If you believe consolidation is happening, why wouldn’t you want to get out in front and choose your own partner?

That’s the simple way that Stephen Catlin, founder and CEO of Catlin Group Limited, explained how he and XL Group CEO Mike McGavick independently decided to talk about combining their companies.

Catlin addressed the unasked question of how the $4.2 billion cash/stock deal to create XL Catlin came about during a conference call on Friday morning. His remarks came after McGavick described how the union of the companies will meet strategic goals of each company—XL seeking to build out specialty expertise, and Catlin aiming to create regional hubs around the world—without the associated expense drag each faces on its own.

With $10 billion in premiums and capital of $17 billion, the combination of XL and Catlin creates an organization that is almost instantly relevant to clients and brokers, the groups’ leaders said.

Mind you, they could continue to go it alone but it’s a tougher slog to move forward in the current manner, noted McGavick, who is more often a champion of organic growth and innovation during public presentations. He agreed with Catlin that industrywide changes are so clearly in the cards that the two executives felt the need to make the first move as the table stakes start increasing around them.

“It was clear to us that the conversation was changing. We were hearing clients who wanted—and expected—more efficiencies from having bigger lines from fewer players. We were hearing more demands from brokers,” who are growing themselves as they continue to acquire, McGavick said.

“We were able to overcome [that] by constantly changing what they needed from us so they had to keep coming back,” he continued. Adding that XL’s pursuit of “constant innovation…will not change,” McGavick observed: “We were seeing that others were having different conversations—conversations that I would characterize as easier. If you were larger, the opportunities presented, the leverage created by the brokers was simply different….

“We overcame that. But to say we overcame it, doesn’t mean it wasn’t harder,” he said.

Catlin said the two executives “independently decided that the talk of consolidation that was going on in the marketplace was going to move from talk to action.

Stephen Catlin
Stephen Catlin
“If you believe that, then why wouldn’t you be on the front foot and be proactive rather than on the back foot and be reactive?”

Stephen Catlin, Founder and CEO, Catlin Group Limited

“If you believe that, then why wouldn’t you be on the front foot and be proactive rather than on the back foot and be reactive? Why wouldn’t you want to choose the partner you wanted to work with rather than have it chosen for you?”

McGavick said, “This is entirely an act on the offense to move forward into what we see as shifting sands in the insurance sector.”

Addressing his usual bent towards organic growth instead of M&A, said, “To have a bias doesn’t mean that you should ignore what is going on in the sector—and the sector forces are a big deal. Nor should you be blind to a genuine opportunity that’s powerful,” he added.

XL is the acquirer in the deal that represents a 23.5 percent premium to Catlin’s Dec. 16, 2014 closing share price (marking the date when the parties publicly confirmed deal rumors). XL will acquire all Catlin outstanding shares for roughly $4.1 billion and Catlin intends to pay a final dividend of approximately $100 million to its shareholders, XL CFO Peter Porrino said during the conference call.

Eighth Largest Reinsurer; Second Largest in Prop Cat

Speaking to the power of the combination, McGavick listed three specific ways the two organizations fit together strategically and financially, noting at one point that all the potential pluses, including the prospect of $200 million in annual expense savings, outweighed one potential financial minus—the dilution to tangible book value per share for XL shareholders.

Mike McGavick, CEO XL Group
Mike McGavick, CEO XL Group
“This is entirely an act on the offense to move forward into what we see as shifting sands in the insurance sector.”

Mike McGavick, CEO, XL Group plc

In terms of the three big positives, he first noted XL’s work in trying to build out a broader specialty platform. As XL has entered additional lines of business, “some people have noted that this has created a drag on our performance, particularly on our expenses, as we have been getting these businesses to scale,” he said. “When blended with Catlin’s businesses almost all this hard work is suddenly completed,” he said, noting that the combination positions XL Catlin as a top-three player in aerospace and fine art and specie, puts it among the top five in political risk and crisis management, and creates a stronger force in aviation, marine and energy classes.

Catlin is already the largest player at Lloyd’s and the deal will add to its strength there, while also curing an expense drag that Catlin faced as it worked through the process of creating regional hubs to make its specialty products available in local markets on a retail basis, McGavick said.

XL CATLIN CHART JAN 2015

Finally, he referred to the market chatter about the changes afoot in the reinsurance market to highlight the third strategic benefit. “The reality is that the reinsurance market is going through meaningful structural change, particularly due to greater importance of alternative capital.

Explaining the deal rationale, XL’s McGavick said: “It addresses new opportunities [and] the macro forces that are changing the P/C marketplace. It addresses broker consolidation. It addresses the rise of analytics. It addresses the need to be global. It addresses the rise of alternative capital and it is made purposely for the evolving regulatory environment.”

“It has been widely argued that it will be more difficult for smaller players and we agree,” he said, noting that XL Catlin will become the eighth largest global P/C reinsurance by net written premium (based on XL’s calculation from A.M. Best data) and the second largest in the property-catastrophe reinsurance space—behind the combination of RenaissanceRe and Platinum, announced in November 2014, and ahead of Everest Re and Validus.

The property-cat reinsurance space is the one under the most pressure from alternative capital suppliers but it is also a meaningfully profitable line of business, McGavick said.

“We will instantly be more relevant to the clients we serve, the brokers with who we work and to the ambitions of the capital market players in bringing alternative capital solutions,” he said, asserting that alternative capital providers, these days, are looking for partners with proven track records in risk underwriting more than they have in the past.

“We have always had that choice [and] have been expanding margins against the headwinds of market forces,” McGavick said. “But the combination is stronger,” he said, expressing the views of both XL’s management team and Catlin’s.

“Added together, this is a better company.”

Catlin agreed. “When you look at these kinds of opportunities in terms of relationships with clients and brokers, it’s a question of being relevant. It’s a question of being trusted. It’s a question of being respected. It’s a question of being innovative,” he said. All of those characteristics will be demonstrated by the combined entity, Catlin said.

Shoulder to Shoulder

McGavick noted that the firm will be still called XL Group “at the top of the house,” but that it will go to market as XL Catlin “so that both of these great brands will live on.” McGavick also emphasized that while he will continue as CEO, he and Catlin will work “shoulder to shoulder” in moving the company forward.

Catlin is expected to become executive deputy chair of the organization, McGavick said, pointing out that when Catlin started in the business as a deputy underwriter for BL Evens/Syndicate 264 at Lloyd’s, McGavick was just a sophomore in high school.

Catlin, who will be inducted into the International Insurance Society Hall of Fame Award in June—in part, in recognition of his work in growing Catlin Underwriting Agencies from a two-main managing agency at Lloyd’s in 1984 to a multibillion-dollar multinational insurance holding company today—interjected that there can only be one CEO of an organization, making clear that McGavick would take the lead role.

Going through other management changes, McGavick emphasized that key functions will be co-led by executives from both XL and Catlin, including insurance underwriting, where Catlin’s Chief Underwriting Officer Paul Brand will keep that title for XL Catlin and become chair of the insurance leadership team, while XL’s Kelly Lyles, currently head of professional insurance, takes the deputy chair spot and the position of chief regional officer of insurance.

The integration planning process, he said, will be co-led by Myron Hendry, XL’s chief platform officer and Adrian Spieler, Catlin’s chief administrative officer. McGavick, a veteran of several turnaround stories that involved significant workforce reductions—including XL and Safeco before that—confirmed that some of the potential cost savings being promised to financial analysts “comes with the harsh reality of fewer jobs to go around.”

“We will be getting specific on such questions as quickly as possible in the coming weeks and months,” he promised employees, adding that “the vast majority of colleagues from both companies will be going forward on an incredibly powerful journey.”

Both McGavick and Catlin said another component of “at least” $200 million in cost savings would come from bigger clout in purchasing ceded reinsurance. Catlin added at there will be opportunities to increase shared services of the group, and economies of scale to be realized in the use of internal modeling and rating tables.

Rounding out the management team, Greg Hendrick, who is currently XL’s chief of insurance operations, will assume the role of chief executive of reinsurance, filling a spot previously held by Jamie Veghte, who announced his retirement in October. Before the deal closes, John Welsh, head North American reinsurance, will be acting head of XL Re, McGavick said.