in at 21% above industry average returns. And in life insurance, the excess TSR outperformance of small deals over large ones was 7%.

But dealmakers do perform better than those who sit on the sidelines, the McKinsey report suggests with support from an analysis of median excess TSRs for dealmakers and non-dealmakers across all industries in the Global 2000 (the top 2,000 companies with market cap size above $2 billion on Dec. 31, 2009 that were still trading as of Dec. 31, 2019). This analysis reveals that Global 2000 median excess TSRs were negative for those companies with organic growth strategies (-0.8%) or with selective M&A strategies (-0.2%). In contrast, a “programmatic M&A” approach produced a median excess TSR of 2.1%.

Programmatic M&A is an approach where a company makes more than two small or midsize deals in a year, with a meaningful target market capitalization acquired (median of 15% for all deals taken together).

In the selective approach, a company makes two or fewer deals per year, and the cumulative value of the deals is more than 2% of the acquirer’s market capitalization.

In the organic approach, a company makes one deal or fewer every three years, and the value of each deal is less than 2% of the acquirer’s market capitalization.

Demonstrating that outperformance over a 10-year period hinges on having a healthy “programmatic” inorganic strategy, authors Cristian Boldan, Alex D’Amico, Jay Gelb, Steven Kauderer, Kurt Strovink and Zane Williams also analyzed the strategies of companies that fell out of the Global 2000 between Dec. 31, 2009 and Dec. 31, 2019. Forty-six% of the dropouts had selective deal strategies, and 35% relied on organic growth. In contrast, only 4% of the dropouts were proponents of the “programmatic approach” the authors recommend.

Analyzing just the “Top 100 survivors” instead — global companies that remained among the Top 100 by market cap across industries over the same 10 years — the researchers found that more than half (53%) used a programmatic approach to M&A.

The report also reveals that this “programmatic approach” is unpopular among the North American insurance industry’s biggest companies. Among the 40 North American insurers (life and P/C) in the Global 2000, 43% pursued organic growth strategies and half were selective acquirers. None fell into the “programmatic approach” category, while 8% pursued one-off large-scale deals.

In terms of forecasts, McKinsey researchers anticipate more insurance industry M&A this year, but they predict only modest activity for P/C insurers vs. a restructuring wave on the life side of the business.