Tokio Marine Holdings Inc [TKOMY: TYO] – Market Cap as of 18/10/2019: $36.95bn (¥4.05tn)

Introduction

Tokio Marine, Japan’s largest non-life insurance company, has agreed to acquire Pure Group: a US-based insurance group majority-owned by private equity players KKR and Stone Point. The deal, valuing Pure Group at $3.1bn, is expected to be funded by a mix of cash and debt and is estimated to close by Q1 2020.

This is the latest in a spree of acquisitions by Tokio Marine. Faced with a shrinking population and negative interest rates in their home market, Japanese insurers are increasingly looking overseas to expand their businesses. Having significantly increased their presence in the U.S. since their initial acquisition of Philadelphia Insurance in 2008, the acquisition of the Pure Group further scales and diversifies Tokio Marine’s product portfolio in the U.S. specialty insurance market

About Tokio Marine

Founded in 1879, Tokio Marine ranks as one of the most globally diversified insurance groups, employing 40,000 employees in 45 different countries. With a market cap of $36.95bn, the company earned revenues of $49bn (in the year ended March 2019), has assets worth $203bn and has a debt to equity ratio of 16.47. Tokio Marine’s core insurance business is divided into three segments: Domestic Non-Life Insurance (51% of core revenue), Domestic Life Insurance (14% of core revenue), and International Insurance (35% of core revenue). It also has a much smaller Financial and General Business segment that offers consulting and asset management services, mostly in the domestic market.

The company has an acquisition focused international growth strategy, spending over $17 billion in overseas acquisitions over the past 11 years (excluding Pure Group). Its acquisitions have largely focused on speciality insurers covering specific industries/liabilities as opposed to general auto, home, and life insurance. This is due to the relatively greater competition in those markets and longer time horizon required to achieve profitability. These acquisitions have increased the international business segment’s contribution to the total profit from 3% in 2002 to 47% in 2019. This highlights the greater profitability of the Tokio Marine’s international operations, contributing 35% of insurance revenue but contributing just less than half of the total profit.

90% of the international segment’s profitability is derived from the U.S. This is a result of three major acquisitions. The company first gained a significant presence in the U.S. in 2008 after its $4.7bn acquisition of Philadelphia Insurance, boosting its pro forma International Business segment earnings by 95%. It then acquired Delphi Financial Group, a firm specializing in property, casualty and workers’ insurance, for $2.7bn in 2011. It later acquired HCC Insurance Holdings, a firm with $11bn in assets that underwrote 100 classes of specialty insurance products, for $7.5bn in 2015. This was the largest acquisition ever by a Japanese insurer. At the same time, the company made numerous bolt-on acquisitions, acquiring 15 smaller companies from 2015 to 2018 to enhance its existing brands. This has made Tokio Marine one of the largest specialty insurance firms in the U.S.

The company is also expanding heavily in Asia, with management aiming to increase the Asia operations’ share of total profits from 5% to 10%. In 2018 alone, Tokio Marine acquired the Thai and Indonesian businesses of Insurance Australia Group for A$525m, Safety Insurance, a Thai company specializing in motor insurance, for A$362 million, and Pt. Asuransi Parolamas, an Indonesian general insurance firm, for A$163 million.

About Pure Group

Pure Group is a U.S. based insurance company specialized in serving high net worth customers. It was founded in 2006 and currently has 800 employees. It was initially capitalized through equity investments from management and Stone Point Capital, a Connecticut based PE firm. It was later re-capitalized in 2015 with additional equity investments from Stone Point and management as well as KKR. As of 2018, the company had approximately $1bn in premiums under management, $230m in revenue, and $52m in profit after tax. The company achieved an average annual organic growth rate of above 20% over the past 12 years.

The firm provides coverage for high-value homes, automobiles, jewellery, art, personal liability, watercraft and flood. Its business model relies on the reduction of risk through the use of a reciprocal exchange. As seen by the diagram above, insurance contracts are written by the Privilege Underwriters Reciprocal Exchange, an unincorporated entity owned by policyholders. The exchange then cedes the majority of the risk to the reinsurance market, with a small part being assumed by Pure’s own insurance subsidiary. The main source of income for Pure is through Pure Risk Management, the management company that operates the exchange (conducting the underwriting, claims and marketing functions) in return for 20% of gross underwritten premiums. Any surplus capital that is accumulated in the exchange is held on the exchange to meet future claims or returned to the policyholder should they leave Pure. This model allows Pure to operate with low capital intensity, with a majority of capital being contributed from policyholders and the utilization of reinsurance, while enjoying stable fee-based income.

Pure also operates as an extremely high-touch company. It proactively provides various loss-prevention measures to clients, providing risk-management personnel to assess clients’ assets/homes and actively enforce safety measures (i.e. changing gas valves for homes in earthquake-prone areas). In addition, Pure provides support to clients after claims to assist them in searching for methods of replacing their damaged assets (i.e finding alternative housing after wildfires). This focus on customer satisfaction is a competitive advantage for Pure, with the company achieving a net promoter score of 79, compared to an average of 38 in the U.S. Home Insurance market, and a policy renewal ratio of 96%.

Industry Analysis

A merger or an acquisition of a competitor remains a key strategy in the insurance industry to increase premium income, by building on their existing offering or accessing new customers and markets. 2018 was plenteous in the sense that as many as 382 deals completed globally, with the year’s largest being AXA’s $15.1bn acquisition of XL Catlin. Even after H2 2018 being marked as the third consecutive period of rising M&A volume, numerous large businesses across the world remain active on the acquisition trail.

Japanese insurance companies have spent more than $50bn on acquisitions over the past five years to become the world’s second-largest buyer of insurance assets, after the US. According to Deloitte’s forecasts, the pace of the deal won’t be slowing down any time soon. The biggest transactions include the $5.7bn takeover of US-based Protective Life by Dai-ichi Life Insurance in 2014, MS & AD’s €5.3bn acquisition of UK underwriter Amlin and the $5bn takeover of StanCorp Financial Group by Meiji Yasuda Life Insurance in 2016.

Among the top three non-life insurance groups, MS&AD Holdings, Sompo Holdings and Tokio Marine Holdings, the share of overseas net premium income has been trending upward, accounting for approximately 25% of net premium income in 2017. In the last few years, Japanese insurance firms have been busy amassing assets in countries, from Australia to the United States, as they struggle to cushion the impact of negative interest rates and a decently mature market at home. As a result, the net premiums written in 2016 of the Japanese P&C market decreased by ¥0.1tn and in 2017 the non-life premium growth slowed to 1.4% from 4% on average between 2009 and 2016.

On the other hand, the high net-worth insurance market is one of the few insurance businesses anticipating strong growth in the United States, as the rate of increase in the number of wealthy individuals exceeds that of the overall population. It is characterised by a stronger client-insurer relationship and more customization than any other insurance, as its business profile is composed of homeowners, automobile, personal excess liability, jewellery, fine arts, antiques & collectables – all being high-value objects. The size of the high net worth market, also called the private client market, is estimated in the range from $27 billion to as high as $80 billion. It is a promising target for insurers looking to grow and diversify, especially since the Chubb acquisition of ACE in 2015, resulting in the consolidation of the two leading high net worth competitors. According to Chubbs estimates there is $33bn uninsured market waiting to be captured while Crestbrook sees the potential of $60bn market, and Chubbs insures only $5bn. After Chubb and ACE became one, W.R. Berkley Corp. has launched a high net worth personal lines brand called Berkley One and several former AIG executives have started another reciprocal for the market called Vault. What’s more, the barriers to entry in this market are not large, especially because the policies are publicly available in the US, which makes them easy to copy.

Deal Structure

Tokio Marine Holdings, Inc. (“TMHD”) is set to acquire 100% of the outstanding shares of Privilege Underwriters, Inc. and its subsidiaries (“Pure Group”) for $3.1bn through TMHCC (“Tokio Marine HCC” – the U.S. subsidiary TMHD purchased for $7.5bn in 2015). According to Tokio Marine Chief Executive Satoru Komiya, the price is “not cheap”, considering its value of 33-times PURE Group’s forecast profit for 2020.

As of September 30th, 2019, the majority of Pure Group was controlled by private equity groups Stone Point (51%) and KKR (31%).

The acquisition terms establish that the deal will be financed through cash and external funding, excluding equity financing. TMHD has said it would as well consider the issuance of subordinated bonds.

Regarding the management of the combined entity, CEO and founder of the PURE Group Ross Buchmueller will remain head of the organization as an independent operating unit under the Tokio Marine Group.

Deal Rationale

The deal comes as a logical response to Japan’s shrinking population, lower domestic interest rates, and growing market pressure on a better return on equity. It may be considered a follow-up of multiple previous strategic moves of Tokio Marine Holdings, as the company has continually extended itself through acquisitions of different insurance groups in the U.S. over the past 11 years.

The acquisition appears to be consistent with Tokio Marine’s M&A strategy criteria in terms of business model, high profitability, and management that will suit Tokio Marine in terms of corporate philosophy.

The transaction will further expand Tokio Marine’s international market presence in both scale and profit. As Pure Group’s business activity has limited overlap with Tokio Marine’s other existing business in the United States, it will therefore further diversify Tokio Marine’s business portfolio and improve its capital efficiency due to Pure Group’s stable fee-based income and its high degree of complementarity with Tokio Marine’s other companies.

Lastly, the transaction will create a combined entity of Tokio Marine’s global strength and Pure Group’s first-rate customer service in the high net worth insurance market, which is one of the few insurance businesses witnessing steady growth in the US. Multiple synergy-creating initiatives will be implemented through the acquisition, such as the expansion of Pure Group’s customer base by cross-selling specialty insurance products to Pure Group customers developed by other Tokio Marine-owned U.S. companies.

Market reaction

Shares in Tokio Marine fell 1.8%, as usually is the case for the buyer, after a Japanese newspaper reported on the deal before the market close. Foreign businesses now account for almost 50% of Tokio Marine’s profits and most of them are coming from the US, leaving Asia and other emerging markets as minor contributors. This could be perceived as shareholders sending the signal to moderate the US investments and turn more actively to Asian, neighbouring markets. However, as the fall was not big, it is also possible it came from an outside shock.

Advisers

Morgan Stanley was a financial adviser to Tokio Marine, while Sullivan & Cromwell provided legal advice. Pure received legal counsel from Skadden, Arps, Slate, Meagher & Flom.

 

 


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