Economy spurs insurers to merge, acquire.

Conditions for mergers and acquisitions became favorable again in 2003 for North American insurers after a couple of years of pain and turmoil in the industry. Last year's deals included Sun Life Financial and Clarica Life, Great-West Life and Canada Life, Prudential Financial and American Skandia, and MetLife Inc.'s purchase of John Hancock's group life business. Planned deals include Axa Financial and the MONY Group, Prudential and the retirement business of Cigna, and the blockbuster: Manulife Financial and John Hancock Financial Services. Also, CNA and Safeco announced a willingness to sell insurance or investment businesses.

There are more than 1,200 life insurers in the United States, according to the American Council of Life Insurers' fact book. This industry fragmentation is why mergers and acquisitions are likely when conditions are ripe.

The Manulife/John Hancock stock-for-stock, tax-free transaction would give the new entity a market capitalization at mid-November valuation levels of about $24 billion, comparable in size to MetLife Inc. and larger than Prudential Financial. A.M. Best analysts said the new company, in which John Hancock would be a wholly owned subsidiary, would strengthen existing businesses in the United States, Canada and Asia by adding to scale and market share, and could lead to significant cost savings. In a similar way, the $2.1 billion cash acquisition of Cigna's retirement business is expected to boost Pru's scale and capability and raise its return on equity, said UBS analyst Andrew Kligerman.

Growth in assets during 2003 helped fuel a return to merger-and-acquisition activity, but the drivers are a need for greater capital strength, diverse distribution sources and expense efficiencies, according to analysts Suneet Kamath and Timothy Sledge of Bernstein Research. They said insurers need the capital strength to offer guarantees on death benefits and living benefits. Securities firms and mutual fired companies offer no such guarantees, and banks have the Federal Reserve as a lender of last resort and the Federal Deposit Insurance Corp. to protect deposits. "With no federal backstop, life insurance companies are on their own," they wrote in an October report.

Mergers or acquisitions can also provide a scale advantage. Greater scale can lead to higher returns on equity and the ability to offer lower-cost products to the consumer and/or higher commissions to the seller, said Kamath and Sledge. Bernstein also reported that last year's deals demonstrate better pricing discipline. American International Group, for example, paid a price/book ratio of 5.3 in 1998 for SunAmerica and 2.9 in 2001 for American General. In contrast, Manulife's bid for John Hancock was priced at 1.59 times book value on Sept. 26, Prudential's cash purchase of American Skandia was 0.72 on the announcement date of Dec. 20, 2002, and Axa's bid for the MONY Group was 0.75 on Sept. 17, 2003.

The Bernstein report noted that the life industry has a long way to run in the consolidation game. As of year-end 2002, its top 10 companies controlled 32.2% of industry assets (on a statutory basis to include mutual companies) as compared with 67.4% for the commercial banking industry and 99.0% for securities brokerages.