MS&AD spends $1b to cash in on industry woes

The Japanese insurer thinks it has spotted a way of benefiting from the sector’s travails as some of its peers sell portfolios in the face of Solvency II and low interest rates.

MS&AD Insurance said on Friday it has agreed to buy up to 15% of Swiss Re’s UK closed book life business ReAssure Jersey One for 800 million pounds ($1 billion), part of the insurer's efforts to diversify away from Japan's high natural catastrophe risk.

For Tokyo-headquartered MS&AD, the investment in ReAssure could also be a counter cyclical play on other insurance companies’ struggle to comply with more onerous regulations and low interest rates.

In the wake of new capital rules, such as the introduction of Solvency II, life insurance companies in the UK have increasingly looked to sell in-force policies to dedicated run-off specialists such as ReAssure, said MS&AD in a statement on Friday.

The closed book life business consists in acquiring books of in-force life and health insurance business bought from other insurance companies.

MS&AD said in its statement that it expects the UK closed book business to grow and consolidate.

The prolonged low interest rate environment in many countries is also spurring the sale of policy portfolios, divestitures and consolidation across the industry.

Therefore, MS&AD said it is building up its knowledge of the closed book business and might expand unlisted ReAssure into other regions in the future.

"The UK closed book market is expected to offer significant consolidation opportunities in the near future. Thanks to this commitment from MS&AD and given our proven acquisition and integration capabilities, we are well positioned to seize these opportunities while delivering attractive returns," Matt Cuhls, CEO of ReAssure, said in a separate statement.

ReAssure acquired the policy portfolio of Guardian Financial Services in September 2015, that of HSBC Life UK in August 2015, and Alico UK in July 2012.

Swiss Re’s management of the subsidiary has followed a policy of draining off most of the profits it generates and infusing capital when required for a new acquisition. The latest deal allows Swiss Re to tap MS&AD for additional investment until its stake reaches 15%. After that, Swiss Re also plans to invest, contributing on a scale that keeps MS&AD’s stake at 15%.

"MS&AD was seemingly added so that Swiss Re can expand the business while keeping its capital burden relatively light," according to equity analyst Natsumu Tsujino at JP Morgan in a note to investors.

Global plan

The acquisition of ReAssure is also another step in MS&AD’s overseas expansion, which seems to be gathering pace.

In August the company announced plans to acquire a 6.3% stake in Australian firm Challenger and separately to buy Singaporean P&C insurer First Capital Insurance from the Fairfax Financial.

In 2015 it agreed to buy British reinsurer Amlin for $5.3 billion.

"MS&AD, which has exposure to P&C through its MS Amlin subsidiary and life insurance in the Asia-Pacific region, will benefit from increased geographic and product diversification through access to the UK closed book market, with a strong and experienced partner," Brandan Holmes, a credit analyst at Moody's, wrote in a note to clients.

Investors in MS&AD are watching closely to gauge the potential profit contribution from its overseas shopping spree, as well as the degree of underwriting risk diversification and synergies the company can achieve via expansion.

"A key aspect of the investment will be whether MS&AD can tap this know-how in the closed-book business and apply it in other operations in Japan and overseas," said Wataru Otsuka, an equity analyst at Nomura, in a note to investors.

MS&AD’s long-term goal is for its international business to contribute 50% of group core profit, compared with the 27.8% contribution it expects in its fiscal year ending March 2018. It aims to achieve an overall ROE of 10%, up from 7.8% in the fiscal year ending March 2017.

Step by step

The acquisition of ReAssure will have several steps.

MS&AD will initially buy 5% of the outstanding shares of ReAssure for 175 million pounds using cash on hand.

It will then subscribe to new shares of the Jersey-headquartered firm up to a total of 800 million pounds, increasing its stake up to 15% over three years.

Upon reaching 15%, MS&AD will account for its investment under the at-equity method, recognising its share of ReAssure's earnings and equity beyond the initial dividend income.

While MS&AD’s initial purchase of a 5% stake values unlisted ReAssure at 3.5 billion pounds, the full transaction implies a 5.3 billion pounds valuation.

The P/E ratio is 6.4 times 2016 earnings and 16.3 times based on two times earnings generated during the first half of this year. The price to book ratio for the acquisition is 0.85 times.

"Those ratios seem like an appropriate range given that a high P/E valuation should not be paid in the absence of a control premium. But it looks like 2016 earnings are abnormally high as one-time profits are recognized from the acquisitions made in 2016. Therefore, we should not use 2016 earnings but rather 1H 2017 earnings as a better proxy of current earnings ability," added Tsujino at JP Morgan.

MS&AD will appoint one director to ReAssure. It expects the deal to close between January and March next year.

Societe Generale Corporate & Investment Banking acted as sole financial advisor to MS&AD. 

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