Insurance M&A: The future is bright for continued investment

Over the past decade, insurance has been a steady, core component of transactions in the financial services sector. Aside from a slight dip in 2017, both the number and total value of insurance deals in the United States has steadily gone up—thanks in large part to the soaring number of insurtechs disrupting the value chain.

However, with an economic slowdown likely approaching, many private equity firms and principal investors are worried about a corresponding slowdown in investment. Consolidations have been rampant in some parts of the value chain—for instance, among claims processing companies and in insurance distribution channels. And in multiple areas, such as in front-end software, collision repair, and life insurance and annuities application intake, only duopolies or oligopolies remain.

Given the sheer amount of activity and soaring multiples, as well as concern over a potential slowdown, it’s easy to see how some investors might think opportunities in insurance may be getting scarce. But the insurance industry is complex enough—by line, by geographic area, and along the value chain—that innumerable opportunities for winning investments still exist.

Where opportunities might lie in insurance M&A

The value available in the insurance sector continues to be remarkable. For parts of the value chain that remain attractive, such as traditional distribution, some acquired firms have traded three times over at sky-high valuations and average deal sizes that are up to 80 percent higher than they were just a few years before. Some of the largest insurers or tech players knowingly overpay to take up-and-coming insurtechs off the market and integrate them into their own organizations before they grow into competitors. In addition, insurers are increasingly building out investment arms that allow them to ride the wave of innovation and capture the benefits of new ideas.

Investors have been clamoring over players in auto and group insurance, for example, where technology has created opportunity by disrupting business models. In specialty lines and home insurance, however, the field is less crowded. Moreover, as applications move into the cloud, there’s opportunity in many of these potential targets to gain efficiencies by updating legacy systems—particularly in the parts of the tech stack that relate to policy administration and claims management. And as more data is collected through various channels, data aggregation and analytics can help create a competitive edge in a relatively undifferentiated industry.

Looking forward: Three observations

Five years ago, brand-new insurtechs were scoring their first rounds of venture capital (VC) funding; by now, many of these players have earned their third round of funding and are equally attractive investment targets for private equity (PE) or large insurance companies with their own investment arms.

Three observations about the current landscape could help interested investors think through attractive investments in the insurance space going forward.

1. A huge bifurcation in deal size

Among insurance industry buyouts, the deals tend to be either very big or very small, without much happening in between—and this is likely to continue. For example, in 2019, out of the 50 investments with a disclosed investment amount, 30 deals were valued at less than $100 million and seven were valued at more than $1 billion. The result of this bifurcation is essentially concentrated spaces, or something that resembles oligopolies. On the one hand, if an investor’s strategy involves going for a huge player, they’ll need to find partners for their deals, since it’s doubtful that any one investor will want to sink billions into a single company. On the other hand, there are many attractive targets among the young companies incubated five or six years ago that are growing up and entering a key phase of their development. Placing bets on young, less-proven firms requires a VC-like appetite for risk.

2. Greater focus at the tail end of the value chain

While most deals have been focused on front-end players (such as those in application intake, sales and distribution management, and pre-underwriting) or on distribution players, we see more activity in the later parts of the value chain. These targets include those in policy administration and claims management, as well as insurtechs that, for example, use automation to streamline internal processes. In the past, traditional investors have shied away from these types of investments, but they are now tackling them head-on. Investing in this space requires that investors get comfortable with less recurrent revenue than what’s common in front-end solutions. Given the right technology and business model, however, such investments can lead to outsize returns.

3. Insurers becoming more sophisticated investors

Of course, the competition won’t come from only VC and PE firms; many large insurers now have their own investment arms and are chasing these deals, too. And these insurers have become active and increasingly sophisticated investors in technology-based firms. Because of the added concern around sustaining their competitive position versus up-and-coming insurtechs, the insurers themselves are feeding the current high valuations. Investors who focus on knowing the space well and having a clear plan to create value will be able to find and win the most attractive opportunities.

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