For 2014, Deloitte expresses optimism that activity will pick up as the worldwide economy improves, insurer capitalization remains high and rate increases moderate.

Click “next” to see the top issues that will impact insurer M&A activity in 2014.

Economic and Market Activity

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Varying economic factors can either spur or discourage M&As in 2014, Deloitte says, and many of the factors in play for 2014 could tip the scale in either direction. After bottoming out in 2013, Deloitte says long-term interest rates will likely modestly increase during 2014, but not “in a way that is anticipated to shift the insurance M&A landscape.”

As a result, Deloitte says the expected low-rate environment could negatively impact investment returns—particularly for capital-intensive/annuity-focused life and health companies—making it more difficult for potential buyers to model improved results post-acquisition. But the low rates do “create an environment where it is easier to obtain and justify debt financing for deals,” Deloitte says, which has particularly been a catalyst for private-equity buyers.

U.S. GDP is improving, Europe is “showing signs of progress and Asia and Latin America are showing strong growth. GDP growth, Deloitte says, will likely stimulate demand for insurance coverage, which could spur M&A activity among insurers looking to expand. However, GDP growth could also allow companies to meet investor expectations solely through organic growth and dampen M&A activity.

Ultimately, Deloitte says economic impacts on M&A activity this year could depend on institution size. Large insurers “need big targets for an M&A transaction to matter,” and with a scarcity of such targets, activity could dampen. Many of these firms, says Deloitte, will look to international M&A in emerging markets. Mid-size insurers, though, will have “more targets in the $250 million to 500 million range and acquiring one or more of these could strengthen a mid-size buyer's product portfolio, market reach, revenue growth or core capabilities.

Regulatory Uncertainty

A regulatory environment that remains in flux has continued to create uncertainty that the “M&A market doesn't like,” says Deloitte. Discussions regarding increasing capital-adequacy requirements, possible tax changes and the designation of insurers as Systemically important Financial Institutions or Global Systemically Important insurers may perhaps continue to deter some companies from engaging in substantial M&A.

For example, Deloitte says companies looking to make an acquisition may consider whether such a move would increase their size and profile to the point where they would be deemed a SIFI, adding an additional layer of regulation at the federal level along with more stringent transparency requirements, restrictions on capital and consumer-protection mandates.

Uncertainty over Terrorism Risk Insurance Act reauthorization could also deter M&A activity until there is a clearer idea of what an extension would look like, Deloitte says, which could drag on for a good portion of the year.

Additionally, as states have begun pushing back against federal-regulation encroachment, they have been more-closely scrutinizing “longstanding business practices and M&A transactions, heightening reputational risk and other costs to insurers,” Deloitte says. The firm says New York, for one, has already “negotiated templates requiring greater oversight and more capital before approving purchases by private equity-related firms.”

Should insurers gain more clarity regarding the direction of regulatory efforts, Deloitte says, firms may become more confident and engage in M&A transactions, even if that clarity comes in the form of increased compliance costs and oversight.

Investment Activity by Private-Equity Firms

Private-equity-firm interest in the insurance industry is expected to continue in 2014, which should spur M&A activity, even outside of private equity's traditional brokerage focus. Deloitte notes that PE buyers have looked beyond brokers and toward the life insurance and annuity space in the low interest-rate environment.

Within the brokerage space, Deloitte notes that PE-backed buyers accounted for about 40% of agent/broker deals in 2013, with HUB responsible for about 10% of the announced deals. Confie Seguros was involved in about 8% of the transactions.

For 2014, Deloitte says some PE firms in the brokerage space may look to “cash out of investments they made a few years ago, which could stimulate additional M&A activity.

But Deloitte notes that PE firms should prepare for more regulatory scrutiny as they wade into the insurance industry. Deloitte says, “those PE firms which have already run the regulatory gauntlet are likely to continue consolidating their insurance-industry holdings. However, firms contemplating market entry via M&A should move promptly if they hope to compete with established players.”

Capital Management

Insurers' current capital position suggests increased M&A activity could be on the way in 2014. Deloitte notes many insurers are holding excess capital, and may look to put it to work in part through M&As. Other companies have capital deficiencies and that could prompt them to exit lines of business or sell the entire enterprise.

Potentially standing in the way is uncertainty over regulatory and rating-agency capital-adequacy requirements. Deloitte notes that there has been tension between insurers and ratings agencies. “Since the financial crisis…insurance industry ratings agencies have not provided much clarity about the amount of capital that is required to achieve certain financial-strength ratings,” says Deloitte, adding that some insurers holding greater amounts of capital have not seen their ratings improve.

“In general, insurance companies have been retaining more capital, including a very liquid, lo-yielding buffer, which should reassure ratings agencies and the investment community that these companies are being prudent in case another recession takes place,” Deloitte says.

And despite concerns, the firm says stockpiling excess capital makes it difficult to achieve an adequate return-on-equity. Many companies, says Deloitte, have adopted a “relatively safe and simple formula” for using the capital, which includes investing some in the core business, designating another portion to acquisitions and returning the rest to shareholders.

Buyer/Seller Expectations

The disconnect between what sellers want and what buyers are willing to pay is shrinking, says Deloitte. Sellers believed during the past year that Wall Street was undervaluing their businesses' worth, the firm notes, but now stock prices are rising, “and with them sellers' confidence that the offered price for an acquisition is more realistic.”

But Deloitte notes that, according to the Wall Street Journal, U.S. companies are paying on average only 19% more than their target's trading price one week before the deal was announced, which is below the historical average of 30%.

Even if the gap between buyers and sellers is shrinking, Deloitte says the decision to sell “is not a given.” From a seller's standpoint, Deloitte says, “Because the economy is improving, there are fewer companies that have to sell their business.”

And for buyers, Deloitte says they may be cautious about paying much more beyond book value “due to continued political uncertainty, industry cycles, a lukewarm economic recovery and the prospect of increasing interest rates.”

M&A Capabilities of Strategic Buyers

Insurers have less infrastructure geared toward identifying and executing mergers and acquisitions in the wake of the recession, says Deloitte.

Large insurers that stayed active during the recession likely have their business-development departments, but “today they may consist of a few dedicated M&A leaders versus larger, multifunctional teams.”

Mid-size carriers, meanwhile, may lack the resources needed to execute a larger scale M&A after reducing budgets and personnel during the recession.

As a result, carriers will have to “work smarter versus harder,” says Deloitte, such as augmenting current staff with part-time specialists, and using technology and data analytics to learn about the strengths and weaknesses of acquisition targets.