the role of the actuary in m&a

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The Role of the Actuary in M&ACasualty Loss Reserve Seminar

Bruce Fell, FCAS, MAAA, CFA

September 5, 2012


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U.S. P&C Insurance/Reinsurance Market Trends


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While pricing is beginning to improve, global catastrophes have made underwriting profitability an elusive goal, even in light of the benefit of continued loss reserve releases

l Towers Watson’s CLIPs pricing survey indicates that commercial insurance prices have continued to risel Aggregate increase of almost 6% during the second quarter of 2012

l For the sixth straight quarter all standard commercial lines show an uptick in pricing

l Through 2011, the U.S. P&C insurance industry failed to generate an underwriting profit for the fourth year in a row (i.e., combined ratios above 100%)

l Global catastrophe losses drove earnings down in 2011 and marked the second costliest year for insured catastrophe losses

l P&C reserve releases continued throughout Q1 2012, but at a slower pacel Commercial lines reserve adequacy may be turning the corner

l Personal lines retaining slight redundancies

l Although industry capital is strong, lower investment yields continue to challenge insurers


-6%

-5%

-4%

-3%

-2%

-1%

0%

1%

2%

3%

4%

5%

6%

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2

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Since 2011, commercial lines pricing continues to exhibit positive rate movements, yet is just starting to reach the level of loss cost trends

Note: Written premium basis.Source: Towers Watson Commercial Lines Insurance Pricing Survey.

Prices have been increasing since 2011 after 2 years of flat pricing

2004 2005 2006 2007 2008 2009 2010 2011 2012

YOY Price Level Change — All Commercial Lines Combined


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U.S. P&C Industry failed to generate an underwriting profit for the fourth year in a row

Source: Towers Watson.

80%

85%

90%

95%

100%

105%

110%

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012E 2013F 2014F

All Personal Lines

All Commercial Lines

U.S. Industry accident year combined ratios


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2011 marked the highest year in insured earthquake losses and ranks as the second costliest year for insured cat losses

$12 $16 $19 $22 $19$30

$70

$125

$20$33

$55

$26$47

$116

2005 2006 2007 2008 2009 2010 2011Half Year Full Year

$35

$12

$12

$7

$7

Japan EQ

Thailand Flood

NZ EQ

U.S. April Tornadoes

U.S. May Tornadoes

l Combined, 2010 and 2011 had over $160 billion of global insured cat losses

l 2011 cat losses of $116 billion far outpaced recent comparable periods

l Ongoing and material upward loss creep is likely due to reporting lags

***Aggregated U.S. April and May Spring Storms. Sources: Swiss Re Sigma, PCS, Towers Watson.

Global Insured Cat Losses ($ Billions)

Five Costliest Disasters in 2011 ($ Billions)

l Four of the top 15 most costly global cats have occurred in the past 12 months**

l Both U.S. and non-U.S. cat events affected reinsurers, the retro market and blanket property insurance covers


Reserve releases have increased during the most recent years of the soft market…$58.7 billion in past five years

6.7

9.5

14.5

11.5

10.1

13.1

0

2

4

6

8

10

12

14

16

2006 2007 2008 2009 2010 2011

Source: SNL Financial (excluding Mortgage and Financial Guaranty lines)

ReserveReleases ($B)

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Declining investment yields and lingering soft market are changing the way insurers think about investments

l Few bonds with purchase yields above 4.5% remain on balance sheetsl Insurers have to accept a lower level of income support from investments or change

their asset allocation

1.05%

1.62%

0.04% 0.04% 0.08% 0.19%0.41%

0.68%

1.54%

2.28%

3.00%

3.95%4.27%

2.34%2.72%

0.39% 0.68%0.07% 0.08% 0.15% 0.19% 0.28%

4.82% 4.96% 5.04% 4.96% 4.82% 4.82% 4.88% 5.00% 4.93% 5.00%5.19%

1M 3M 6M 1Y 2Y 3Y 5Y 7Y 10Y 20Y 30Y

July 2012 Yield Curve*Pre-Downgrade (July 2011)Pre-Crisis (July 2007)

U.S. Treasury Yield Curve Trends

*July 5, 2012. Sources: Board of Governors of the United States Federal Reserve Bank, Insurance Info. Institute.


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While the number of mergers and acquisitions has increased since 2001, the value of the deals has decreased

0

10

20

30

40

50

60

70

80

0

3,000

6,000

9,000

12,000

15,000

18,000

21,000

24,000

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012*

Value of Deals ($M)

Number ofDeals

Property and Casualty UnderwritersMergers and Acquisitions

Source: SNL Financial, Towers Watson

*2012 is through August 27, 2012


Since 2008, market value has been below book value for the industry.

0.80

1.00

1.20

1.40

1.60

1.80

2.00

Source: SNL Financial

Price to Book Value

*2nd Quarter 2012

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During the last 12 months, 30% of respondents acquired or pursued a company, while 20% acquired or pursued a block of business

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Source: Towers Watson CFO Survey #2 – Fall 2011

During the past 12 months, has your company undertaken or considered an M&A transaction?

25%

20%

15%

10%

35%

30%

5%

5%

5%

5% 35%

50%

80%

85%

95%

Acquiring a company*

Acquiring a block of business

Selling a company

Selling a block of business

Merging with another company

Transaction completed or being pursued Considered but did not pursue/complete Both Did not undertake or consider


Further, at least half of respondents are considering acquiring either a company or block of business in the coming year; considerably fewer plan to sell or merge

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Over the next 12 months, how likely is your companyto undertake an M&A transaction?

5%

5%

50%

45%

15%

10%

5%

45%

50%

85%

90%

95%

Acquiring a company

Acquiring a block of business

Selling a block of business

Merging with another company

Selling a company

Highly likely Possible Not likely


Over half of respondents report that all or most recent M&A transactions met or exceeded expectations

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How would you rate the success of your company’s M&A transactions during the last three to five years relative to expectations?


33%

23%

33%

11%

Some deals met or exceeded our

expectations, and some deals fell

below expectations

All or most of our transactions exceeded

expectations

All or most of our transactions met

expectations

All or most of the deals fell below our expectations


Key findings about overall deal activity in the marketplace…

l General CFO sentiment regarding deal activity is similar over both short- and medium-term horizons, with a majority expecting an increase

l Expanding into new markets and achieving economies of scale are the biggest factors influencing deal activity

l General economic uncertainty and capital constraints are the biggest concerns dampening deal activity

l Respondents consider actuarial advisors the most important for buy-side transactions, followed by legal and investment banking

l Investment bankers are rated most important for sell-side transactions, followed by legal and actuarial

l Over one third of respondents expect an increase in bidding wars/hostile takeover activity over the next 12 months

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Drivers of M&A activity depend upon the constituencies

l Customersl Bigger is better = Ìl Lots of choice is good = ▬

l Company Managementl Supply/Demand imbalance (many voluntary buyers but few voluntary sellers) = ▬

l Insurance and Reinsurance Brokersl Smaller insurers give brokers more negotiating leverage = ▬l More insurers give brokers more choice = ▬l Bigger insurers provide clients with more security = Ì

l Rating Agenciesl Bigger is better – more capital and diversified risk = Ì

l Company Owners/Investorsl Bigger companies provide more stability = Ìl More insurers give investors the ability to diversify their holdings = ▬

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We expect to see a sharp increase in M&A activity in the industry over the next few years

l Some of the key drivers (capital levels, stock valuations) may continue at current levels or even decrease before they increase

l Despite the past global catastrophic events and the continued economic volatility, we think companies will begin to look away from internal concerns and focus on M&A

l The key drivers of financial distress, consolidation, attractiveness of runoff deals, restructuring opportunities as well as the pent-up demand from private equity and other financial players still exists as capital is waiting to be deployed

l Regulatory changes around the world will impact activity in several different waysl In the short term, causing some companies to focus internally on capital management

l For others and possibly over the longer term, acting as a driver of activity levels

— As markets realign to the benefit of the most capital advantaged jurisdictions

— As companies reassess the impact of the new capital requirements on group balance sheets and look to restructure or use M&A to manage or optimize the capital requirements of new solvency regulations

l Overall, willingness to buy and sell should increase as fire sale stigmas disappear, along with some realignment of valuation expectations

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The Role of the Consulting Actuary

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Unsuccessful transactions can be attributed to failures or omissions at key stages in the acquisition process

l Incompatible cultures

lSynergy nonexistent or overestimated

l Incompatible marketing systems

ImplementationDue Diligence

lAcquirer paid too much

lDid not anticipate foreseeable events

lAcquired firm too unhealthy

lNeed to spin off or liquidate too much

l Inability to manage target

lUnable to implement change

lClash of management styles/egos

Strategy


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Actuaries have a key role in many areas of the M&A process to ensure success

ImplementationDue DiligenceStrategy

lFormulate strategy

l Identify targets

lPreliminary appraisals

l Initial assessment

lReview alternative options

lDevelop the business case

lStrategic due diligence

lOperational due diligence

lFinancial due diligence

lActuarial appraisal valuation

lStructuring the transaction

lSupporting negotiations

lEstablishing the strategic framework

lDeveloping integration plans

l Implementing plans

lCommunicating effectively


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Strategic evaluations require actuarial assistance with quantitative analysis

Pre-Due Diligencel Market scans for companies that meet the targeted criteria

l Preliminary financial projections and appraisals of potential targetsl Preliminary projections of combined new company

Due Diligencel Competitive market position of target companyl Product offerings and specializationl Actuarial pricing/rating

l Sustainability of target company business results


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Many aspects of due diligence are critical

DueDiligence

Strategic

l Strategic fit with buyerl Market positioningl Sustainability of competitive positionl Assessment of organizational fitl Marketplace assessment

Operational

l Organizational fit with buyerl Organization performance and capabilitiesl Business risk assessmentl Claim and underwriting capabilities

Financial

l Actuarial valuationl Review of liabilitiesl Financial projectionsl Financial risk assessment


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Operational due diligence is all about getting behind the numbers

Areas to be Investigatedl Actuarial management, structure and personnel expertisel Reserving process, methods and assumptionsl Rating/pricing proceduresl Management information system access and usel Price-monitoring approachesl Underwritingl Claim handlingl Business distribution economicsl Expected profitability and results monitoringl Capital managementl ERM capabilitiesl Reinsurance structure analysis

Are you getting whatyou pay for?

Is it all good news before you buy and bad news after?or


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Financial due diligence will focus on analysis of the available financial information

l Calculate/ reviewl Assumptionsl Methodologyl Accuracy of

resultsl Sensitivity

analysis

l Adequacy of claim/loss reserves

l Other loss sensitive assets and liabilities

l Hidden liabilities

l Claims exposures

l Earnings re-statementsl U.S. GAAPl Other

l Pro forma earnings projections

l Business plans

l (Economic) capital requirements

l Asset/liability management

l Rating agency impacts

l Financial/actuarial controls

l Risk mitigation strategies

ActuarialValuation

LiabilitiesReview

Financial Management

Financial Projections


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Review of Liabilities

l Adequacy of the loss reserves (including latent exposures)l Variability of loss reservesl Adequacy of unearned premium reservesl Reinsurance collectabilityl Loss sensitive commissions and premiumsl Direct and Assumedl Ceded


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Implementation Efforts

l Form A filingsl The change in corporate structure associated with the acquisition of a U.S.

company requires a Form A Filing with the appropriate insurance regulator for the target company’s state of domicile

l Regulatory approval is needed prior to closing

l Completion of the Form A Filing will require the combined efforts of actuarial, legal and business management

l Rate filingsl New product offerings or pricing schemes may be developed for the new

combined entity

l Merging the various actuarial aspects of the new combined company


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Conclusions

l Actuary’s role in M&A encompasses more than just the loss reserves

l Stay focused on the broader business issues and not just the technical actuarial ones

l Keep digging in to issues as they are identified. Often there is something more there.

l Don’t forget to quantify the impact.

the role of the actuary in m&a

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