Article updated with further commentary from AM Best.
NEW YORK ( TheStreet) -- The $3.2 billion merger of Transatlantic Holdings (TRH) and Allied World Assurance (AWH - Get Report) might reignite deals in the reinsurance sector as companies seek to enhance balance sheets and diversify the earnings base, according to industry analysts.
On Sunday Transatlantic Holdings, a specialty reinsurer once majority owned by AIG (AIG - Get Report), announced its merger with Swiss-based Allied World Assurance in an all-stock deal. The merger would create an entity that will have total assets of $21 billion and a total capital of $8.5 billion.
The combination could leave reinsurers with a smaller capital base -- $3 billion or less -- hungry for scale, some analysts say."The reinsurance business has become more differentiated on size because of this most recent deal," said Kevin Lee, analyst at Moody's (MCO), commenting on the Transatlantic deal. "On one hand, you have a group of companies with more than $5 billion in capital, some others with $2.5 billion to $5 billion in capital and then you have a group of companies below $2.5 billion. For companies in the lower end of the range, and given the extent of losses from first quarter, there is possibly more interest in M&A." Companies with a total capital of less than $3 billion include Endurance Specialty (ENH - Get Report), Enstar group (ESGR - Get Report), Platinum Underwriters (PTP) and Montpelier (MRH - Get Report), according to data available on Bloomberg. "Over the past decade, there has been a drive for size," says Laline Carvalho, director and reinsurance analyst at Standard and Poor's. "There have been a lot of management teams that have pushed to become bigger." Tracy Dolin, also an analyst at S&P points out that size might be more relevant for property catastrophe reinsurers where they can get better pricing terms for their size. But other factors besides size also may drive more consolidation. According to Carvalho, reinsurers are also looking to diversify their earnings stream. "It has been a significant year of catastrophes for reinsurance companies," she says, noting the disasters in New Zealand, Australia and the U.S. "There is a desire for some management teams to become more relevant to their brokers, reduce exposure to catastrophic events and if they are more diversified they can choose to play those opportunities where they see the best returns for their capital."