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Actuaries in Acquisitions CAS Limited Attendance Seminar on Valuation St. Louis, Missouri

Actuaries in Acquisitions CAS Limited Attendance Seminar on Valuation St. Louis, Missouri April 10-11, 2000. Identification. Fit Analysis. Merger Effects. Negotiate & Close. Value. Integrate. Due Diligence. Iterative. Acquisition process. Phase I: Internal. Phase II: External.

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Actuaries in Acquisitions CAS Limited Attendance Seminar on Valuation St. Louis, Missouri

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  1. Actuaries in Acquisitions CAS Limited Attendance Seminar on Valuation St. Louis, Missouri April 10-11, 2000

  2. Identification Fit Analysis Merger Effects Negotiate & Close Value Integrate Due Diligence Iterative Acquisition process Phase I: Internal Phase II: External Phase III: Legal Phase IV: Operational

  3. Actuarial involvement in the process Actuaries could, perhaps should, be involved in every major step of the acquisition process. • Critical areas: • Valuation • Due diligence • Important areas: • Merger consequences • Proactive identification • Deal structure

  4. Valuation • Sturgis lists five forms of valuation: • Market • Book • “Comparative” • “Dilution” • Economic • Miccolis defines economic value as: {Stat. Net Worth + Reserve Adjustments + Non-admitted assets + Special Liabilities - Excess of Book over Market of Bonds} + {NPV(Future Earnings) - Cost of Capital}

  5. Valuation (continued) The valuation is the sum of : • The “true value” of the balance sheet (old business) • The “true value” of the current and future business on an “as is” basis Market Value • Marginal value to the buyer of intended use Economic Value • Are there other sources of value? • Option value • Intangibles Price

  6. Balance Sheet Reserves Adequacy Run-off pattern Capitalization Taxes Assets Yields Market values Future Earnings Revenue (premium) Loss experience Expenses Expected expense savings Integration costs Cash flows Capitalization Taxes Valuation - critical assumptions Cost of Capital • Target ROE • WACC

  7. Valuation (continued) • Separate the economics of the target in question from the financing of the deal • Our business is stochastic by nature; valuations should be expressed in ranges based on simulations, scenarios, or both

  8. Merger consequences analysis • Pro forma income statements and balance sheets of the buyer and the target, appropriately reflecting the deal structure -- before & after • Key considerations • Reflect the transaction financing • Constraints • Restructuring the balance sheet • Is there a diminished value to the buyer?

  9. Merger consequences example Effect on: EPS ROE RBC D/C +0.50 +1.5% -225 to 20% +0.60 +2.0% - 20 to 45% -0.15 +1.5% - 20 to 15% +0.25 +0.0% - 20 to 25% +0.35 +1.5% - 20 to 15% Financing All Cash All Debt All Stock “Optimal” Combination Pooling

  10. Common reasons for failure The causes for “failed” acquisitions are equally split between pre-acquisition and post-acquisition. • Pre-acquisition causes can be summarized simply as “paid too much” • Inadequate financial analysis • Deal not based on the value of cash flows • Lack of understanding of the company • Over optimistic market assessment All balance sheet and future income related Actuaries can -- and should -- be the principal form of protection for pre-acquisition causes of failure

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