Recently imposed corporate governance regulations could be at the root of a slow down in acquisitions and mergers between businesses, according to reinsurance executives in a panel discussion last week.

The volume of mergers and acquisitions (M&A) has fallen off sharply since a frenzy of activity in the late 1990s, and ACE vice-chairman Donald Kramer cited recent corporate governance legislation, imposed under the Sarbanes-Oxley Act, as the likely cause. He also cited the negative overview that rating agencies had of the industry as having a “depressing effect on rescues”.

The Sarbanes-Oxley Act was enacted last year in an effort to address a loss of investor confidence following such high-profile corporate scandals as WorldCom and Enron that saw shareholders lose their investments. In effect, Sarbanes-Oxley put tighter corporate governance regulations, especially in the area of accounting and reporting, on US listed companies.

Mr. Kramer was first to address the issue when he made a speech to a group of peers last Friday during the Hawksmere 17th Annual International Reinsurance Congress. His comments were seconded by a fellow reinsurance executive who added that complying with Sarbanes-Oxley was a prohibitive expense for the industry.

In his speech, Mr. Kramer said: “In an attempt to correct the corporate abuses of the last two years the US Congress tried to specifically legislate corporate integrity by passing a fairly strict set of corporate governance requirements. It shifts power from the corporate executive to the board, which by its very nature is very risk averse.”

He added the net result of the move could be that company boards would be calling the shots, and may be less inclined to take the calculated risks that management took in the past: “I believe that this will have a negative impact on corporate entrepreneurial spirit,” he said.

Recent M&A figures are a stark contrast to activity in previous years which saw an increase in the late1990s and spiked in 1999 and 2000.

Data from Dealogic, a global provider of investment banking analysis, showed that M&A transactions stood at $464 billion for the first half of 2003 - a fraction of activity seen in past years, and a 33 percent drop off the same period in 2002 which itself was down 45 percent on the year before.

In 1997, $1,618 billion was recorded while activity jumped to $2,432 billion in 1998. M&A's skyrocketed in 1999 when $3,435 billion in activity was recorded. In the US alone, M&A volume reached $1,730 billion - up from $1,630 billion in 1998. In 2000, volume exceeded 1999 levels to a value of more than $3,500 billion.

Last week Mr. Kramer said those days could be past, and pointed out what could happen in the insurance industry: “As to our industry specifically, it will reduce large insurance company acquisitions by making it harder, if not impossible, for one company to take on the historic but uncertain liabilities of another company. As a result deals in the insurance industry will likely be made for new and renewal business rather than for entire corporate entities.”

Looking at examples of what merger activity could look like in this Sarbanes-Oxley era, Mr. Kramer cited recent examples: “You can see this trend in the recently announced RSA-Travelers deal, where Travelers acquired the renewal rights to RSA's USA business. Even more recently White Mountains Folksamerica unit announced that is acquiring the renewal rights to CNA Re's business. These deals signal the fact that the long trend towards consolidation among insurance companies is effectively over. Clearly this will prove a boon to the run-off managers since companies will be unable to shed their liabilities through merger.”

He also pointed to greater scrutiny from rating agencies putting a damper on company take-overs: “The next issue for consideration is the rating agencies. Over the last five years the rating agencies have become the de facto global regulators. In the good old days a company with a combined ratio below 100 percent got an A or better rating from AM Best's and went about its business. Today insurance company ratings have become a virtual licence to do business, regardless of where a company is legally authorised to do business. “The rating agencies have become very, very powerful. Their extensive credit analysis and focus on risk based exposure is commendable. Unfortunately, however, they are operating with a negative bias. Recently both Standard and Poor's and Moody's have issued industry overviews which expressed a negative view of the cycle. This will also have a depressing effect on insurance company rescues since rating downgrades will accelerate the demise of troubled companies once their ratings fall below minimum acceptable levels. More bullishness for the run off companies,” Mr. Kramer said.

In the subsequent panel discussion, veteran reinsurer and CEO of Montpelier Re Tony Taylor agreed with Mr. Kramer that traditional M&A activity could see a decline as company's were wary of taking on any ‘legacy' issues from others.

Speaking from his company's perspective, Mr. Taylor said: “We are quite often approached about companies to buy, but we don't want to buy anyone's history.”

He added that his company was “heavily involved” with complying with Sarbanes-Oxley: “This is major work for us and for the industry,” he said, adding that the cost of compliance was “enormous”. Mr. Taylor added that Montpelier Re - which was set up in late 2001 and is one of Bermuda's newer companies - would do nothing to dirty the clean slate it has: “As the new guys, we don't have any of the problems...”

Mr. Taylor added it was critical to their success to guard against any adverse developments to ratings as that could ultimately impact business with a new ‘downgrade clause' written into almost all reinsurance contracts. In effect, the new contracts state that if the reinsurers' rating falls below a certain level the policy is considered cancelled and premium returned to the insurer.