Navigating Mergers and Acquisitions in the Insurance Industry: Challenges and Strategies

2. Drivers • International M&A monograph • Gaps on syllabi • Lack of standardization • Lack of communication between professions • Promote actuaries outside industry • ERM • Non-Insurance M&A Insurance Industry Mergers & Acquisitions

3. Contributors • Actuarial Disciplines • Health • Employee Benefits • Life • Property & Casualty • Other Professions • Accounting • Investment Banking • Legal Insurance Industry Mergers & Acquisitions

4. Writing Process • One meeting to discuss outline • Two directed meetings to write and work on collaborative chapters • Matrix approach • Most chapters assigned multiple authors • Each chapter assigned a “Wrangler” • Each chapter assigned an editor to work with Wrangler Insurance Industry Mergers & Acquisitions

5. Content • M&A Process • Finance • Valuation • Due Diligence • Corporate Due Diligence • Tax • Accounting • Integration Insurance Industry Mergers & Acquisitions

7. Process Overview Insurance Industry Mergers & Acquisitions

8. Preparing to Sell • Strategic and financial considerations • Assembling the transaction team • Types of sale processes • Pre-marketing • Marketing efforts • Documents • Process Insurance Industry Mergers & Acquisitions

9. Strategic / Financial Considerations • Strategic • Horizontal vs. Vertical (Distribution) • Diversification • Eliminate competitor • Financial • Growth (organic vs M&A); relative risk • Scale • Utilize excess capital (reinvest); returns Insurance Industry Mergers & Acquisitions

10. Auction Process - Overview • Deal structuring considerations • Due diligence (buy and sell side) • Buy side evaluation • Bidding process • Negotiation • The “Definitive Agreement” • Closing the deal Insurance Industry Mergers & Acquisitions

11. M&A Financing • Consideration (cash, stock or other) • Financing providers / sources of funds • Equity • Debt • Mezzanine (Trups) • Other (Seller Notes etc.) Insurance Industry Mergers & Acquisitions

12. Valuation: Why Insurance Companies are Unique • “Balance sheet-based profit opportunity” • Long tail of insurance liabilities • Uncertain liabilities (“Choosing COGS”) • Statutory accounting and capital requirements • Unique rules for distributable earnings to shareholders Insurance Industry Mergers & Acquisitions

13. Valuation: Market Multiples • Why market value = intrinsic value • Comparable company analysis • P/E and P/B • Embedded Value (life) • Comparable transaction analysis • Change of control • Discounted cashflows with terminal value • Greater Than / Less Than Insurance Industry Mergers & Acquisitions

14. Marketing on the Sell side • Process & Strategy • Auction vs Negotiated Deal • Objectives • Maximize shareholder value • Other considerations • Buyers • Strategic buyers • Financial Buyers Insurance Industry Mergers & Acquisitions

15. Due Diligence: What you can expect • When (setting the stage) • Why (objectives of due diligence) • Who (due diligence team) • What (due diligence process) • Actuarial Due Diligence Insurance Industry Mergers & Acquisitions

16. (Why) Objectives of Due Diligence • Investigation and Evaluation • Confirm strategic value • Confirm financial value • Confirm operational value • Implementation • Construct final bid • Prepare for successful integration Insurance Industry Mergers & Acquisitions

17. Getting to the Finish Line • Definitive Agreement • Regulatory Reviews • Form A • HSR • Closing Insurance Industry Mergers & Acquisitions

19. Overview of Project • Excellent Process to Develop Research • Incorporated External Experts and Academics • Peer Review • A lot of Work….BUT an Enjoyable Experience • Encourage more Joint Efforts with SOA Insurance Industry Mergers & Acquisitions

20. Role of the P&C Actuary: Seller’s Valuation Rarely Exist for P&C - Adjusting Market Multiples • Key Model Parameters - Premium Volume, Loss Ratios • Loss & LAE Reserves M&A vs. Actuarial Opinion Review • Quantifying Material Risk Factors • Valuation for PGAAP Accounting Insurance Industry Mergers & Acquisitions

21. Valuation – Life vs. P&C • Life more of a Financial Acquisition P&C more Strategic in Nature • Life Appraisal Drives Sales Price P&C Seller’s Appraisal Rarely Exists • Life – Long-term Perspective P&C – Sometimes Short-term View More Important • Same Valuation Methods - DCF, EVA Insurance Industry Mergers & Acquisitions

22. Valuation – P&C Resources • Older Readings: Sturgis, Miccolis, Weiner, Whitehead, Witcraft • Recent Papers: Blackburn, Danhel Insurance Industry Mergers & Acquisitions

23. Valuation – Components of Value • Statutory Net Worth • Embedded Value = SNW+ Value of In-force Business • Actuarial Value = EV + Value of New Business • Buyer’s Value = Actuarial Value + Strategic Value – Integration Costs Insurance Industry Mergers & Acquisitions

24. Valuation – Purchase Accounting (PGAAP) • SFAS 141 – Business Combinations must use purchase method of accounting • Liabilities must be stated at “Fair Value” Loss and Unearned Premium Reserve • Identify and Value Intangible Assets • Goodwill = Purchase price – net assets including intangible assets Insurance Industry Mergers & Acquisitions

25. Valuation – Purchase Accounting (PGAAP) • VOBA • Value of Renewals • Other Intangibles: - Distribution Relationships - Insurance Licenses Insurance Industry Mergers & Acquisitions

26. Valuation – P&C Loss Reserving • Not Just a Balance Sheet Issue • Adjusting Earnings and Market Multiples • Cash Flows, RBC and Rating Agency are a key Concerns for P&C Companies • Target Company not characterized by stable historical claims experience • Diagnostic statistics are critical. Insurance Industry Mergers & Acquisitions

27. Role of the P&C Actuary: Insurance Company Due Diligence P&C Acquisitions are Predominately Strategic – Know Your Buyer’s Motives • Life – Predominantly Horizontal Growth • P&C – Usually Vertical Growth New Products New Technologies Distribution Channels Underwriting Expertise Insurance Industry Mergers & Acquisitions

28. Role of the P&C Actuary: Insurance Company Due Diligence • Identifying and Measuring Value Drivers - Marketing/Distribution Channels - Underwriting - Claims Insurance Industry Mergers & Acquisitions

29. Role of the P&C Actuary: Insurance Company Due Diligence • Unexpected Integration Costs - Distribution Channels - Underwriting - Claims - Systems • Identifying Material Risks Insurance Industry Mergers & Acquisitions

30. Role of the P&C Actuary: Corporate Due Diligence • Assessing the Risk Management Program • Accounting for Uninsured or Self-Insured Exposure • Claims Made Policies • Security Requirements • Warrantees Insurance Industry Mergers & Acquisitions

31. Role of the P&C Actuary: Corporate Due Diligence • Captive Insurers • Carve Outs Insurance Industry Mergers & Acquisitions

32. CAS Resources • CAS Librarian (Erin Clougherty) Search for Articles, Bibliography • CAS On-Line Resources – (Jen DeMarr) • Peer Reviewers THANK YOU!!! Insurance Industry Mergers & Acquisitions

34. What is an Actuarial Appraisal? • DCF analysis, where: Distributable Cashflow = After-tax Earnings minus Increase in Required Capital = Premium + Investment Income – Benefits – Expenses – Commissions – Increase in Statutory Reserves – Taxes – Increase in Required Capital Insurance Industry Mergers & Acquisitions

35. Components of an Actuarial Appraisal Insurance Industry Mergers & Acquisitions

36. Actuarial Appraisal Issues • Uses of an appraisal beyond a single “value” • Basis for assumptions • Description of specific issues for a range of business: Life, Health, and P&C Insurance Industry Mergers & Acquisitions

37. Tax Issues • Understanding the impact of federal and state tax issues on M&A transactions • Transaction structuring can be highly tax-sensitive • Post-closing tax opportunities affect the value of the target • Investigating tax issues is an important part of the due diligence process Insurance Industry Mergers & Acquisitions

38. Taxable Transactions • Stock sale vs. asset sale • Recognition of gain or loss • Capital vs. ordinary • Basis in stock vs. basis in assets • Economic value of amortization deductions • Asset sales in the insurance industry—reinsurance • Assumption reinsurance and coinsurance • Treatment of ceding commission • DAC Tax • Allocation of basis Insurance Industry Mergers & Acquisitions

39. Accounting • What constitutes a “business combination” • Identifying the acquiring entity • Determining acquisition date and purchase price • Direct costs and contingent considerations • Purchase Price Allocation (US Purchase GAAP) • Fair Value of Invested Assets • PGAAP Liabilities • Value of Business Acquired (VOBA) • Intangible Assets, including Goodwill • Deferred tax • Reinsurance and Statutory Accounting Principles Insurance Industry Mergers & Acquisitions

40. Integration • Successful outcome of acquisition hinges on integration! • Comparatively little typically spent on integration vs acquisition • Goal is to capture the value drivers used to justify the acquisition to the board Insurance Industry Mergers & Acquisitions

41. Implementation • Corporate integration unit • Implementation teams • Process control • “Day one” issues • People issues • Importance of culture Insurance Industry Mergers & Acquisitions

42. Making it Work • Essentially change management • Leadership • Speed • Communication • Planning • Project management Insurance Industry Mergers & Acquisitions

43. C r y p t s ! ! ! “In making acquisitions over the years, we've tried our best to get good quality assets to back the liabilities. Cash is always best - investment grade bonds are fine - and good quality mortgages are acceptable. But when you're buying a company, or taking over a block of business that's in receivership, sometimes you get assets that are not as desirable…” Insurance Industry Mergers & Acquisitions

44. C r y p t s ! ! !

45. Final Process • External peer review • Professional editing • Final editorial review • Layout • Glossary • Index Insurance Industry Mergers & Acquisitions

46. Bibliography • SOA & CAS Libraries • Exam syllabus • Textbooks • Industry & professional source material • Popular press Insurance Industry Mergers & Acquisitions

47. Project Scope • 500 Pages • 100+ contributors • $150,000 budget • 5,000 projected sales • Actuaries • Industry Executives • Professionals • Risk Managers • Students (SoA, CAS, MBA) Insurance Industry Mergers & Acquisitions

48. Insurance Industry Mergers & Acquisitions