Free Essay: Merger and Acquisition in the Global Insurance Sector

The Insurance Sector comprises of companies that offer risk management services in the form of insurance contracts. It includes the acquirer and the acquired or the insurer and the insured. An Insurer is a company offering the services while the insured is the individual or company that seeks to get contracts so that they get their items covered. The basic concept is that the insured pays some amount for an agreed period of time so that in case of any risk the insurer pays the insured.

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Mergers and Acquisitions are a consolidation of companies. Mergers are corporate activities conducted to bring two or more insurance companies together and form one single company/firm while Acquisition is when one of the merged companies overtakes the other. 2018 had the largest number of M&As registered (Sinha & Gupta, 2011). The importance of Merger & Acquisitions is that it expands the company's reach and the overall performance tends to increase in value. Merger and Acquisitions take place when companies notice there's scarce growth. The rise of competition in the market has resulted in companies not being able to work on their own hence the need to create Merger and Acquisitions (Nayak & Mishra, 2014).

Managers of these companies, therefore, need to work with joined skills to remain profitable and competitive. This means that a firm has to have its strategy, however much profit the company gains. Even the most profitable companies always work to having greater income (Cummins, Klumpes, & Weiss, 2015). Merger and Acquisition has been prompted by the cost-efficiency or a rather cheap financing, growth potentials, increased product line, used to meet specific legal requirements, regulatory pressures supported by the desires of global reach, urge to reduce the market competition, new technological developments enhanced to ensure the company's performance and providing a strong capability of meeting the customer's satisfaction both locally and globally (Sinha & Gupta, 2011). In recent years, Merger & Acquisitions have increased and this has led to the change in the world's economy.

The rule for M&A is that companies should go for M&A only if they create value. M&As perform well if the financial, managerial and operational sectors are well taken care of. However, there are problems that affect the M&A practice that include language barriers, leadership challenges, lack of strategic planning, unrealistic targets and rapid change of employees over a certain period of time (Kangetta & Kirai, 2017). Research shows that in the future, more Mergers & Acquisitions are to be on the increase if the government reduces the capital requirements for financial institutions and this move will stabilize the country's economy (Nayak & Mishra, 2014). However, research says that M&A provide mixed results of their effect to an organizations performance.

Mostly, companies tend to hike their prices hence making abnormal profits. Merged firms record high asset productivity and higher cash flow returns (Elango, 2016). There are two theories that explain the relationship between M&A and financial performance (Smith & Walter, 2018). One, production theory that relates to the cost, profit, and revenue of affirming attainably. Two, market imperfections theory that involves value in relation to the existing market. Other theories include market power theory; firms earn higher economies scales due to higher market power (DeYoung, Evanoff, & Molyneux, 2009). There are two factors that lead to the failure of M&A; errors of valuation and human factors which include cultural clashes and ego battles among the managers.

Examples of Merger and Acquisitions in 2018 are; CVS & Aetna for $69 billion, AXA & XL capital for $15.3 billion, AIG & Validus for $5.6 billion, Phoenix Group & Standard Life Aberdeen for $3.2billion and Axis Capital & Novae for $0.5billion (Cummins et al., 2015). However, researchers found that 50% of the operations by M&A destroy value (Sinha et al., 2010). For example, Dresdner Bank by Allianz in 2001 went for $24 billion and when Allianz sold Dresdner to Commerzbank 7 years later, it went for $5 billion (DeYoung et al., 2009). Also, the acquisition of DLJ Bank by AXA in 1992, and the selling of DLJ Bank to Suisse First Boston for $10 billion seemed a bad deal for AXA (Sinha & Gupta, 2011).

Pattern Emerging from the Analysis

The core need for M&As is to create value. However much companies want to merge, some are highly selective on the limit of their activities to either local or regional levels or when targeting members of a certain profession and branches. Such companies do not market their companies beyond national borders hence most companies concentrating on working within national borders (DeYoung et al., 2009). Both Cross-border and Within-border transactions bring an impact in the Insurance sector.

Research shows that the value for cross-border is neutral for acquirers whereas the within-border led to a loss or small market value gains for acquirers. Findings support that M&A deals are value-creating for targets than for acquiring firms. Acquirers get small market value returns. Targets gain from both cross-border and within-border transactions, but the within-border transaction gains are larger (Kangetta & Kirai, 2017). Acquirers realize small negative market value losses from M&A transactions but targets realized substantial market value gains.

Companies considering to go for cross-border transactions, need to check the following issues; structural considerations for an insurer, structural considerations for the insured, licensing requirements, security, exchange rates upon risk, the possibility of a change of law, data protection ways and the effect of the tax. M&As in the global insurance sector can be motivated by the following theories; pure production theory, and/or diversification theory. The diversification theory provides a reason as to why banks should seek to diversify into insurance and other financial areas (Kangetta & Kirai, 2017). Diversification means expansion regarding either geography or product range or both. It aids in increasing the capacity in which debt is owed and decreases the present value of future tax liability. The depicted, however, leads to the stability of the flow of the cash even when there's variability through mergers (Smith & Walter, 2018). Mergers are a better route for diversification since the timing and availability of resources do not match through internal growth.

Diversification has benefits like reputational benefits, preserving reputational capital and demand for diversification by managers and employees (Elango, 2016). Diversification is observed as an investment behavior. Diversification acquisition is an action where a company takes to control interest in another company to expand its products and services (Cummins et al., 2015). Diversification acquisition occurs when a company needs to lift a shareholder's confidence and believe making an acquisition can facilitate a company's increase in stock and earnings growth.

Takeovers between related companies are knowns as related or horizontal acquisitions, and when two different codes fit in are of an unrelated takeover (Sinha et al., 2010). Large companies find themselves in diversification acquisitions most of the time to minimize the potential risks of one business component not performing or maximizing the earnings potential of running a different operation. Creating new values takes time so it is not guaranteed whether greater returns will be registered. As a matter of fact, many companies do not ever live up to their acquisition valuation while others get excess cash flow from their services. Some companies believe unrelated acquisitions contribute to reducing risks (Elango, 2016).

The theory of production is based on the economic theory that considers only efficient production. Efficient and productivity methodologies are used in the economy recently to measure the performance of a company. For any firm to acquire a lot of produce, there's the need to invest in several inputs (Elango, 2016). Any mixture of inputs and outputs is considered a technical position if the firm manages to exploit its total capacity of production. Hence, no increase in the production of any output quantity. However, some outputs are divided into two types; desirable and undesirable outputs (Smith & Walter, 2018).

The traditional theory assumes that all firms minimize costs and maximize profits and that any firms that do not attain these do not survive. Total productivity is defined as the total quantity of outputs produced divide by the index of the total inputs used in the production process. The total factor productivity growth has two components; technical and efficiency change. Technical changes involve a change in the production frontier while efficiency change includes the index of a firm's efficiency relative to both the present and past frontiers (Elango, 2016). Also, it is possible for firm productivity to decline either because a firm becomes less efficient or the frontiers shift adversely. Therefore, the activity analysis becomes more complicated since we cannot rely on traditional functions that are to minimize cost or maximize profits and revenue (Kemal & Shahid, 2012).

The emergence of directional output distance function recently takes account of undesirable outputs and provides the best sample of the production technology of insurance companies. Technology production contributes a lot to a directional output distance function. The theory also allows the finding of an optimal production plan which is used to determine an insurance company's optimal quantity for each input, desirable and undesirable output (Kemal & Shahid, 2012). The theory addresses issues concerning profit efficiency and optimal production plan in non-life insurance companies. Modern productivity methods are used a lot recently hence becoming the dominant approach to measuring a firm's performance using accounting data (Sinha et al., 2010).

Discussion between Acquiring an Existing Market Player or Investing in an Insurtech Company

An existing insurer means that the company existed before but is being changed or rebranded or terminated hence the term replacement. Recent developments in the insurance industry embrace insurance technology (InsurTech) innovations. The manifestation of digitalizing is far much ahead and even goes beyond shifting from analog to digital. In this case, insurance companies struggle to be digitalized. Since there's an increase in the economy, there's the need for insurance companies to provide both traditional and technological services to cater for all clients. However, through the use of technology, information reaches a broader audience. This challenges traditional insurers since they are risk carriers (Pinter, 2011).

Insurance consists of the transfer of risks where a customer transfers the risk to an insurer. With technological advancements, companies are brave enough to alter risk parameters by enriching objects like vehicles, houses with sensors and connectivity. The connected items are traceable, programmable, communicable, associable and memorable. Study shows that customers have changed their ways of dealing with insurance to digitized forms (Kemal & Shahid, 2012). Data and technology enable a better risk assessment by insurers. The advantage of technology is that the insurers, the customers, the risks as well as their properties are affected. Research shows that an existing insurance company gives greater value than starting up an insurance company.