Insurance – What’s next?   

M&A activity in the insurance sector held up reasonably well in 2023. This is despite the sector being impacted by many of the trends outlined in our global M&A outlook for 2024, with issues such as ESG, geopolitics and changes in M&A processes all playing a part.

We have, however, picked two trends that feature high on the agenda of most insurance M&A teams: private capital and the digital transition.

Private capital

In common with many other sectors, the insurance sector has attracted significant investment from private capital in recent times. This is most pronounced in the US, where The Economist recently reported that life and annuity insurers backed by private equity are estimated to own assets worth nearly US$800 billion, from an almost standing start a decade or so ago.

Other jurisdictions have clearly noticed this and have made what appear to be overtures to those investors with a view to attracting new capital into their economies. Politicians in several countries are taking steps to give insurers more investment flexibility, which will allow them to generate better returns. This both makes those insurers more attractive for investors and encourages those insurers (especially life insurers) to invest in illiquid assets that will benefit the wider economy (infrastructure investments are most often given as the example). This, in some ways at least, follows the approach seen in the US, where the assets on insurers' balance sheets, and insurers owned by private equity in particular, have changed considerably over the last decade.

If there are better returns for investors and there is a boost for the wider economy, everybody wins and so everyone is happy, right? Well, not quite.

Regulators have for some time expressed concerns about perceived risks with private equity ownership. Specifically, they are concerned about the possibility of more aggressive investment strategies and the greater risks that might come with that. These concerns are more pronounced in the context of insurance carriers than insurance brokers, for the simple reason that policyholders tend to have a greater financial reliance on the former than the latter.

While those concerns have been aired for a few years, 2024 may be the year when the tension between those regulatory concerns and the political impetus to attract new capital for investment comes to the fore. In the UK and Europe, laws that increase investment flexibility are expected to come into force. At the same time, the year saw a dramatic example of the real-world impact of the regulatory concerns, with BaFin, the German regulator, rejecting a deal that would have seen Zurich sell a €20 billion life-assurance portfolio to Viridium, which is majority owned by a major PE firm. The commentary on BaFin's decision, including from the parties involved in the deal, left little doubt that BaFin's concerns stemmed from Viridium's ownership.

That rejection may prove to be a one-off, given the PE firm in question had a significant disagreement with the Italian regulator in the context of Eurovita (an Italian insurer owned by the same PE firm) going into special administration. It does not seem too big a leap to imagine that the German regulator's decision was mainly, if not solely, influenced by the experience and views of the Italian regulator. That said, EIOPA (the EU's ‘regulator of regulators’ for insurers) issued a supervisory statement in 2022 that included concerns about private-equity ownership, and so some level of regulatory scepticism has been present in the EU for a few years now.

This scepticism goes beyond regulators, with the IMF having expressed similar concerns as recently as December 2023. That report shows that the relevant investments to date have been concentrated in the US. Of the PE-influenced life insurers the IMF identified, about 60% are in the US. Even so, the IMF's paper encourages regulators globally to consider the trend and several related policy points.

That context aside, countries that are serious about attracting significant amounts of new capital into insurance (and financial services more generally) will need to find a way to work with private capital. Private-capital investors, on the other hand, will need to go into deals with their eyes open, and realise that what works with one country's regulator will not necessarily translate to the next country. It will be important to be clear at an early stage on where the boundaries are; regulators are not afraid to ask difficult questions and will be hard to win over if the answers give the wrong first impression.

It is worth noting that in some major markets significant investments in the insurance sector have been focused on international strategic investment recently, despite strong private capital investment in other aspects of financial services. In Australia, for example, most significant life insurance investments in the last few years have been for more traditional reasons, like diversifying exposure to longevity risk, strengthening market position and increasing distribution capabilities. However, as private capital interest in the financial services sector continues to gain pace, we expect that trend to become increasingly relevant for the insurance sector in these markets (as it already is for investments in other kinds of financial services). In Australia, one development to watch is whether upcoming reforms to better enable banks, insurers and superannuation trustees to provide personal financial advice to customers will reshape the way insurance products are distributed and make these assets more attractive to private capital investors.

The investment of private capital in the sector, and the related regulatory points, does not manifest through M&A activity alone. Some reinsurance transactions, and life reinsurance transactions in particular, are also relevant. The PRA in the UK, for example, has issued a consultation paper on precisely this topic, with the concern being directed towards reinsurance transactions where large amounts of assets are transferred outside of the jurisdiction to be managed by an "offshore" reinsurer. Where a regulator potentially loses the ability to issue directions in respect of those assets, it starts paying closer attention. Precisely how close that attention becomes depends on a range of factors, like where the assets are held, what security is in place, the legal risks that might arise, the make-up of the reinsurer's balance sheet and the nature of the risk reinsured.

The digital transition

While it has not happened at the same pace as in the banking sector, it has always seemed inevitable that the digital transition will impact the insurance sector in a major way. The question has always been "when" rather than "if". With artificial intelligence now a realistic possibility in the short term, insurers everywhere will be considering how that might affect the market and refreshing their strategy accordingly.

While tech companies opening insurers cannot be ruled out, Amazon's decision to discontinue its insurance offering shows that having capital and data are not a guaranteed way to break into the insurance sector. Insurers, on the other hand, are unlikely to develop breakthrough technology themselves. As such, collaboration between insurers and tech companies seems the most likely course.

The digital transition is primarily about efficiency. Realising that efficiency in the insurance sector is, however, proving more difficult than many predicted. According to McKinsey's Global Insurance Report for 2023, life insurers' costs as a share of revenue have increased by 23% since 2003. Other financial services companies, such as asset management (and indeed general insurers), have fared much better in this respect over that period. As a result, it seems likely that there will be a clear case for tech investments by insurers, in which case the question would be what investments make the most sense.

In the past, the answer to that question was usually to identify a target and acquire it outright. That can, however, represent a very big and very risky bet, particularly given how quickly technology is developing and changing. It is in this context that venture capital (VC) tends to come up as one potential answer (alongside others, like strategic commercial partnerships).

Interest in this approach has ebbed and flowed. Since its peak in 2021, VC investment in insurtech has declined in all growth stages, particularly with later-stage funding. Insurtech has largely reached a stage of maturity with lower expectations of investment growth and valuations, although the advent of AI (and the hype connected with that) could change the equation again. Even in the relatively mature parts of the insurtech market, however, previous investments are still reaping the benefits of previous growth, with a compound annual growth rate of 34% between 2018 and 2022.

Most recently, VC investment in insurtech had a mixed experience, reaching only US$4.1 billion in 2023 (the lowest since 2017). This slowdown was a result of compressed valuations, a slower VC environment and a reduced number of successful exits. The latter part of 2023 showed signs of improvement. US$1.7 billion was raised across 115 deals in Q3, marking a 53% growth in deal value compared to the equivalent in 2022. This was the highest amount in the last four quarters, albeit flat in terms of deal count.

Both those increases and the interest in AI mean that there is cause for optimism for 2024, although the types of deals will only become clear once insurers finalise their strategies and identify credible targets that fit.