Although making acquisitions is a prudent strategy forforward-thinking surplus lines insurance executives seeking tobuild their organizations, potential sellers are unlikely to agreeto lower the deal prices offered, experts recently warned.

The interplay between thoughtful buyers looking to diversifyexisting platforms in a tough market and stubborn sellers couldfuel hostile takeover attempts, predicted Stephen Way, managingdirector of Southwest Insurance Partners. Insurance executives“don't want to sell their companies below book. That's about whatmost of them are worth–certainly according to their current [share]prices,” he said.

“So, hostile acquisitions mightprove to be a little more successful than friendly ones at themoment, because shareholders may be more interested in the M&Aactivity than managements are,” said Mr. Way, whose firm–aHouston-based insurance holding company–was set up in 2007 to makeacquisitions and investments in the insurance industry.

Mark Watson, president and chief executive officer ofBermuda-based Argo Group International Holdings, agreed. “It's hardfor a management team to recommend to its board that it sell itselfbelow book value unless it's hit the wall and it's got nothing elseto do strategically,” he said.

Both spoke at the New York Society of Securities Analystsinsurance conference in New York last month, going on to predictthat the most likely deals will involve large insurers swallowingsmaller ones.

“The energy that goes into integrating some of these businessesis enormous, particularly when you're talking about putting two bigcompanies together,” said Mr. Watson, an experienced strategicbuyer whose company has made roughly a dozen deals of varying sizesover the last 10 years.

“I don't know that you're going to get that much earningsbenefit,” he added. “One-and-one isn't going to equal much lessthan two,” he said, explaining that the only place to generateincreased near-term earnings is through cost savings.

“That is a reason you're likely to see larger companies buyingmuch smaller companies that are more easily digestible,” heconcluded.

Mr. Way went further. “Big companies can buy small companies andfiddle with the numbers more,” he said.

“There were several large acquisitions in the 1990s, wherecompanies were paying two-times book and swearing [deals] wereaccretive when obviously they weren't,” he recalled. “If you're amultibillion-dollar company and you're buying aseveral-hundred-million-dollar company, I guess it can be whateveryou say it is. It's hard to track it anyway.”

With smaller deals, “you can afford to pay a little extra ormake a few mistakes,” Mr. Way said. “You've got to be aggressive inyour forward-looking thinking [and] it's easier to do that with asmaller company than it is with a bigger acquisition.”

Providing examples of forward-looking deals, Mr. Watson saidpast deals at Argo were done to help the insurer “reposition itselfinto different markets and expand its presence in thosemarkets.”

Argo, which in the late 1990s was a West Coast workers'compensation insurer then known as Argonaut, shed that focus whenit acquired Colony Insurance, a U.S. E&S insurer in 2001.

The company later moved into the Bermuda reinsurance market witha 2007 deal to acquire PXRE, and into the London market byacquiring Heritage Underwriting Agency at Lloyd's in 2008.

Other deals for specialty businesses in the United States,including several MGAs, allowed the company to build niches, suchas surety and professional liability.

“A lot of that acquisition activity occurred at the end of thelast soft market,” Mr. Watson said. “It is a good time.”

Still, buyers need to have “intestinal fortitude. You have tomake sure [a deal] supports your strategic goals,” he said. “I'vewatched competitors buy assets because they're cheap, and then theywake up and wonder what they've got their hands around and what dothey do with it all.”

During a question-and-answer session, an analyst, referring toMr. Way's remarks about the possibility of hostile-deal tacticsbeing used in situations where managements and boards are slow tosell, asked whether activist shareholders at target companies mightcatalyze M&A activity.

In the insurance industry, “it's too easy to get around activistinvestors,” Mr. Way responded, suggesting that regulators get inthe way of aggressive takeovers.

“The company only has to get their state to say no, or to saymaybe, and it's all over,” he added. “You don't have to havewritten in your bylaws how to get rid of an aggressive purchaser.You just go to the state and get it taken care of.”

(Editor's Note: Not all the publicly traded E&Sinsurance organizations mentioned in this edition of NUcurrently trade below book. W.R. Berkley, RLI and HCC all trade ator above book value, while Argo and American Safety are trading ata about 50 percent of book values.)