Underwriting firms face acquisition, mergers over poor capitalization

Matthew Otoijagha

More than two-thirds of insurance companies are valued below the minimum capital requirement to operate in the lowest rung of the proposed new insurance capital base, making most insurers susceptible to aggressive mergers and acquisitions.

Current valuation of insurance companies obtained at the weekend showed that some 70 per cent of insurance companies are valued below the N5 billion required to operate as a composite tier- 3 insurance company under the planned minimum capital requirements. Only 15 per cent of insurers meet the N15 billion requirement while 15 per cent meet the N5 billion for the second-tier composite operator.

While regulators use the book value or shareholders’ fund as a measure of regulatory compliance, investment experts agreed that market value is a major component in any corporate valuation. Market value is usually ahead of book value because of the wealth creation potential and future value accretion of the book value. A reversal poses challenges in the event of capital raising and mergers and acquisition, according to investment pundits.

Chief Operating Officer, GTI Capital, Mr. Kehinde Hassan, said market valuation is one of the criteria for valuation of a company for any purpose of new share issuance or mergers and acquisitions.

According to him, corporate finance experts use market value, net asset value or book value, peer group analysis and scenario analysis to reasonably ascertain possible valuation for a company. The financial ratios tend to revolve around a range and any value significantly outside the range is usually treated as an outlier and removed in the calculation of the pricing average.

Hassan said low market valuation might have strong influence on the overall valuation of a company as strategic investors may only at best offer slight premium on market value of a company. In a hard-pressed situation, large investors may demand for market-based value or offer price around the pricing range.

Managing Director, Sofunix Investment and Communications Limited, Mr. Sola Oni said low valuation is a possible trigger for aggressive mergers and acquisitions as low-capitalized companies may find it difficult to raise required capital in the event of massive capital raising exercise by many companies.

According to him, market valuation, though not absolutely the exact determinant of the value of a company in all cases, it is a major indicator of the health of a company and over a period of time, the true reflection of its worth.

“If a company is struggling to meet shareholders’ expectation, such a company is a target for acquisition. Strategic investors usually look for low valuations and synergies and for a company under pressure of minimum capital requirement, the market valuation may play a big role in the negotiation,” Oni said.

He noted that one of the immediate expectations from the implementation of the new tier-based capital by the National Insurance Commission (NAICOM) is mergers and acquisitions, which may lead to historic consolidation of the insurance sector.

Citing the example of the Nigerian banking industry, Oni said consolidation, though somewhat a bitter pill, it may be the much-needed tonic to boost investors and customers’ confidence in the sector, adding that capitalization is a major requirement for global competitiveness.

“Investors’ confidence in the insurance sector is low, so there is the need for a turnaround of the sector. Consolidation may lead to such turnaround. However, the current low valuations also present good opportunities for discerning investors who can see into the future, who know that Nigeria as a growing country cannot exist without a viable insurance sector, to take positions ahead of the repositioning of the sector,” Oni said.

Most of the insurance companies are trading below their 50 kobo nominal value. Investment experts agreed that boards of insurance companies may find it difficult a decision to offer shares below nominal value.

Under the new NAICOM’s tier-based minimum solvency capital policy, insurers will be classified into three tiers according to the minimum capital base and risk-bearing capacity. Tier 1 insurance companies are required to have minimum capital base of N9 billion for general insurance and N6 billion for life insurance, implying a composite capital base of N15 billion.

Tier 2 companies are divided into two categories, with N4.5 billion minimum capital base for general insurance and N3 billion for life assurance. Thus a composite insurance-general and life insurance will be required to have minimum capital base of N7.5 billion.

Tier 3 companies will continue to operate on the existing minimum capital base of N3 billion for general insurance and N2 billion for life insurance, implying a composite capital base of N5 billion for a composite tier 3 insurance company.

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