Mergers and acquisitions activity in the insurance industry waslower than expected in 2013, as buyers and sellers remained at oddson values, regulatory uncertainty continued and economic recoveryremained tepid, according to Deloitte.

U.S. activity—which accounts for more than 40% ofglobal-insurance M&A activity—fell by 60% in 2013, saysDeloitte. And beyond the decrease in the number of deals, the firmsays there was a “significant decline in the reported aggregatedeal value and average deal value, due in part to fewer “large,transformative deals in the marketplace.”

Property and casualty fared better than life and health in thisregard though. P&C transactions actually saw an increase in2013 with respect to aggregate deal volume and average deal size.Deloitte says there were four transactions in excess of $500million in 2013 versus one in 2012. Still, even in P&C, the“majority of the transactions were…of the smaller, bolt-on type,”Deloitte says.

The broker/agent segment continued to be the most active forM&As, but even this segment suffered some under 2013's economicconditions and saw a decrease in transactions compared to 2012.

For 2014, Deloitte expresses optimism that activity will pick upas the worldwide economy improves, insurer capitalization remainshigh and rate increases moderate.

Click “next” to see the top issues that will impact insurerM&A activity in 2014.

Economic and Market Activity

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Varying economic factors can either spur or discourage M&Asin 2014, Deloitte says, and many of the factors in play for 2014could tip the scale in either direction. After bottoming out in2013, Deloitte says long-term interest rates will likely modestlyincrease during 2014, but not “in a way that is anticipated toshift the insurance M&A landscape.”

As a result, Deloitte says the expected low-rate environmentcould negatively impact investment returns—particularly forcapital-intensive/annuity-focused life and health companies—makingit more difficult for potential buyers to model improved resultspost-acquisition. But the low rates do “create an environment whereit is easier to obtain and justify debt financing for deals,”Deloitte says, which has particularly been a catalyst forprivate-equity buyers.

U.S. GDP is improving, Europe is “showing signs of progress andAsia and Latin America are showing strong growth. GDP growth,Deloitte says, will likely stimulate demand for insurance coverage,which could spur M&A activity among insurers looking to expand.However, GDP growth could also allow companies to meet investorexpectations solely through organic growth and dampen M&Aactivity.

Ultimately, Deloitte says economic impacts on M&A activitythis year could depend on institution size. Large insurers “needbig targets for an M&A transaction to matter,” and with ascarcity of such targets, activity could dampen. Many of thesefirms, says Deloitte, will look to international M&A inemerging markets. Mid-size insurers, though, will have “moretargets in the $250 million to 500 million range and acquiring oneor more of these could strengthen a mid-size buyer's productportfolio, market reach, revenue growth or core capabilities.

Regulatory Uncertainty

A regulatory environment that remains in fluxhas continued to create uncertainty that the “M&A marketdoesn't like,” says Deloitte. Discussions regarding increasingcapital-adequacy requirements, possible tax changes and thedesignation of insurers as Systemically important FinancialInstitutions or Global Systemically Important insurers may perhapscontinue to deter some companies from engaging in substantialM&A.

For example, Deloitte says companies looking to make anacquisition may consider whether such a move would increase theirsize and profile to the point where they would be deemed a SIFI,adding an additional layer of regulation at the federal level alongwith more stringent transparency requirements, restrictions oncapital and consumer-protection mandates.

Uncertainty over Terrorism Risk Insurance Act reauthorizationcould also deter M&A activity until there is a clearer idea ofwhat an extension would look like, Deloitte says, which could dragon for a good portion of the year.

Additionally, as states have begun pushing back againstfederal-regulation encroachment, they have been more-closelyscrutinizing “longstanding business practices and M&Atransactions, heightening reputational risk and other costs toinsurers,” Deloitte says. The firm says New York, for one, hasalready “negotiated templates requiring greater oversight and morecapital before approving purchases by private equity-relatedfirms.”

Should insurers gain more clarity regarding the direction ofregulatory efforts, Deloitte says, firms may become more confidentand engage in M&A transactions, even if that clarity comes inthe form of increased compliance costs and oversight.

Investment Activity by Private-Equity Firms

Private-equity-firm interest in the insuranceindustry is expected to continue in 2014, which should spur M&Aactivity, even outside of private equity's traditional brokeragefocus. Deloitte notes that PE buyers have looked beyond brokers andtoward the life insurance and annuity space in the lowinterest-rate environment.

Within the brokerage space, Deloitte notes that PE-backed buyersaccounted for about 40% of agent/broker deals in 2013, with HUBresponsible for about 10% of the announced deals. Confie Seguroswas involved in about 8% of the transactions.

For 2014, Deloitte says some PE firms in the brokerage space maylook to “cash out of investments they made a few years ago, whichcould stimulate additional M&A activity.

But Deloitte notes that PE firms should prepare for moreregulatory scrutiny as they wade into the insurance industry.Deloitte says, “those PE firms which have already run theregulatory gauntlet are likely to continue consolidating theirinsurance-industry holdings. However, firms contemplating marketentry via M&A should move promptly if they hope to compete withestablished players.”

Capital Management

Insurers' current capital position suggestsincreased M&A activity could be on the way in 2014. Deloittenotes many insurers are holding excess capital, and may look to putit to work in part through M&As. Other companies have capitaldeficiencies and that could prompt them to exit lines of businessor sell the entire enterprise.

Potentially standing in the way is uncertainty over regulatoryand rating-agency capital-adequacy requirements. Deloitte notesthat there has been tension between insurers and ratings agencies.“Since the financial crisis…insurance industry ratings agencieshave not provided much clarity about the amount of capital that isrequired to achieve certain financial-strength ratings,” saysDeloitte, adding that some insurers holding greater amounts ofcapital have not seen their ratings improve.

“In general, insurance companies have been retaining morecapital, including a very liquid, lo-yielding buffer, which shouldreassure ratings agencies and the investment community that thesecompanies are being prudent in case another recession takes place,”Deloitte says.

And despite concerns, the firm says stockpiling excess capitalmakes it difficult to achieve an adequate return-on-equity. Many companies, says Deloitte, have adopted a “relatively safe andsimple formula” for using the capital, which includes investingsome in the core business, designating another portion toacquisitions and returning the rest to shareholders.

Buyer/Seller Expectations

The disconnect between what sellers want andwhat buyers are willing to pay is shrinking, says Deloitte. Sellersbelieved during the past year that Wall Street was undervaluingtheir businesses' worth, the firm notes, but now stock prices arerising, “and with them sellers' confidence that the offered pricefor an acquisition is more realistic.”

But Deloitte notes that, according to the Wall Street Journal,U.S. companies are paying on average only 19% more than theirtarget's trading price one week before the deal was announced,which is below the historical average of 30%.

Even if the gap between buyers and sellers is shrinking,Deloitte says the decision to sell “is not a given.” From aseller's standpoint, Deloitte says, “Because the economy isimproving, there are fewer companies that have to sell theirbusiness.”

And for buyers, Deloitte says they may be cautious about payingmuch more beyond book value “due to continued politicaluncertainty, industry cycles, a lukewarm economic recovery and theprospect of increasing interest rates.”

M&A Capabilities of Strategic Buyers

Insurers have less infrastructure gearedtoward identifying and executing mergers and acquisitions in thewake of the recession, says Deloitte.

Large insurers that stayed active during the recession likelyhave their business-development departments, but “today they mayconsist of a few dedicated M&A leaders versus larger,multifunctional teams.”

Mid-size carriers, meanwhile, may lack the resources needed toexecute a larger scale M&A after reducing budgets and personnelduring the recession.

As a result, carriers will have to “work smarter versus harder,”says Deloitte, such as augmenting current staff with part-timespecialists, and using technology and data analytics to learn aboutthe strengths and weaknesses of acquisition targets.