The Impact of Insurance Mergers on Shareholder Returns

Transcription

1 THE IMPACT OF INSURANCE MERGERS ON SHAREHOLDER RETURNS 109 The Impact of Insurance Mergers on Shareholder Returns Jeannie Kusnadi Ahmad Sohrabian University Community Finance, Real Estate and Law This study explores the impact of acquisitions on shareholders return within the insurance industry which took place between 1993 and The results reveal that acquiring firms do not post any significant abnormal returns during the announcement period, while the target firms get positive significant abnormal returns. When acquisitions are analyzed based on transaction price, cumulative average abnormal returns for large acquisitions are significantly higher than for medium-to-small acquisitions. In terms of payment methods, stock acquisitions are the ones with the greatest return. Finally, when acquisitions are grouped based on type, the returns on conglomerate mergers are superior to non-conglomerate mergers. Introduction Mature and overcapitalized, the insurance industry has been involved in mergers and acquisition activities to increase profit and revenue. Acquisitions are the easiest way to expand market share. Furthermore, mergers allow insurers to achieve greater economies of scale and permit a greater investment to modernize the existing technology. The merger activities started a long time ago with a much lower volume and few transactions as compared to recent years. In 1996, insurance mergers and acquisitions set a record in terms of volume and size. The average transaction size increased dramatically where the total reported deals jumped from 349 in 1995 to 382 in 1996, while aggregate dollar volume rose from $27 billion in 1995 to $41 billion in Many studies have been conducted to examine the effect of mergers and acquisitions upon shareholders return. Yet most of them focus on the banking industry or the overall financial services industries. This paper specifically addresses the impact of mergers within insurance industry on shareholders return of acquiring firms and target firms. First, this article analyzes the overall impact of mergers and acquisitions in insurance industry for the period of Then, it analyzes other factors, such as acquisition size, payment methods, and merger type, offer different pattern of returns to shareholders. To investigate the effect of acquisition size, the acquisitions were divided into large acquisitions and medium-to-small acquisitions. Large acquisitions involve all acquisitions with transaction price greater than 1 billion dollars. As for payment methods, the acquisitions were categorized into cash acquisitions, stock acquisitions, and combination of both. Finally, acquisitions based on merger type include conglomerate mergers and non-conglomerate mergers. Conglomerate mergers involve the merger of two firms engaged in different types of business, while non-conglomerate mergers reflect the merger of firms in the same type of business activity. Methodology This section is divided into two parts: data sources and design. The data sources section explains the criteria applied in this study and the data collection process. The design section, on the other hand, describes the procedure of event study conducted in this research.

2 110 AHMAD SOHRABIAN Fall 1999 Data Sources The sample in this study consists of one hundred insurance firms, or fifty mergers, which have announced the acquisitions during the period of In fact, there are much more mergers announced during that period. But, those fifty mergers are the ones that meet the criteria for this study. The followings are several criteria enforced in this study: 1. Both the acquiring firm and target firm s stock has to be traded publicly in New York Stock Exchange (NYSE) or American Security Exchange (AMEX). 2. The return of both acquiring firm and target firm s securities should be available at least from 90 days prior to and 30 days after the announcement date. 3. The information related to merger terms, such as transaction price, announcement date, firm s nature of business, and payment method, must be disclosed. 4. The payment method for transaction must fall into one of these categories: cash, stock, or combination of both. The information about the firms involved in the merger activities was collected from Mergers & Acquisitions (M&A), The U.S. Merger Yearbook, and Wall-Street Journal. Wall- Street Journal Index and/or New York Times were used to verify the announcement dates of the merger. The individual firm s security return and the market return (in this case, valueweighted return) were gathered from CRSP tapes. Design Event-study methodology is used to examine the market response to a merger announcement (Schweitzer, 1989). The ordinary least square (OLS) market model is applied to estimate the abnormal return on a specific stock. The event study procedures in this study are gathered from previous researches by Bowman (1983), Brown & Warner (1980 and 1985), and Kritzman (1994). The following is the formula for OLS market model to compute abnormal returns: where: AR jt = R jt (α + βr mt ) AR jt = abnormal return of stock j on day t R jt = actual return on the j th stock on day t R mt = return on the market index, value-weighted return. α, β = the market model parameter estimates for stock j for the control period (event day 90 through 31). The coefficients estimated were used to compute the abnormal daily returns for the test period (event day 30 to +30) where event day +t(-t) represents the t th trading day after (before) the announcement date (t=0). After computing the abnormal returns for all securities in the sample, the average of abnormal returns (AAR t ) should be calculated during the test period (event day 30 to +30). It is then measured by AAR t = 1 N N AR jt Σj =1

3 THE IMPACT OF INSURANCE MERGERS ON SHAREHOLDER RETURNS 111 where AAR t = average of abnormal return for day t N = number of securities in the sample Cumulative Average Abnormal Returns (CAAR t ) is calculated after AAR t is set. Attention should be focused on CAAR t during the period 1 to +1. Most likely, CAAR t will show dramatic changes around that period as compared to others. The formula for CAAR t is: CAAR t = where k = number of event days before day t CAAR t and AAR t need to be tested for their statistical significance using the t-test. The formula for t-test used in event-study is different from the commonly used t-test. Prior to conducting t-test, the aggregate of pre-event standard deviation of abnormal returns across all securities should be computed. The aggregate of pre-event standard deviation for all securities consists of the standard deviation of abnormal return for each security. The following is the formula for estimating standard deviation of daily abnormal return during the pre-event period (from 90 to 31): t Σ t - k AAR i σ i,pre = 31 Σ 90 AR jt AAR pre 2 n 1 where σ i,pre = standard deviation of abnormal returns of security i estimated from preevent measurement period. AAR pre = average of abnormal returns of security i estimated from pre-event measure ment period. N = number of days in pre-measurement period. The standard deviation of abnormal return for each security, as formulated above, can be aggregated by squaring it, summing these values across all securities, dividing it by the number of securities, and taking the square root of the value. The formula is as follows: σ N,pre = N σ2 i,pre Σi =1 N where σ N,pre = aggregate of pre-event standard deviation of abnormal returns across all securities. N = number of securities Having completed all calculation for aggregate standard deviation of pre-event abnormal return for all securities, the t-test is for AAR t is: AAR t t - stat = AAR t σ N, pre For cumulative average abnormal returns, the t-test formula is:

4 112 AHMAD SOHRABIAN Fall 1999 CAAR t t - stat = CAAR t σ N, pre N t where N t = the absolute value of event day, t, plus 1 (e.g. for event day 30, the absolute value is 30 and Nt = 31). EMPIRICAL RESULTS All of the time series data in the study passed the Durbin Watson test, which indicate the absence of serial correlation. Table 1 shows the list of abnormal returns for both acquiring firms and acquired firm on the announcement date. Among all mergers that occurred in insurance industry during period of , fifty of them are qualified in this study. Twentyseven acquiring firms and nineteen target firms received negative abnormal returns while the rest of them ended up with positive abnormal returns. TABLE 1 Summary of Abnormal Returns on the Announcement Date Acquiring Firms Target Firms Event Day Name AR j0 Name AR j0 7/1/94 General Electric Co Harcourt General Inc /6/93 General Electric Co Reliance Group Holdings /1/93 St Paul Cos, Inc Kemper Corp /26/93 Acordia Inc American Financial Corp /19/93 Wellpoint Health Network Inc UniCare Financial Corp /3/94 Conseco Inc Statesman Group Inc /16/94 General Electric Co Quaker State Corp (Heritage Ins) /1/94 General Electric Co Harcourt General Inc /15/94 American International Group Alexander & Alexander Services Inc /28/94 Integon Corp Travelers Inc /6/94 Hartford Steam Boiler General Re /15/94 Torchmark Corp American Income Holdings /27/94 American International Group th Century Industries /5/94 Columbia/HCA Healthcare HealthTrust, Inc /11/94 Fremont General Corp Casualty insurance (Continental) /10/94 AllState corp Sears Roebuck /14/94 Protective Life Corp National Health Care system /28/94 American General Corp American Brands (Franklin Ins) /6/94 C.N.A. financial Corp Continental Corp /21/94 Healthsource Inc Provident life &accident ins /18/95 C.N. A. financial Corp Alexander & Alexander Services Inc /27/95 Conseco Inc CCP Insurance inc /27/95 Guaranty National Corp Viking Insurance (Xerox) /11/95 First Financial Management Employee Benefits Plans Inc /26/95 American Annuity Group Inc Laurentian Capital Corp /26/95 Conseco Inc Bankers life holding corp /13/95 Sierra Health Services CII Financial inc /10/95 Humana Inc Emphesys financial group inc /10/95 Jefferson-Pilot Corp Household international /18/95 Financial Sec Assurance Hld Capital Guaranty Corp /25/95 Berkshire Hathaway Inc GEICO Corp /5/95 Fund AM Enterprises holdings Zurich Reinsurance Centre

5 THE IMPACT OF INSURANCE MERGERS ON SHAREHOLDER RETURNS 113 9/20/95 SunAmerica Inc Zenith National Insurance corp /13/95 General Electric Capital corp Aon Corp /13/95 SunAmerica Inc Ford Life insurance /28/95 United Heathcare Corp PHP Inc /29/95 Travelers Inc Aetna Life & Casualty Co /26/95 General Electric Co Aon Corp /11/96 Conseco Inc Life Partners Group, Inc /1/96 Aetna Life & Casualty Co US Healthcare Inc /29/96 Provident Cos Paul Revere Corp /7/96 Orion Capital Corp Guaranty National Corp /22/96 Frontier Insurance Group Inc Capsure Holdings /18/96 St. Paul Cos. Inc Allstate Corp /28/96 General Re Corp National Re Corp /2/96 General Electric Capital corp First Colony Corp /26/96 Conseco Inc Bankers life holding /26/96 Conseco Inc Capitol American Financial /13/96 American General Corp Western National Corp /6/96 American Financial Group Inc American Eagle Group Inc /14/96 PennCorp Financial Group Washington National Corp The overall result of abnormal return during announcement date are sixteen acquisition in which the acquiring firms received negative abnormal returns and target firms ended up with positive abnormal returns, eight acquisitions in which the acquiring firms had positive abnormal return and target firms received negative abnormal returns, fifteen acquisitions in which both acquiring firms and target firms experience positive abnormal return, and eleven acquisitions resulted in negative abnormal returns for both acquiring and target firms. The average abnormal returns during the control period ( 30 to +30) for all acquiring firms show none of average abnormal returns are statistically significant, even during the period 1 to +1. Conversely, the average abnormal returns for target firms show significant positive returns of 3.97% on the announcement date at 10% level of significance. The analysis of cumulative average abnormal returns shows that the acquisition has brought positive impacts on the acquiring firm s stock. CAARs started to be on the positive zone since day 18 and dropped to negative zone during day 6 to 4. On the event day, CAAR increased up to 0.83%; then, continued to increase up to 2.70% on day 30. None of these acquiring firm s cumulative abnormal returns are significantly different from zero since t- statistic results were less than the t-table at required level of significant. As for target firms, CAARs indicate that the merger brought one-time positive impact to the firms. CAARs jumped drastically from day 1 to day 0 with the value of 1.87% and 5.85% respectively. From day 0 to day 5, CAARs were statistically significant from zero. Specifically, CAARs on day 0 and day 1 were significant at 0.01, day 2 are significant at 0.02, day 3 are significant at 0.05, and, finally, day 4 and 5 are significant at 0.1 level. In conclusion, this study confirms the previous studies by Dennis & McConnell (1986), and Asquith (1983) that acquiring firms did not receive any significant abnormal returns during the merger period. The acquired firms, on the other hand, experienced significant positive abnormal returns. Furthermore, cumulative average abnormal returns for acquired firms were significantly greater than the one for acquiring firms.

6 114 AHMAD SOHRABIAN Fall 1999 Analysis of Mergers Based on Transaction Size The analysis of mergers based on transaction size is categorized into large merger and medium-to-small merger. Large merger involves all mergers with the transaction value more than 1 billion dollars, while medium-to-small merger captures the deal worth 1 billion dollars or less. There are ten large acquisitions and forty medium-to-small acquisitions. The average abnormal returns for large acquisition were positive for the acquiring firms on day 1 and 0, but they are not statistically significant. For target firms, the average abnormal returns on day 0 and 1 were positive; they were 2.76% and 4.89%. The average abnormal return on day 0 is not statistically significant, but on day 1 is significant at 0.01 level. In medium-to-small acquisition, the average abnormal returns for acquiring firms were 0.052%, 0.41%, and 0.28% on day 1, 0, and 1. They were not statistically significant. Target firms received positive average abnormal returns three days before and after the announcement date. On day 0, the target firms posted a statistically significant positive abnormal return of 4.28% at 0.05 level. Cumulative average abnormal returns (CAARs) for large acquisition was statistically significant on day 1 while the one for medium-to-small acquisition was statistically significant on day 0, day 1, and day 2 with 0.05, 0.05 and 0.1 level of significance, respectively. In summary, CAARs for large acquisitions were greater than the one for medium-to-small acquisitions. These findings confirm the result of previous studies by Chavaltanpipat (1996) and Mandelker (1974) that in medium-to-small acquisition the abnormal returns for acquiring firms were insignificantly different from zero. The research by Asquith (1983), Mandelker (1974), and Jensen & Ruback (1983) also gave the same conclusion as this study that target firm in large acquisitions received significantly positive abnormal returns on the announcement period. In general, both large and medium-to-small acquisitions got positive return, but statistically insignificant, from day 1 to day 1. Nevertheless, cumulative average abnormal returns (CAARs) for large acquisition was statistically significant on day 1 while the one for mediumto-small acquisition was statistically significant on day 0, day 1, and day 2 with 0.05, 0.05 and 0.1 level of significance, respectively. In summary, CAARs for large acquisitions were greater than the one for medium-to-small acquisitions. Analysis of Acquisitions Based on Payment Type The analysis of acquisitions based on payment type were grouped into cash acquisition, stock /securities acquisition, and combination of cash & stock acquisition. In the sample, there are thirty acquisitions in cash, twelve acquisitions in stock, and eight acquisitions in combination of cash and stock. Thus, cash acquisition is the most popular among other categories. The result of cash acquisition analysis shows that the average abnormal returns on the announcement day were positive for both acquiring firms and acquired firms, but they were statistically insignificant. Cumulative average abnormal returns support the fact that the merger brought positive impact to both acquiring firms and target firms. None of CAARs for acquiring firms are statistically different from zero. As for target firms, CAARs on day 0, day 1 and day 2 are statistically significant at 0.05, 0.02, and 0.1 level, respectively.

7 THE IMPACT OF INSURANCE MERGERS ON SHAREHOLDER RETURNS 115 The analysis of average abnormal returns for stock acquisitions gives acquiring firms negative abnormal returns on the announcement day, even though it is not statistically significant. Target firms received positive average abnormal returns on the announcement day. The pattern of CAARs for acquiring firms in stock acquisition increased before the event was announced, which means that the market anticipated the acquisition since day 24. As for target firms, the plot of CAARs shows that market reacted positively to the event starting on day 12. In the combination cash and stock acquisition, the acquiring firms received positive average abnormal returns on the announcement day but it was not statistically significant, while the target firms posted significant negative average abnormal returns. CAARs were positive for acquiring firms, but were negative for target firms. When comparing average abnormal returns and cumulative average abnormal returns across all payment type, the result shows that average abnormal returns for cash acquisition were statistically insignificant during the announcement period. For stock acquisition and combination cash & stock acquisition, they are statistically significant on day 0. This study confirms the previous researches by Travlos (1987) that cumulative abnormal returns in stock acquisition were positive and highly significant. It can be seen from the table that in stock acquisition, CAARs was statistically significant at 0.01 level. As for combination cash & stock acquisition, CAARs were positive on announcement day, but they were negative during the post-announcement period. None of CAARs in cash acquisition or in combination cash & stock acquisition were significantly different from zero. Analysis of Acquisitions Based on Type To simplify the analysis, the acquisitions based on type are grouped into conglomerate mergers and non-conglomerate mergers. Conglomerate mergers include all mergers involving firms with different type of businesses. On the contrary, non-conglomerate mergers capture all mergers in which their acquiring firms and target firms have the same type of businesses. For conglomerate merger, the average abnormal return for both acquiring and target firms were statistically insignificant. On the event day, the acquiring firms posted negative return of 0.067% while the target firms received positive return of 2.844%. CAARs for acquiring firms are statistically significant during the control period. Target firms received positive CAARs during the pre-announcement period and post-announcement period, which indicated that market anticipated the event far before the announcement date. Starting day 1 up to day 14, the positive returns for target firms were statistically significant. In non-conglomerate mergers, average abnormal returns were positive for both acquiring firms even though they were not statistically significant. Acquiring firms received negative average abnormal return one day before the announcement day, but became positive until day 7. Target firms, on the other hand, received positive returns from day 7 to day 3. The result of CAARs analysis for acquiring firms indicates that the market anticipated the merger starting on day 3 and remained on the positive zone until day 30. None of these acquiring firms CAARs were statistically significant. Target firms CAARs jumped drastically on day 1 with 0.836% from the previous day s return of 0.428%. The plot for target firms also verified the one-time positive impact of the merger. CAARs on target firms were statistically significant on day 0, 1, 2, 3, and 4, with t-statistic value of 2.48, 2.89, 2.38, 2.09, and 1.83, respectively.

8 116 AHMAD SOHRABIAN Fall 1999 In summary, conglomerate mergers and non-conglomerate mergers experienced positive insignificant average abnormal returns. CAARs for conglomerate mergers were statistically significant from day 1 to day 4, while the one for non-conglomerate mergers were significant only on day 1. In terms of CAARs, conglomerate mergers received higher percentage than non-conglomerate mergers. Thus, this result confirms the study done by Elgers & Clark (1983) that returns for conglomerate mergers was superior to non-conglomerate mergers. Conclusion The study was conducted to examine the impact of acquisitions for firms in insurance industry. The sample consisted of 50 acquisitions during Event-study methodology was applied to determine the abnormal returns, average abnormal returns, and cumulative average abnormal returns. In this study, the acquisition was analyzed from three different segments, which were acquisitions based on transaction size, acquisitions based on payment method, and acquisitions based on type. The overall analysis showed that acquiring firms did not receive any significant abnormal returns while the target firms posted positive significant abnormal returns. Cumulative average abnormal returns (CAARs) for large acquisitions were significantly larger than for medium-to-small acquisition during the announcement period. Stock acquisitions gave the greatest CAARs on the announcement day across all payment methods. Finally, when acquisitions were analyzed based on their type, the result showed that the returns on conglomerate mergers were superior to non-conglomerate mergers. References Asquith, P. (1983). Merger Bids, Uncertainty, and Stockholder Returns. Journal of Financial Economics, 11, Bowman, R. G. (1983). Understanding and Conducting Event Studies. Journal of Business Finance & Accounting, 10, Brown, S. J. & Warner, J. B. (1980). Measuring Security Price Performance. Journal of Financial Economics, 8, Brown, S. J. & Warner, J. B. (1985). Using Daily Stock Returns: The Case of Event Studies. Journal of Financial Economics, 14, Chavaltanpipat, A. (1996). Bank Acquisition and Stockholder Wealth. Unpublished master s thesis, California State Polytechnic University, Pomona, CA. Dennis, D. K. & McConnell, J. J. (1986). Corporate Mergers and Security Returns. Journal of Financial Economics, 16, Elgers, P. T. & Clark, J. J. (1980, Summer). Merger Types and Shareholder Returns: Additional Evidence. Financial Management, 9, Jensen, M. C. & Ruback, R. S. The market for Corporate Control: the Scientific Evidence. Journal of Financial Economics, 11, Kritzman, M. P. (1994, November). What Practitioners Need to Know About Event Studies. Financial Analysts Journal, 50, Mandelker, G. (1974). Risk and Return: The Case of Merging Firms. Journal of Financial Economics, 1, Schweitzer, Robert. (1989). How Do Stock Returns React to Special Events? Business Review, Travlos, N. G. (1987). Corporate Takeover Bids, Methods of Payment, and Bidding Firm s Stock Return. Journal of Finance, 42,