With a spate of deals in late 2009, the insurance software M&A market is resurgent, with activity being driven by new players as well as long-established market participants. There's also the additional activity caused by new potential investors attracted by the hype around the Verisk IPO and Ebix's coronation as a "hot stock" by Fortune magazine. Amidst all this activity, insurers continue to rely on software vendors to enable critical business functionality, but many feel as if the sands are shifting under their feet.
While analyst estimates vary, the general consensus is that U.S. insurers spend approximately $2 to $4 billion or more on industry-specific software applications per year. However, unlike other industries where a technical monoculture has evolved (e.g. banking) the insurance software market is highly fragmented by size of company, lines of business, distribution model and a market made up of specialized functional components (rating, policy administration, claims, etc.) as well as end-to-end suites.
The marketplace includes what Novarica has termed "Portfolio Players" and "Independent Software Vendors" (ISVs). The Portfolio Players sell multiple solutions or sets of solutions across categories. These players are mostly publicly traded companies, many of which include significant services arms (CSC, CGI, Accenture, TCS) or other software and technology services assets (LexisNexis). Two of the major players in this market, StoneRiver and SunGard, were recently taken private. New entrants to this marketplace include Ebix, Sword Group, and iPipeline. Portfolio Players tend to be strategic acquirers.
The ISVs are mostly privately held companies that tend to focus on a single solution or set of closely linked solutions. There are more than 100 independent software vendors serving various sectors of this market. Insurance ISVs generally fall into one of three categories: "Rising Stars," which enter the market with a new approach and quickly gain traction; "Good Tech, Small Company," many of which are founder-controlled, and have a solid but not rapidly growing customer base or "Stagnating Product Providers," which have large customer bases that generate maintenance and services revenue, but are not adding new clients to their outdated products. Of these categories, the last is by far the largest.
In addition to these there are the tech giants: Oracle, SAP, IBM and Microsoft, some of which (especially the first two) act like Portfolio Players in this market. Oracle made a series of high profile acquisitions in 2008.
Also newly reactivated in this market are private equity and venture firms. While many of these companies were in a holding mode in 2008 and most of 2009, their interest in the sector has been re-ignited.
The pace of M&A in the insurance technology marketplace is likely to accelerate in 2010. This has different implications for insurers, acquirers and targets.
Insurers should make sure they understand in what category their ISV providers are located, and who is likely to buy them or why. For example, acquisitions of a Rising Star or a Good Tech, Small Company provider are likely to result in increased investment in the product, while acquisitions of stagnating product providers are likely to results in forced conversions or migrations. Insurers should also protect themselves as much as possible through contractual means, including demanding base code escrow and service-level guarantees that survive change of control.
Insurers that work with Portfolio Players should seek to understand their acquisition strategies, and what new assets may be brought under their umbrellas.
Strategic acquirers should act quickly. More financial investor attention to the sector, and other well-funded aspiring portfolio companies is likely to mean fewer available targets and higher valuations. Portfolio companies or services companies that have an interest in adding a Rising Star or Good Tech, Small Company ISV to their portfolios should act quickly before those companies disappear from the market.
ISVs who may want to be rolled up might consider themselves in the drivers seat, but they should be aware of the competitive risks of remaining small while their competitors gain access to the deeper pockets and organizational stability of larger companies.
Overall, the consolidation trend is likely to accelerate as smaller vendors look to compete with a growing group of mega-vendors. At the same time, portions of the market are still underserved, and will attract new innovators to keep the emerging mega-vendors on their toes.
Matthew Josefowicz is director of the insurance practice at Novarica, New York.
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