The Actuary Magazine October 2004 - Kinder, Gentler M&A

Kinder, Gentler M&A

by Robert D. Shapiro

Life insurance company mergers and acquisitions are seeing a renewal of activity. Now, however, they are being handled with a new consciousness.

The year 2003 marked a change in an insurance M&A marketplace that had slowed from its frenzied activities of the 1990s. Table 1 illustrates the pattern of life insurance company deals over the 1999–2003 time period. Although the number of deals did not increase from 2002 to 2003, the aggregate purchase price amount almost tripled with the return of a flurry of mega–deals.

Let's take a brief look back at the drivers of M&A deal activity over the past five years, and then examine what the future insurance M&A market holds for North American life insurance companies and the actuaries that serve them.

Famous Last Words

The last half of the 1990s was characterized by a high level of insurance M&A activity. Prices were often high relative to actuarial appraisal and traditional industry comparables. This aggressive pricing was driven by a number of factors including intense competition from European and other " buyers," as well as permitted accounting approaches and board/management pressure to participate in the M&A market. Some of the things we heard when apparently high prices were questioned were:

  • "It's a new era, old standards for valuation are irrelevant."
  • "We've priced this deal to assure us of a 15 percent return."
  • "We'll send out the pink slips once the deal is closed. Meanwhile we'll keep assuring their people that we need them."
  • "The agency force will be more productive and profitable for us if we add more recruits, pay higher commissions and keep giving assurance that we need them."

Sounds a lot like the logic underpinning the Internet bubble! The desire to do deals had pushed prices to a level that didn't fit our old (actuarially based) theories. So new "perspectives" (justifications) popped up. All of this seems to reflect the general "bubble consciousness" that existed, particularly in the late 1990s the same consciousness that enabled Internet ventures to command high stock market valuations relative to any historic standards.

Aggressive pricing and flawed planning (and related unrealistic expectations) ultimately led to the failure of many deals, resulting in depressed buyer earnings and in some cases, more dramatic challenges like impairment.

What Did Learn (What Should We Have Learned?)

As we look over the landscape of the 1990 insurance marketplace, we (hopefully) have tightened our commitment to a handful of important deal principles.

  1. Value is managed to, not priced for:
  2. Our actuarial appraisals are based on a set of assumptions regarding the future (e.g., mortality, morbidity, investment earnings, expenses, persistency and sales). Each of these assumptions, in turn, reflects an expectation for how the business will be managed in the future. For example, the persistency assumption demands that the buyer manage the inforce as well as future sales to appraisal persistency standards. "Sharpening one's pencil" in the pricing/negotiating process merely increases the pressure on future management to achieve more aggressive results!

  3. Deal strategies, not deals, succeed:
  4. The ultimate value of a deal to the buyer flows directly from the effectiveness of the buyer's post–purchase management plan design and execution. Most deals fail to meet expectations because the buyer's management features past acquisitions. Successful buyers use due diligence not only to "check everything," but also to shape their post close management plans so that the required value is derived from the deal.

  5. Acquired employees can accept uncertainty, but not dishonesty:
  6. Here's where a clear post–purchase management plan is particularly valuable, as it clearly communicates a picture of what the buyer intends to do. Obviously no plan is perfect and no management executes a plan without hiccups. But execution uncertainties are a lot easier to accept than obfuscation or unkept promises. Any misdirection, or perceived misdirection, will be internalized by acquired employees in a manner that will almost always be detrimental to the buyer.

  7. M&A reflects, and occasionally drives,industry and environmental trends:
  8. Much can be learned by stepping back from the intensity of the transaction process long enough to: (a) size up marketplace signals flashed by deal competitors, (b) monitor due diligence activity and (c) interpret feedback from the process of obtaining needed approvals. Often the post management plan can be tightened by reflecting this learning appropriately.

A Look Ahead

Early 2004 produced a handful of significant new life company M&A transactions, including:

  1. The acquisition of Safeco Life and investments for $1.35 billion by an investor group including Warren Buffett and Jack Byrne.
  2. The proposed acquisition of Forethought Financial Services by Devlin Group LLC for $280 million.
  3. The (challenged) acquisition of MONY by AXA for $1.5 billion.
  4. The acquisition of CIGNA's retirement business by Prudential Financial for $2.1 billion.
  5. The acquisition of CNA's individual life business by Swiss Re for $690 million.
  6. The acquisition of Mutual of Omaha's variable life and variable annuity business by The Security Benefit Group of Companies.

So, interest in significant life company transactions continues. Pricing has become more realistic as inherent economic value is again driving deals more than psychological or accounting factors. The natural tensions between today's buyer realism and seller hopes can be observed in the AXA–MONY transaction in which a handful of significant MONY shareholders fought for a higher (and what they thought was more appropriate) price. It is also interesting to note that, in deals like the Safeco and Forethought transactions, savvy financial buyers are again appearing more frequently as pricing rationality (i.e., read "lower prices") returns.

As we look further into our crystal ball, what do we see? Through the still hazy clouds we can identify a handful of emerging M&A trends:

  1. The insurance M&A market will continue to strengthen. Although much consolidation has already occurred, today's marketplace realigning, along with the forces of convergence and globalization, is likely to produce a number of new and often larger, consolidation candidates.
  2. Increased financing availability and increased rating agency pressures will also be drivers of the deal marketplace.
  3. Many insurers need expanded or new capabilities to compete in their targeted future markets. Acquisitions that accelerate business development or that strengthen organizational capabilities will be more frequent.
  4. Life companies will continue to divest businesses that lack the scale needed for effective management and competitive unit costs. Consolidation in businesses like long term care and variable life/annuity lines exemplify this broadening trend.

Successful acquirors almost always have a clear vision of what they are trying to build as an organization. They also have a disciplined acquisition process, characterized by strong leadership, clear standards and an effective integration process. And they are not afraid to back away from a deal if it doesn't meet its minimum standards, no matter how compelling it might be or how much time/energy they have invested in the process.

In short, we expect to see continuing strong life company M&A activity. We also expect to see more disciplined buyers, with fewer irrational players, and hence prices at more traditional multiples. If pricing on a deal gets too high, we expect sellers will be disappointed in the result! As Samual Butler said so well many years ago, "It's better to have loved and lost than never to have lost at all."

Robert D. Shapiro, FSA, is president of The Shapiro Network, Inc., Milwaukee, WI 53202.