mergers and acquisitions in the (re)insurance industry casualty actuaries in reinsurance seminar...
TRANSCRIPT
Mergers and Acquisitions in the (Re)Insurance Industry
Casualty Actuaries in Reinsurance SeminarBoston, MassachusettsJune 16, 2000
Presentation Overview
Valuation Overview Critical Assumptions Example
Balance Sheet Income StatementTotal Value
Merger consequences Overview and Critical Assumptions Example
M&A market dynamics Statistics Conclusions
Questions?
Valuation
S
Valuation
Overview
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
Marginal value to the buyer of intended use
Are there other sources of value? Option value Intangibles
Market Value
Economic Value
Price
Valuation
Critical Assumptions
Balance Sheet Reserves
Adequacy Run-off pattern Capitalization Taxes
Assets Yields Market values Liquidity
Income Statement Revenue (premium) Loss experience Expenses
Expected expense savings Integration costs
Cash flows Capitalization Taxes
Cost of Capital Target ROE WACC
Valuation
Balance Sheet
Assets (GAAP): Economic Assets: Invested Assets: 1,800.0 Invested Assets: 1,800.0
Cash: 100.0 Cash: 100.0 Premium Receivables: 500.0 Premiums Receivables: 500.0
DAC: 100.0 Reinsurance Recoverables: 400.0 Prepaid Reinsurance Prem: 100.0
Accrued Inv. Income: 200.0 Accrued Inv. Income: 200.0 Deferred Income Tax: 50.0
Goodwill 50.0 Other Assets: 200.0 Other Assets: 200.0
Total Assets: 3,500.0 Total Assets: 2,800.0
Liabilities (GAAP): Economic Liabilities:Gross L&LAE Reserves: 1,600.0 Net Loss Reserves: 1,098.7
Gross Unearned Premium: 400.0 Net L&LAE in UEPR: 212.9 Other Liabilities: 600.0 Other Liabilities: 600.0
Total Liabilities: 2,600.0 Total Liabilities: 1,911.6
GAAP Equity 900.0 Total Adjusted Equity: 888.4
Valuation
Income statement
2000 2001 2002 2003 2004 2005 …
Written Premium 450.0 475.0 525.0 575.0 625.0 650.0 % Change 5.6% 10.5% 9.5% 8.7% 4.0%Earned Premium 490.0 455.0 485.0 535.0 585.0 630.0 Incurred Loss 367.5 332.2 349.2 379.9 409.5 441.0 Expense 146.3 142.5 157.5 172.5 187.5 195.0 Underwriting Result (23.8) (19.7) (21.7) (17.4) (12.0) (6.0)
Loss Ratio 75.0% 73.0% 72.0% 71.0% 70.0% 70.0%Expense Ratio 32.5% 30.0% 30.0% 30.0% 30.0% 30.0%Combined Ratio 107.5% 103.0% 102.0% 101.0% 100.0% 100.0%
Return on Equity 10.5% 16.2% 17.4% 18.7% 19.9% 19.9%
Economic Value:
NPV
Value of Future Earnings 72.5 Integration Expenses (15.3) Economic Value 57.1
Valuation
Total Value
Value of the Balance Sheet $890Value of the Income Statement $60Other sources of value $50 Total value $1,000Per Share (1) $20
Ratios:Value/Market Price (2) 111%Value/Book (3) 111%Value/Earnings (4) 18.0
(1): Based on 50 million shares outstanding(2): Current share price of $18(3): Book value is $900 million(4): Pro-forma 2000 earnings are $56 million ($1.12/share)
Merger Consequences
S
Merger Consequences
Overview and Critical Assumptions
Pro forma income statements and balance sheets of the buyer and the target combined, appropriately reflecting the deal structure
Key considerations Transaction financing Restructuring the balance sheet
Preferred stock Outstanding options Impaired assets Transition costs Conforming accounting
Impact on operating results EPS ROE
Constraints RBC Debt/Capital
Merger Consequences
Sample Analysis
2000 2001 2002 2003 2004
Operating Results:
Statutory UW Result (24) (20) (22) (17) (12) GAAP Adjustment (7) 3 7 7 7 GAAP UW Result (30) (16) (15) (11) (5)
Investment Income and Other 101 102 105 110 118 Pre-Tax Operating Earnings 70 86 90 99 112
Income Tax (10) (15) (16) (19) (22) Operating Income 61 71 74 80 90
Transaction Impact: Goodwill (5) (5) (5) (5) (5) Transition Costs (25) - - - - Lost Investment Income (28) (30) (31) (33) (35) Interest on Debt Issued (38) (38) (38) (38) (38) Income Tax Benefit 28 20 20 20 21
Adjusted Earnings (7) 18 20 25 33
Per Share (0.03)$ 0.09$ 0.10$ 0.13$ 0.17$
Debt/Capital Ratio: Before 16.5% After 20.4%
M&A Market Dynamics
S
Chart 1: Number of Deals vs. Statutory Surplus
0
20
40
60
80
100
120
140
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999
Nu
mb
er
of
M&
A D
ea
ls
$0
$50,000
$100,000
$150,000
$200,000
$250,000
$300,000
$350,000
$400,000
Sta
tuto
ry S
urp
lus
($
millio
ns
)
Number of Deals Stat Surplus
Source: Conning & Company
Chart 2: Number of Deals vs. P&C Index
0
20
40
60
80
100
120
140
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999
Nu
mb
er
of
M&
A D
ea
ls
0.0
20.0
40.0
60.0
80.0
100.0
120.0
Ye
ar
En
d In
de
x C
los
ing
Pri
ce
Number of Deals Year-End Close
Source: Conning & Company
Chart 3: Aggregate Deal Size vs. P&C Index
$0
$10,000
$20,000
$30,000
$40,000
$50,000
$60,000
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999
Ag
gre
ga
te V
alu
e o
f A
ll M
&A
De
als
($
millio
ns
)
0.0
20.0
40.0
60.0
80.0
100.0
120.0
Ye
ar
En
d In
de
x C
los
ing
Pri
ce
Deal Values Year-End Close
Source: Conning & Company
Chart 4: Average Deal Size vs. P&C Index
$0
$100
$200
$300
$400
$500
$600
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999
Av
era
ge
M&
A D
ea
l S
ize
($
millio
ns
)
0.0
20.0
40.0
60.0
80.0
100.0
120.0
Ye
ar
En
d In
de
x C
los
ing
Pri
ce
Average Deal Size Year-End Close
Source: Conning & Company
Deal Pricing vs. P&C Index
Not only is the quantity and size of deals impacted by relative stock prices, but evidence (albeit limited) shows that the price companies pay in a deal is also impacted by relative stock price…
Over the past three years, the price paid in a transaction versus earnings has followed the P&C index both up in 1998 and down in 1999.
Likewise, the price to book value has also followed the trend in the P&C index.
GAAP P/E vs. P&C Stock Index
01020
304050
1997 1998 1999
GA
AP
P/E
75.085.095.0
105.0115.0125.0
P&
C In
de
x C
los
e
GAAP Price to Earnings Year-End Close
GAAP P/B vs. P&C Stock Index
1
2
3
1997 1998 1999
GA
AP
P/B
75.085.095.0
105.0115.0125.0
P&
C In
de
x C
los
e
GAAP Price to Book Year-End Close
Source: Conning & Company
Key Conclusions
Our discussion of St. Paul’s valuation and merger consequences approaches, combined with our review of P&C merger and acquisition activity suggests the following…
When market valuations are low: sellers feel they are undervalued buyers stock is generally of low value future earnings are poor premiums to market decline fewer deals get done
When market valuations are high sellers feel the market has more appropriately valued their enterprise buyers have additional currency in the form of stock future earnings are better premiums to market increase more deals get done
Said another way, when market valuation decline, insurers are not necessarily the bargains they appear to be.
Questions?
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