Consolidation in Light of Solvency II – The Impact of Mergers and Acquisitions on Insurers’ Default Risk

Abstract

As a result of Solvency II, academics and practitioners anticipate further consolidation in the insurance industry as the new regulatory framework rewards well-diversified insurers with lower capital requirements and challenges smaller insurers to meet the (operational) regulatory requirements. Therefore, this study examines the implications of 478 M&A between 1984 and 2015 on acquiring insurers’ default risk. By employing Merton’s distance to default, we show that mergers increase risk on average. This effect is particularly pronounced for pre-merger low-risk insurers and reinsurers. As Solvency II generally aims to enhance the soundness of the insurance sector and its firms, policymakers should be aware of this merger-related contrary risk effect. By contrast, the analysis also documents that mergers announced during the recent financial crisis were risk reducing. Consolidation can thus have a stabilizing effect on the insurance sector during market turmoil. Finally, the study reveals that merger-related default risk changes are mostly driven by acquirer characteristics and to a limited extent by deal characteristics. In this regard, we find that diversifying M&A strategies provide default risk-reducing diversification benefits. However, most identified determinants differ significantly for life and non-life insurers.

Keywords: Solvency II, Mergers, Consolidation, Insurers, Default risk, Distance to default, Financial Crisis

JEL Classification: G01, G14, G22, G28, G33, G34