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M&A - Happily Ever After?

Source: Asia Insurance Review | Apr 2016

More M&A activity is expected this year. We take a look at the notable deals in 2015, the challenges, and what can be done to improve the odds of creating a successful union. 
By Benjamin Ang
 
 
Value of insurance-focused M&A deals in 2015 exceeded US$111 billion, “a record high for recent years”, according to EY’s “Global insurance M&A themes 2016”.
 
   Despite a 15% drop to 565 in the volume of deals compared to 2014, the total value of deals rose by 73% driven by megadeals. The top 10 global insurance deals accounted for $74 billion or 67% of deal value. (See Figure 1.)
 
Top 10 deals by disclosed value in 2015
 
   Notably, five of the top 10 deals were by Japanese groups investing largely in the mature US and UK markets. 
 
M&A drivers
According to KPMG’s “Insurance M&A trends” review of 2015, the high levels of M&A activity were driven by insurers seeking new or expanded opportunities in select high-growth markets. It also noted that “the year was also marked by an impressive volume of reverse deal flow as acquirers from Asia, particularly China and Japan invested in mature markets, such as Europe and the US”. 
 
   Other factors it cited include the positive regulatory developments being the catalyst for the deals, such as the increased foreign direct investment (FDI) limits in India; companies focused on divestments of non-core or under-performing assets; large broker players which sought to build geographic reach or specific capability; and the active alternative capital providers which completed deals in the insurance sectors across mature and high-growth markets. 
 
   For EY, it stated that the key driver has been the underlying transformation of the sector. Insurers are not simply engaging in large deals in search of greater scale. Large-scale M&A is playing its part as one of the key enablers for transformation – one of the key ways of accelerating the journey toward a desired future model. 
 
Asia to be centre of M&A activity
The high number of transactions looks set to continue this year with Asia “expected to be a centre of M&A activity over the next three years”, according to a survey of senior insurance executives by Willis Towers Watson M&A Risk Consulting. More than half of the 750 respondents to the survey see Asia as the marketplace where activity will rise most significantly. 
 
   In 2015, the value of deals with an Asian target was four times as high as 2014, at EUR19.1 billion (US$21.3 billion), while the value of deals with an Asian acquirer was nearly five times as high, at EUR43.3 billion. 
 
   News coming out from Asia in the first quarter of this year seems to support the view. Japan’s top insurers look set to continue pursuing M&A abroad in search of opportunities given the matured domestic insurance 
market.
 
Japan and Korea activities
Nippon Life Insurance’s President Yoshinobu Tsutsui hinted earlier this year that the insurance giant is seeking M&A deals in the US. It had bought smaller rival Mitsui Life Insurance and National Australia Bank’s insurance business last year, but Mr Tsutsui said the insurer still has JPY1 trillion (US$8.8 billion) to spend on further acquisitions.
 
   Other than Nippon Life, Tokio Marine Holdings, MS&AD Insurance Group, and Dai-ichi Life Insurance have all indicated that they are aiming to pursue overseas expansion opportunities.
 
   In Korea, a life insurance association executive was quoted in local media saying that a series of M&A is expected in the domestic market this year, with Allianz’s Korean unit, ING, KDB Life Insurance and PCA Life Korea among the insurers cited in the media report. 
 
Tough competition
However, with greater attention and expectations around M&A activity, the level of competition in a transaction has increased. 
 
   Mr Jack Gibson, Global M&A Leader for Willis Towers Watson M&A Risk Consulting, said: “Competition for the best transactions is tough. Just 4% of deals proceeded without competition from other potential buyers. Incumbent local insurers are fighting hard, international competitors are also trying to cherry-pick the best deals, and an increasing threat is posed by emerging players such as private equity and non-insurance investors from Asia.”
 
Issues emerge after closing
And “a significant number of M&A transactions worldwide may see issues arise from breaches of deal terms discovered after closing”, according to a study of AIG’s representation and warranties (R&W) insurance claims data between 2011 and 2014.
 
   AIG revealed that nearly 14% of the M&A policies it wrote globally resulted in a claim. Financial statement misrepresentations were the leading cause of these claims, accounting for 28% of all claims during the period. Tax errors or misrepresentations were the second most frequent claim type, accounting for 13% of filed claims, followed by 11% of claims filed due to discrepancies that emerge from a company’s contracts. And the study found that clients in the Asia Pacific region were the most likely to file claims with some 18% of policyholders in the region reported a claim during the study period. 
 
   “Transactions pose risks to a significant number of companies, despite the best efforts during due diligence. Even the most sophisticated and largest companies can and do miss critical issues during the deal process,” said Ms Mary Duffy, Global Head of M&A Insurance, AIG.
 
When two become one
Once the challenges of competition and deal completion are overcome, what are the ingredients needed to create a successful M&A union? 
 
   According to EY, the top three lessons learnt by insurers from their recent M&A integrations are:
Resourcing: Despite continuing pressure on business-as-usual (BAU) margins and the scale of regulatory change, releasing sufficient resources to work on the integration is essential to success. Of the insurers surveyed, 58% involved more than 50 dedicated full-time equivalents (FTE) in an integration.
 
Planning: Integration planning needs to commence alongside due diligence and build momentum thereafter. Sixty- four percent of insurers on average now have a synergy and integration plan in place at signing, rising to 100% for deals more than $1 billion in value.
 
Execution: Establishing and then maintaining the right integration programme governance, management and controls are necessary to ensure that the acquirer and target collaborate effectively, that functional areas do not operate in silos and that integration work streams collectively focus to achieve the target operating model.
 
   The importance of integration was highlighted by EY, which noted that “there is significant integration activity happening in the market across all regions, with almost $1 billion of cost synergies being targeted by the Ace-Chubb, Willis-Towers Watson and XL-Catlin mergers alone” and that “whatever the value drivers for any deal are, effective integration planning and rigorous execution are critical to both enable value creation and protect the inherent value of the business-as-usual (BAU) operations of both the acquirer and target”.
 
Regulations and poison pills – Perspective from a legal firm
 
Other than due diligence, which is “of course, as important as it ever was”, Mr Michael Cripps, Partner at Clyde & Co, shares some key factors to note in an insurance M&A from a legal perspective.  
 
 
1 Change-of-Control Regulatory Approvals/Filings: As an important and systemic part of the world’s financial services sector, regulation of insurance companies has become ever more complex and burdensome. Unfortunately, this enormous increase in regulatory oversight of insurers has not been achieved by stream-lined, integrated global standards, but rather by heightened levels of regulation and activity by individual jurisdictions’ regulators.  
 
   What this means for the acquirer of a target insurance entity, where the target has multiple regulated/registered businesses in multiple jurisdictions, is that the processes and outcomes of change-of-control regulatory approvals or filings have become the most complex aspect of any insurance sector acquisition (from a legal perspective). Each jurisdiction’s regulator must be engaged separately, and on its own terms. 
 
   The requirements of different jurisdictions’ regulators can, and often do, vary very significantly. The transaction closing condition related to the obtaining of all regulatory approvals is, now, typically the very last condition to be satisfied (it simply takes a long time to work with and through multiple regulators).
 
2 Prudential Capital – Representation & Warranties: The global increase in insurance regulatory oversight has also seen exponential growth in the complexity of prudential capital calculation. 
 
   “Risk-based Models” are of course now ‘de jour’. However, from a lawyer’s point of view, there was much to be said for the “old-fashioned”, and much blunter, “Prescriptive Models”. Prescriptive Models were, due to their comparative simplicity, more likely to be streamlined and amenable to integration than Risk-based Models. Risk-based Models, even within one jurisdiction, can be difficult to fully understand, let alone multiple Risk-based Models spread across multiple jurisdictions, in a group of companies which may include non-insurance businesses as well.  
 
   The issue which can arise for acquirers is that a target will often argue that the fast-moving world of prudential capital calculation makes it difficult to provide “hard” R&W in this area. Even where “hard” R&W in this area are obtained, short of a formal regulator-issued order, it is often difficult to prove, let alone quantify, breach/damages arising out of these R&W.
 
3 “Poison Pills”:  Although this issue is not unique to the insurance sector, it is surprising how often it arises in insurance acquisitions. That is, the historic planting of a “poison pill”, by person or persons sometimes unknown, into the constituent documents of an insurer, making a change-of-control of that insurer by many, if not all, interested acquirers difficult to achieve, or financially painful to achieve. Recent transactions indicate that the poison pill may be losing some of its historic potency.
 
Rating under review – Perspective from a rating houseRating under review – Perspective from a rating house
 
Mr Moungmo Lee, Managing Director, Analytics, A.M. Best Asia-Pacific (Singapore), shares his observations on M&A and the key factors to note from a ratings perspective. 
 
 
   A.M. Best is viewed as an insider and obtains confidential information from companies during the rating process. With this in mind, many companies share knowledge with their analyst about a transaction prior to any public announcement. This allows the analytical team to formulate a well-informed opinion about the impact of the transaction on published ratings. 
 
   For the rating of the company being acquired, a typical response from A.M. Best would be to put the company’s rating under review. When ratings are placed under review, it is with implications – either positive, negative, or developing – for a short period, generally about six months. Upon completion of a detailed review of the transaction and discussions with management, these ratings may be taken out from under review and either affirmed, upgraded or downgraded. The rating outlook would also be updated at that time and could reflect stable, negative, or positive. 
 
Increased M&A activity
There has been increased M&A activity in many countries where the number of insurance providers is high relative to the insurance market size providing the regulator with a strong incentive to consolidate the market. 
 
   There has also been an increase of other forms of M&A, such as the merger of two large companies that are both highly rated, or the acquisition of a highly rated larger company by a lower rated but similarly sized company. In cases such as these, the number of possible rating outcomes increases and the analysis becomes more complicated. Many of the recent transactions have been in the reinsurance and commercial segments due to fierce competition, soft market conditions, and excess capacity. 
 
Unrated or lowly-rated insurers
There has been a recent increase in transactions involving Chinese-based insurance companies or conglomerates, many of which are either not rated or lowly rated by either A.M. Best or other global rating agencies, looking to diversify their asset bases globally. 
 
   The rating outcomes will depend on the structure of the acquisition, post-merger financial leverage and other key metrics, as well as the execution of integration plans. The regulatory environment surrounding inflows and outflows of capital will also play a role. 
 
Take a proactive approach
In any transaction, acquisition and integration issues are reviewed on an individual case-by-case basis by A.M. Best. In the current M&A environment, it is critical for the parties involved to understand the rating methodology and to take a proactive approach to satisfying any concerns about the transaction or post-merger position. 
 
Integrating cultures successfully 
 
M&A in the insurance industry get the numbers right, but often stumble on cultural obstacles, say Mr Pierre Fel and Ms Jenni Hibbert from Heidrick & Struggles, in this extract from their article “Getting beyond risk in insurance M&A”. Here are some highlights on what can be done to integrate cultures successfully.
 
 
Before the deal is done
Spotting and addressing cultural challenges should start well before the papers are signed. Parallel to due diligence, acquiring companies should critically compare attitudes, work habits, customs, and other less overt characteristics of the two companies involved. The effort should be a routine part of the standard M&A process, rather than an ad hoc response if friction develops.
 
Encourage clear, honest communication
In general, workers at an acquired company understand – and sometimes fear – that job cuts are possible. Painting too rosy a picture ahead of a deal could create tensions later when reality hits. Be honest from the outset. 
 
After the papers are signed 
If efforts before the deal can be seen as cultural intelligence-gathering, those after the deal focus on execution. After all, each integration effort is unique in its cultural aspects. A company may have a standard approach for combining product service lines, for example, but bringing staff members with diverse backgrounds together effectively requires a tailored approach.
 
Do not rush big changes 
In many takeovers, cutting costs (and jobs) at the acquired company is one of the first priorities. But moving too fast can cause unnecessary friction and inadvertently force valuable talent out the door. 
 
   By taking a long-term view of the value potential of an acquisition, companies can take the time needed to understand cultural differences, and then focus only on those that may directly prevent the company from reaching its goals. 
 
   The acquiring company must take pains to demonstrate that any cuts to duplicated roles will be decided based on merit, rather than internal connections. 
 
. . . but when the time comes, act
However, once a decision is made to cut staff or to take another significant step, the acquiring company should act quickly and completely. Drawing out painful measures only accentuates lingering staff anxieties and delays the return to normalcy.
 
   Cultural differences can often ruin an otherwise well-planned acquisition. By purposely including culture in the negotiation process and after the deal is signed, companies can improve their odds of success.
 
Mr Pierre Fel is a principal at Heidrick & Struggles’ Singapore office. Ms Jenni Hibbert is a partner in the London office.
 

 

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