The Financial Community’s Needs From Actuaries In Due The Financial Community’s Needs From Actuaries In Due DiligenceDiligence

A CFO’s Perspective

Presented at the CAS Annual MeetingWashington, DC

November, 2000

by

Gayle Haskell, FCAS, MAAA

CFO & Chief Actuary, Providence Washington Insurance Companies

A PERSPECTIVE ON M & A’sA PERSPECTIVE ON M & A’s

• Consolidation to continue, P/C Industry• Many reasons to pursue an acquisition• Poor Industry results breed opportunities, and Risk• Many (?most?) Mergers fail

Failures more visible then internal failures• Decisions required: fast, and at excitable point

Ramifications often emerge later

“SYNERGIES” COME & GO; FINANCIAL IMPACTS LAST

FINANCIAL COMMUNITY’S NEEDS FROM FINANCIAL COMMUNITY’S NEEDS FROM ACTUARIES PERFORMING DUE DILIGENCEACTUARIES PERFORMING DUE DILIGENCE

• OF COURSE, “TRADITIONAL STUFF”:• Reserve evaluation

Reprinted Courtesy of ‘Schiff’s Insurance Observer’

FINANCIAL COMMUNITY’S NEEDS FROM FINANCIAL COMMUNITY’S NEEDS FROM ACTUARIES PERFORMING DUE DILIGENCEACTUARIES PERFORMING DUE DILIGENCE

• OF COURSE, “TRADITIONAL STUFF”:

- Reserve evaluation

- Economic valuation

- Rate adequacy assessment

FINANCIAL COMMUNITY SEEKS MORE !!

WHY SEEK MORE?WHY SEEK MORE?

• Reserves, economic valuations often a range; buy/sell decisions aren’t

• Volatility of some valuation vehicles

Example: “Market Value”, and Market Caps ($B)12/99 10/00

Amazon $ 36 $ 10Ins Web 1 .06AIG 172 214Marsh & McLennan 24 32

• Economic valuations may not reveal some important pressuresExample: “Cash Is King”

• It’s a short-term world!

HELP THE CFO & THE COMPANYHELP THE CFO & THE COMPANY MAKE THE RIGHT DECISION MAKE THE RIGHT DECISION

• Understand the audiences• Understand the constraints• “Put skin in the game”• Can it be “fixed”? How fast? Costs?• What are the risks? Timing? Solutions?• To “Economic”, add nearer-term financial impacts

 Concisely Articulate & Stand Behind Your

Recommendation!

UNDERSTAND THE AUDIENCESUNDERSTAND THE AUDIENCES

• CEO, Board

• Owner(s)

• Rating Agencies

• SEC (Public)

Improves Input Quality & Personal Credibility

UNDERSTAND THE CONSTRAINTSUNDERSTAND THE CONSTRAINTS

• Examples:

- Return horizon: “accretive to EPS by 2nd year”?

- cash flow demands?

Commercial Lines Companies

‘97 ‘98 ‘99

# Organizations 796 781 746

U/W Cash Flow ( 4.3) (10.1) (17.8)

Investment Inc. 21.8 22.2 21.4

• leverage

CONSTRAINTS, AND CONSOLIDATED CONSIDERATIONS, MAY OUTWEIGH TARGET’S STAND ALONE VALUE

PUT SKIN IN THE GAMEPUT SKIN IN THE GAMEPUT SKIN IN THE GAME

Target's Reserve Adequacy

Best Estimate

$12M $200G

•Ranges often appropriate, BUT•For Acquisition decision , not necessarily good enough•CFO needs tighter range , key risks, “When” , ….. 

AVOID PERCEPTION MORE IMPORTANT TO NOT BE WRONG - THAN - TO BE HELPFUL

CAN IT BE “FIXED”? HOW FAST?CAN IT BE “FIXED”? HOW FAST?

• Current and recent accident years: Trend? Expectations next 2-3 AY’s?

• Cash flow: To improve? Deteriorate? Asset implications?

• Concentration: Excessive? Implications?

• Data content & quality: Ability to effectively manage book

• Quality of Key Personnel

WHAT ARE THE RISKS? TIMING? WHAT ARE THE RISKS? TIMING? SOLUTIONS?SOLUTIONS?

• Asbestos? Other singular exposures? Reinsurance solutions?

• Developments, key state/line? How soon impact Net Income?

• Past successes/failures masking emerging picture? Examples:

• Release of previous reserve redundancies• Runoff of unprofitable business masking profitable

growth

TO “ECONOMIC”, ADD TO “ECONOMIC”, ADD NEARER-TERM FINANCIAL IMPACTSNEARER-TERM FINANCIAL IMPACTS

• AY + Reserve development potential --> projected CY performance

• Paid development techniques --> Cash flow projections

• Pricing trends and opportunities --> WP and cash flow forecasts

• Use DFA/other approaches to measure:

- risks to financial proforma

- target’s asset allocation vs. financial goals

CONCISELY ARTICULATE & STAND BEHIND CONCISELY ARTICULATE & STAND BEHIND YOUR RECOMMENDATIONYOUR RECOMMENDATION

• Concise, to the point: ‘due diligence’ is unlike fine wine

• Provide straightforward, comprehensive linkage:– Longer term: reserves, valuation with

– Nearer term: CY projections, cash flow estimates, etc .

• “Go beyond the numbers”:– Any ‘walk-away’ issues you encountered?

– Target’s capabilities

– “Fixing it”: Slam dunk? Iffy?

• Don’t equivocate

SEEK TO BE:More than: THE TEAM’S BEST TECHNICIANOptimally: THE TEAM’S MVP