An Evaluation of Merger and Acquisition on the Insurance Company on the Nigerian Economy
Chapter One
Objective of the Study
To analyze the effects of mergers and acquisitions on the insurance company on the Nigerian economy.
CHAPTER TWO
LITERATURE REVIEW
Introduction
This section draws on literature in the area of M&A. Secondary materials such as books, journals, and articles that carry precious research work on the study topic are analyzed. The material is of importance to this study as it forms a basis for observation which will be made during the study in line with the study objective.
Theoretical Review
This section looks into the theories on M&A. It looks at the different schools of thought of different scholars and how they view mergers and acquisitions. There are three broad categories of arguments about the value relevance of M&As namely: production theory, market imperfections theory, market power theory, and corporate control theory among others.
Production Theory
In terms of economic production theory, firms operate with cost, revenue, and profit functions, all of which could be affected by M&As. One rationale often given for M&As is economies of scale, usually associated with the cost function. The argument is that firms operating at sub-optimal scale may be able to achieve scale gains more quickly through M&As than through normal growth. Although evidence on the potential for scale economy gains in various industries is mixed (Cummins & Xie 2008), scale economies may provide a potentially valid motivation for M&As. Economies of scope provide another production theory rationale for mergers and acquisitions. Scope economies can be present for costs, revenues, and profits. Cost economies of scope generally arise from the joint use of inputs such as managerial expertise, customer lists, computer technologies, and brand names. Revenue economies of scope are often said to arise due to reductions in consumer search/acquisition costs and improvements in service quality from the joint provision of related products such as life insurance and automobile insurance. In some US insurance industries for example Berger (2007) provides evidence that scope economies are present.
Potential gains in across-company efficiency provide another production-based rationale for M&As. Across companies, inefficiency arises when firms fail to operate on the cost, revenue, or profit frontiers but rather incur higher costs or earn lower revenues because of various inefficiencies. A potentially important justification for M&As is to improve the efficiency of the merger target, e.g. by replacing inefficient managers or introducing superior technology possessed by the acquiring firm. There is some evidence that insurance M&A transactions have led to efficiency gains in the US life and personal lines insurance industries (Cummins & Xie 2008), and the Spanish insurance industry (Cummins & Rubio-Misas, 2006).
Market Imperfections Theory
According to Cooper et al. (2000), M&As also may be value-relevant due to the existence of various market imperfections/information asymmetries. One important market imperfection is the existence of costs of financial distress. Financial services firms such as banks and insurers face stringent solvency regulation which creates the potential for financial distress costs. Insurers who are over-leveraged or in weakened financial condition for other reasons incur increased regulatory costs and potential operating restrictions. Moreover, because buyers of insurance are especially sensitive to insolvency risk, insurers in deteriorating financial health are likely to lose their best customers to rivals. Because larger insurers have lower insolvency probabilities (Cummins et al., 1999) argue that M&As can be beneficial to the extent that increases in scale are accompanied by reductions in income volatility due to enhanced diversification. The existence of corporate income taxation also provides a rationale for M&As as a possible mechanism for increasing net cash flows.
Financial synergies theory in yet another way puts it that, with asymmetric information in financial markets, a firm with insufficient liquid assets or financial slack may not undertake all valuable investment opportunities (Myers and Majluf, 1984). In this case, the firm can increase its value by merging with a slack-rich firm if the information asymmetry between the two firms is smaller than that between the slack-poor firm and outside investors.
Market Power Theory
Choi and Weiss (2005) argue that M&As can also create value if they increase firm market power, allowing the post-merger entity to earn higher economic rents. However, this rationale for market-value gains is questionable in some industries such as the US personal lines insurance industry. The study by Choi and Weiss (2005) does not support the structure-conduct-performance hypothesis that concentration and larger firm size lead to market power and anti-competitive conditions.
CHAPTER THREE
RESEARCH METHODOLOGY
Introduction
This chapter sets out various stages and phases that were followed in completing the study. It is a blueprint for the collection, measurement, and analysis of data. It gives the plan and structure envisaged to aid the researcher in answering the raised research question. Specifically, the following subsections should be; research design, target population, data collection instruments, data collection procedures, and finally data analysis.
Research Design
This study adopted a survey research design. Kraemer (1991) defined as survey research design as a research design used to quantitatively describe specific aspects of a given population by examining the relationships among variables. Survey research uses a selected portion of the population from which the findings can later be generalized back to the population. As of the year 2012, only 3 insurance companies in Nigeria had undergone a merger, and data for only one insurance firm namely IRCSL was readily available and complete. Consequently, the researcher considered a survey research design as ideal at present.
Population of the Study
According to the Insurance Regulatory Authority Annual Report (2012), there were 35 general insurance companies registered to transact insurance business in Nigeria. This being a case study, the population of the study was Insurance Resourcery Consultancy Services Limited.
CHAPTER FOUR
DATA ANALYSIS, FINDINGS AND INTERPRETATION
Introduction
This chapter presents analysis of the data found. The study used the data obtained for Insurance Resourcery Consultancy Services Limited to represent all insurance companies that had undergone a merger and / or acquisition making a representative rate of 100%. To date only three insurance companies in Nigeria had undergone a merger.
CHAPTER FIVE
SUMMARY, CONCLUSION AND RECOMMENDATIONS
Introduction
The essence of this last chapter is to give an overview of the research paper, make significance conclusions based on the findings of the study and make recommendations in regards to the effects of mergers and / or acquisitions on the insurance company on the Nigerian economy.
Summary
The idea to investigate the outcome of mergers and /or acquisitions of the insurance company on the Nigerian economy was informed by their increasing number in the insurance sector in Nigeria. To date, three insurance companies in Nigeria had undergone a merger.
UAP Insurance Company Limited formed in 1994 after the merger of Union Insurance and Provincial Insurance following the merger of their parent companies, UAP of France and Provincial of the UK; Insurance Resourcery Consultancy Services Limited formed in 2003 following the merger of Great Nigeria Insurance General divisions; ICEA LION Group formed in 2012 after the merger of Lion of Nigeria Insurance Company Limited and Insurance Company of West Africa.
The research design was a case study that relied heavily on secondary data from published financial statements of insurance companies. Data was analyzed on the basis of descriptive statistics. The study sought to establish the association (significance) between the means of the pre and post-merger and acquisition performances of insurance companies in Nigeria using a paired t-test statistic. The study used a five-year average annual profitability of the insurance companies, pre and post-merger. To compare the two paired profit before tax values (such as in a before-after situation) where both observations are taken from the same or matched subjects, a paired t- test was perform.
Carrying out paired t-test statistic, the mean profit before tax was 316.2, with standard deviation of 405.598 for 5 observations was significantly greater than zero, t(4)=1.74, two-tail p = 0.16, providing evidence that the merger is effective/significant on the financial performance of the insurance company. A 95% confidence interval about mean weight loss was (187.42, 820.02) hence rejecting the null hypothesis. By carrying out regression tests, it was possible to confirm the relationship between mergers and financial performance where it was found out that the two have a strong relationship. However, the regression analysis could not be used exclusively since it was found out to be much lower than the residual figures hence confirming that financial performance of insurance companies were affected to a large extent (67%) by other factors other than mergers/acquisitions (33%)
Conclusion
Given the desire of the Nigerian insurance industry to embrace information technology, research and innovation, thereby expanding its capacity to exploit the existing untapped insurance market, this is likely to see sustained cost pressures, together with stringent advancements in the regulatory environment this is expected to enhance insurance penetration and risk management will in turn put a lot of pressure on the independent local insurer. Statutory demands for a stronger capital base and solvency margins, demand for insurance which is also expected to rise as the recent natural catastrophes in Japan and Oceania have highlighted the importance of insurance in mitigating financial impact of catastrophes events; all this put together will see mergers as the only strategic option to the independent insurer in order to remain competitive and profitable in the long-run.
On a paired t-test statistic test, the study established an association between mergers and the insurance company on the Nigerian economy with a P value of P=0.16 and ttest t=1.74 at 95% confidence level. The findings show that insurance company performed well over the period of study after the merger.
Recommendation for Policy
According to “Africa Reinsurance Corporation 2011, Annual Reports and Accounts”, the year 2011 was in many ways very bad for property / casualty insurers and reinsures. Surprisingly, heavy catastrophe losses hit the industry even where they were not expected, in the previously called “cold spots”. It is believed that the earthquake and tsunami in Japan (above US$ 35billion incurred losses), the earthquake in New Zealand, the floods in Thailand and other natural perils caused over 30,000 deaths and US$350 billion total economic losses compared with US$226 billion in 2010. Insured catastrophe losses of above US$103 billion could be the costliest year for the industry. As a result of this, struggles to maintain a stable outlook for 2012 from major credit rating agencies (CRA), the uncertainty of the pricing improvement level, the low investment return environment and the limitations of the reserves release to support future earnings will see mergers among other common avenues such as the strength of surplus capital and enterprise risk management capabilities a viable option for the insurer.
In addition, according to “Africa Reinsurance Corporation 2011, Annual Reports and Accounts”, regulation is believed to be another big issue weighing down on the insurance and reinsurance industry in the years to come. As the implementation deadlines approaches, insurers and reinsurers are bracing to face the new requirements of sophisticated risk management, possible capital increase and high compliance costs. Keeping up with the focus on growth with profitability and to grow premium income by a greater percentage across all business lines, effort to deal with claims expeditiously and pro-actively, to settle claims and outperform the market, make adequate provisions for outstanding claims, develop new products that are not only flexible but the are also targeted at the uninsured populace of the society whilst adding value, are part of challenges that engulf the insurance industry and its players.
The fundamental aim of mergers and acquisitions (M&A) is the generation of synergies that can, in turn, foster corporate growth, increase market power, improve production efficiencies, boost profitability, and improve shareholders‟ wealth. Accordingly, M&A should constitute positive net present value projects. The synergies that come by as a result of the merger will alleviate the above mentioned challenges facing the insurer / reinsurer.
In this study, by carrying out regression tests, evidence obtained supported and confirmed the relationship between mergers and financial performance where it was found out that the two have a strong relationship. The resulting merged entity performed better financially after the merger.
The paired t-test statistic, the mean profit before tax was 316.2, with standard deviation of 405.598 for 5 observations was significantly greater than zero, t (4) =1.74, two-tail p = 0.16, providing evidence that the merger is effective/significant on the financial performance of the insurance company. Based on this evidence collected from the study, the researcher is for policy that insurance companies should go for for mergers / acquisitions to enable the insurer / reinsurer alleviate the above challenges among others engulfing the insurance industry in Nigeria.
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