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It is not often that an AIM newcomer initiates merger talks with a larger, long-established, fully-listed and well-regarded company in the same sector. That is what Omega Underwriting, the Lloyd’s insurance company brought to AIM in April by stockbroker Numis, did when it opened approaches to Hardy Underwriting at the beginning of July. The plan was to create an enlarged entity with a market value of £120 million.

Omega, whose successful Lloyd’s Syndicate 958 specialises in short-term property insurance and reinsurance, is one of two London market insurance players brought to AIM in 2005 by Numis, the other being the somewhat larger Advent Capital, headed by veteran market figure Brian Caudle, whose successful Syndicate 780 has a more traditional ‘seat of the pants’ volatile reinsurance profile. They have both come aboard in the middle of what several corporate financiers and institutions had expected would be a period of frenzied consolidation, with juicy bids and deals aplenty, though as yet a number have stalled.

Disagreement over valuation is usually blamed when these problems arise. Not everyone can have as smooth a run as the directors of professional indemnity specialist PIH which floated on AIM at the height of the insurance premium cycle only to be almost immediately taken over at a handsome premium.

Strong willed players
Most Lloyd’s insurance companies are the creations of strong-willed underwriters — often with remuneration packages larger than some smaller AIM companies’ market capitalisations — who have decided opinions about their own worth and that of their peers. That can be a stumbling block, even in an increasingly institutional market place.

Several institutions with holdings in both Omega (valued at £43 million) and Hardy (tagged at £77 million), such as Fidelity, Hermes and the Prudential, are understood to have supported the idea of merging the two, but exploratory talks broke down over terms. The Takeover Panel gave Omega until noon on 1 August to put a bid on the table or withdraw, thus putting another institution, Phoenix Asset Management, with 17 per cent of Hardy, in a key position.

Although Phoenix had only shortly beforehand tried unsuccessfully to shift top management at Goshawk, a Lloyd’s insurance group seen as emerging from a more turbulent recent past, Hardy cited it as one of its own institutional holders which had said they were ‘not minded’ to accept the merger terms at that point mooted by Omega. But Phoenix has an influential voice in the ultimate resolution of Hardy’s future.

Much talk but less action — so far
Elsewhere in and around Lime Street, other deals have been proposed — and foundered. Amlin, one of the larger groups with a market tag of £717 million, sought to conclude an agreed bid with the much smaller Chaucer group, where the largest sector player Brit Insurance has nine per cent, but, though both have significant motor business, Chaucer could not agree terms.

Meanwhile, Chaucer is one of the companies with which motor-oriented Highway has over the past 12 months been in talks about possible deals. Another is Cox, which recently lured away Highway’s chief executive Andrew Gibson to steer its own progress.

The logic was clear, even more in ‘commoditised’ insurance sectors such as motor than in more ‘niche’ areas. With insurance premiums in the London market well down from their 2003 peaks and international competition remaining formidable, insurers focused on the specialist areas of cover traditionally written by Lloyd’s insurers are minnows in terms of size — the combined written premiums of Lloyd’s insurers amounted to £8.8 billion last year representing only 2.1 per cent of the world total.

With tougher capital requirements now imposed by Lloyd’s and insisted upon elsewhere by the powerful credit rating agencies, the case for combining to cut costs and increase market clout seemed clear. Hardy, steered by formidable chief executive officer Barbara Merry, has long been well regarded for its policy of sticking to ‘short-tail’ insurance cover in property and other sectors, though a recent foray into financial insurance and political risk knocked profits last year, partly because of a bank fraud in Italy.

Omega, whose star underwriter and key shareholder John Robertson is seen as having an impressive track record, wanted to do a deal with Hardy based on ‘the value of the existing business and new business pipelines of both’. Some in the Omega camp suggest Hardy’s coyness reflects a wish by its top brass to keep their positions and suggest Omega, poised to show some good results shortly, could find other fish to fry in the sector.

Where the value is
Merging and acquiring these specialised and comparatively small companies is complicated by the fact that they are ‘people businesses’, whose key players must be kept sweet to retain their value. In the words of Shore Capital analyst Eamon Flanagan, ‘the premium over net assets can walk out of the door’.

The business of insurance is naturally volatile, with premium rates, interest rates and exchange rates all making a big impact, over and above the claims and underwriting results achieved. Premium rates trebled between 2001’s World Trade Center attack and 2003, and, argues Flanagan, are still only 15 to 20 per cent down on average, with catastrophe premium falls in particular curbed by hefty hurricane losses last year. Analyst Charles Coyne of broker KBC Peel Hunt points out that Amlin has scored a return on equity of significantly more than 20 per cent for three years, but warns of its high gearing at 180p.

Brit could be a large-scale merger candidate at 87p, Hardy at 219p represents sound quality but hangs on corporate moves, as does Omega at 109.5p. Kiln at 93p looks relatively well placed, with SVB at 24.25p a bold recovery speculation and Atrium at 209.5p offering long-term possibilities.