The insurance industry is struggling. Investors, who are struggling to achieve a better return on their money elsewhere, are pouring money into the sector, depressing returns.
However, this influx of capital, along with a lack of natural catastrophes, has left many insurers with plenty of excess cash and many are now predicting a way of mergers across the sector. The first of these deals came at the end of December when New York-listed XL made a ÂŁ2.5bn offer for Lloyd’s of London insurer Catlin. Now other insurers such as Beazley (LSE: BEZ), Amlin (LSE: AML), Hiscox (LSE: HSX) and Lancashire Holdings (LSE: LRE) look approachable.
Away from Lloyd’s, Admiral (LSE: ADM) could also succumb to any industry consolidation.Â
Potential takeover targets
Beazley, Amlin, Hiscox and Lancashire Holdings are all attractive takeover targets thanks to their Lloyd’s exposure. Despite industry-wide pressures, the specialist the Lloyd’s of London to insurance market still remains an attractive place to do business. Â
And these insurers are currently undervalued, as over the past 12Â months or so, investors have fled the sector, fearing falling profits as competition increases. For example, at the end of the first half of last year, Hiscox announced that rates on both its US property catastrophe book and its Japanese earthquake account had slumped by 15%.Â
So, with valuations falling and high levels of capital across the industry, a spate of merger activity looks to be on the cards. Deals will reduce costs, increase financial fire power and help companies gain access to new markets.Â
Long-term play
Still, picking takeover targets is a risky business and almost impossible to get right. With this in mind, the best approach is to invest on valuation and income grounds, not takeover potential.Â
Amlin and Lancashire are the best picks in this respect. At present levels Amlin trade at a forward P/E of 11.2 and offers a dividend yield of 5.9%. Lancashire currently trades at a forward P/E of 9.5 and is set to yield 9.6% next year.
Beazley is also an attractive pick. The company currently trades at a forward P/E of 11 and is set to yield 3.8% next year. If you’re willing to pay slightly more, Admiral makes a great income pick. Admiral is set to offer a dividend yield of 6.7% next year, although it currently trades at a forward P/E of 14.8.Â
Hiscox is the least attractive prospect as the insurer currently trades at a forward P/E of 13.4 and only offers a yield of 3.3%.Â
The bottom line
So overall, with insurance premiums falling and high levels of capital across the industry, analysts believe that the insurance sector is now set for a wave of consolidation. However, trying to pick possible takeover targets is almost impossible but there are plenty of bargains out there.
Amlin and Lancashire are the cheapest picks and these two companies would make great additions to any portfolio.Â