Life2016: Using M&A to optimise your business

Using M&A to optimise

your business

Waheeda Narker,

Fergal O’Shea,

Brian Shea, Steve Allan

What next for the Risk FunctionKirsty Leece and Liz Ryan

Commercial Risk Director, Zurich

Session 2Chaired by Marcus Bowser

Life2016

© 2016 Willis Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only. 1

#WTWLife16

Agenda


Fergal O’Shea: M&A trends and the external environment

Waheeda Narker: Optimise or sell? (A case study)

Brian Shea: How the investment community views M&A

Steve Allan: HR considerations key to deal success

Using M&A to optimise your business - Agenda

Future

Low interest rates

Economic uncertainty

Capital strain

Declining new business

Shareholder shake-up

Regulatory uncertainty

Distributor value RDR review

Customer proposition – Efficient and

profitably managed

Product relevance – Diversity vs. niche

Distribution – More economic

Growth challenge - Increased penetration in

emerging markets and in selected market

segments in mature markets

Capital optimised

Consolidated sector

Solvency II goes live

Capital focus 2016

What we see happening in the European Life sector


MARKET BACKGROUND

2010

Deal Activity


DEAL ACTIVITY

0

10

20

30

40

50

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

Deal V

alu

e (

€bn)

EMEA Deal Breakdown by Value (€bn)

Life Insurance Composite Insurance Property & Casualty Insurance Reinsurance

EMEA Life M&A activity since financial crisis

Globally

M&A volumes

recovering

Mega-deals are

back

EMEA Life

Still holding back

UK Life

Significant activity

Deal Drivers


Capital & consolidation going forward

DEAL DRIVERS

Transformational

deals

Bailouts & distressed

sales

Topline

Consolidation

Scale

Diversification

Capital and portfolio

management

More consolidation

More consolidators

More markets

Capital

Solvency II

G-SII

Basel III

Local regulatory

Portfolio management

Buyers

Traditional participants

Non-traditional players

PE

Asians

SWF’s

Agenda







WTW Perform Opportunity Assessment Considering…


Optimise

value

Increase asset risk

Predictive modelling

Reinsurance

Impact

of

sale

Simulate sale prices

Impact on metrics

“Walk away price”

?vs.

Optimised Portfolio


Technical

Provisions

Capital

Assets

Surplus Assets

Technical

Provisions

Capital

Assets

Surplus AssetsRelease of capital

Release of

reserves

No Matching/Volatility

Adjustment

Value of benefit after loss of future profits and capital releases:

£45m

Current Optimised

13bps

Matching

Adjustment

1.5% GLM

demographic

assumptions

£55m

distributable

cash benefit

after tax

With Matching/Volatility

Adjustment

Reinsurance

Sale Impact – Peer Companies were Earning Significantly Higher Yields

(After Allowing for Defaults)


-

1.00

2.00

3.00

4.00

5.00

6.00

7.00

Co 1 Co 2 Co 3 Co 4 Co 5 Co 6 Co 7 Co 8 Co 9 Co 10 Co 11 Co X

(bp

s)

Co X

Competitive Tension will Drive Buyers to Price in a Significant Yield Uplift

(Compared to X’s Portfolio)


14 21

62

101 105 106

129

168 169

183 186

-

20

40

60

80

100

120

140

160

180

200

Co 1 Co 2 Co 3 Co 4 Co 5 Co 6 Co 7 Co 8 Co 9 Co 10 Co 11

(bp

s)

Possible range for buyer

pricing enhancement

Simulation of Buyer Price – 50bps and 100bps Yield Uplift


Current position

Capital

Technical

Provisions

£1 bn

Buyer 50bps uplift:

95% reserves

Capital

Technical

Provisions

£950m assets

Buyer 100bps uplift:

90% reserves

Capital

Technical

Provisions

£900m assets

Impact of Disposal on Distributable Cashflow


0.00

1.00

2.00

3.00

4.00

5.00

6.00

1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 49 51 53 55 57 59

Cashflow Capital Release including investment income

Sales at

(£m)

Purchase

Price

Received

Tax Capital

Released

Distributable

Cash on Sale

95% reserves 50 (10) 60 100

90% reserves 100 (20) 60 140

Loss of

Future

Profits

Value of

Future

Capital

Releases

Value

Benefit

After Tax

(20) (25) 55

(20) (25) 95

Impact of Disposal on Net Income After Tax


The graph shows the estimated reduction in NIAT

This compares with the balance sheet impact shown above

£m

Initial

IFRS

Liabilities

Book Value

of Assets

Transferred

Impact

before

Tax

Tax Net

IFRS

Impact

Sale at 95% reserves 885 895 (10) 2 (8)

Sale at 90% reserves 885 850 35 (7) 28

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0

1 2 3 4 5 6 7 8 9 1011121314151617181920212223242526272829303132333435363738394041424344454647484950

Millio

ns

Impact of Disposal on Economic Capital and MCEV


(£m) Current

EC

Available EC

(no illiquidity

premium)

35

Required

Capital

(45)

Reduction,

Free Capital

(10)

Sale proceeds

Total Benefit

(£m) Current

MCEV

MCEV (40

bps

illiquidity

premium)

60

Sale

proceeds

Total

Benefit

Economic Capital MCEV

Sale at

95%

reserves

Sale at

90%

reserves

45 45

50 100

95 145

Sale at

95%

reserves

Sale at

90%

reserves

(60) (60)

50 100

(10) +40

Optimise vs Sale


MCEV:

£(60)m plus £50m

Distributable cashflow:

£55m

Net IFRS Impact:

£(8)m

EC:

£45m Capital Release

plus £50m

90%

reserves:

£100m

95%

reserves:

£50m

Sale

£45m benefit

internal

optimise

<=95%

reserves

“walk away

price”

MCEV:

£(60)m plus £100m

Distributable cashflow:

£95m

Net IFRS Impact:

£28m

EC:

£45m Capital Release

plus £100m

Board Decision


Sale

Buyer perspective

ROC

Risk appetite

Metrics impact

Capital release

Future earnings

“Walk away price”<=95%

Outcome

Competitive tender

c90% of reserves

>£100m cash benefit

WTW performed

Appraisal and ran

Auction

Why do Investors own the European Insurance Sector?


Sector has outperformed over the past five years… . . . at a time when fundamentals are deteriorating

40%

60%

80%

100%

120%

50

150

250

350

€ 450

1/01 1/04 1/07 1/10 1/13 1/16

STOXX Europe 600 Insurance – Price (€)

STOXX Europe 600 Insurance – Relative Value to STOXX Europe 600 (%)

Source: FactSet.

Interest rates have declined to record

lows

Life growth has slowed

Non-life pricing is under pressure

Agenda







Investors Own Insurance for Cashflow and Dividends


Group-wide FCF generation remains robust

€12.4 €14.9 €15.2 €16.4 €16.3 €19.1 €18.2 €19.1

€11.7 €5.4

€14.0 €19.6 €17.7

€20.7 €20.0 €20.9 €24.2 €20.3

€29.2

€36.0 €34.0

€39.8 €38.2 €40.0

0.0

12.5

25.0

37.5

€50.0

2010 2011 2012 2013 2014 2015E 2016E 2017E

Sector Life FCF Generation P&C & Other FCF Generation

(€ in billions)

2016E FCF usage well covers financing & dividend costs

59%

25%

11%

5%

Dividend Costs

Retained Cash

Financing Costs

Buybacks

Insurance Sector FCF Yield is among the most attractive in Europe

8.1% 7.2% 7.1% 7.0%

6.2% 6.1% 5.8% 5.5% 4.9% 4.8% 4.7% 4.7% 4.3% 4.2% 4.2% 4.2% 4.0% 3.9% 3.7% 3.5%

0.5%

0%

2%

4%

6%

8%

10%

Ba

nks

Life

Insura

nce

Insura

nce

Non-L

ife

Insura

nce

Technolo

gy

Media

Tele

com

s

Ph

arm

a

Dvrs

f'dF

inancia

ls

Avera

ge

Tra

nsp

ort

ation

Mate

rials

Au

tos

Pe

rsonal G

oods

Real E

sta

te

Food &

Be

vera

ge

Utilit

ies

Capital G

oods

Reta

il

Healthcare

En

erg

y

Investors will judge any back book transaction in terms of how FCF and dividends are affected

Source: BofA Merrill Lynch Global Research.

0

20

40

60

80

100

120

Analyst Fair Values for the Life Segment of a European Composite

FV EV

0%

10%

20%

30%

40%

IFRS book value Tangible bookvalue

Embedded value IFRS earnings Dividend yield Free cash flowyield

Which valuation approach will gain the most in popularity over the coming 12m?

Dec-09 May-10 Sep-10 May-11 Oct-11 Jun-12 Sep-12 Dec-12

FCF has replaced EV as a valuation tool amongst investors

Source: BofA Merrill Lynch Global Research and other analyst research.

Embedded Value is a less Important Metric for the Investment Community


European life insurance companies

no longer trade at a premium to EV . . .

Analyst fair values typically lie below EV

0.7x

1.0x

1.2x

1.5x

1.7x

2.0x

2.2x

2.5x

2.7x

'97 '99 '02 '05 '08 '10 '13 '16

Pri

ce

/ E

nte

rpri

se

Va

lue

37%

46%52%

58%65%

81%85%

89%93% 95%

102% 103%107%

115% 117%119%

0%

20%

40%

60%

80%

100%

120%

140%

Delta

Llo

yd

. . . and many currently trade at a meaningful discount

Sto

reb

ran

d

AE

GO

N

Sw

iss L

ife

Ge

ne

rali

Ag

ea

s AX

A

Se

cto

r A

ve

rag

e

Aviv

a

NN

Gro

up

Old

Mu

tua

l

Pru

de

ntia

l

Sta

nd

ard

Life

Alli

an

z

L&

G

ZIG

Selling at less than EV could still be accretive to your company’s valuation

The Metrics That Matter More When Investors Assess M&A


Impact on IFRS results

One-off impact on book value less important

Any impact on on-going earnings is more important

Especially if it impacts expectations about the dividend

Impact on solvency ratio


Impact on volatility of capital


140%

150%

170%

130%

150%

160%

180% 175%

140%

170%

180%

230%

160%

200%

220% 220%

180%

0%

25%

50%

75%

100%

125%

150%

175%

200%

225%

250%

Companies are working to reduce the

sensitivity of their solvency ratios

Still a wide range of sensitivities

today . . .

. . . and this is driving differences in

target solvency ratios(2)

Capital Volatility is Under the Spotlight


Example: Allianz

-80%

-60%

-40%

-20%

0%

20%

40%

Credit Spread +100bps

Equity Markets -25%

Equity Markets +25%

Interest Rates -50bps

Interest Rates +50bps

-70%

-60%

-50%

-40%

-30%

-20%

-10%

0%

10%

20%

30%

Q4 14 Q4 15

Credit Spread +100bp

Equity Market -30%

Equity Market +30%

Interest Rates -50bp

Interest Rates +50bp

(1) Figures: Q4 15. (2) Generali does not specify an upper limit for its target solvency.

(1)

A transaction that lowers the volatility of capital,

and therefore may lower a company’s target solvency, is dividend-generative

It’s all about capital & dividends

Analyst Reactions to Back Book Disposals are Generally Favourable


Zurich: Sale of UK Annuity Book to Rothesay Life (May 2015)

Aegon: Sale of remaining part of UK annuity portfolio to Legal & General (May 2016)

“Transaction reduces credit and longevity risk and releases cash. Group capital impact $208mm” (Zurich Investor Day Presentation)

“Aegon divests another £3bn of annuity portfolio in the UK… to L&G, releasing £275m of Solvency II capital, with the Solvency II ratio increasing

15pts at the outset and another 5pts following the Part VII transfer. Results in an IFRS loss of c£215m in Q2, reduces annual capital generation by c

£30m, underlying earnings before tax reduce by £16m…. This should be sentiment positive for both: Aegon for disposing of non-core business;

L&G for winning a bulk annuity deal in line with cost of capital hurdle rates.” (Morgan Stanley analyst comment)

“The transaction is expected to add +20%pts to the UK S-II ratio. The impacts… on free capital generation are negative -£30m and on underlying

earnings before tax -£16m…. Following its disappointing 1Q16 results, where S-II disappointed badly, this is at least helpful relief for AEGON in

terms of capital.” (Autonomous analyst comment)

“[AXA] believe they have better opportunities to redeploy this capital elsewhere…. Approximately €400m from the UK will likely be up streamed, with

the remainder (~€400m) staying locally to fund the pensions business.” (Barclays analyst comment)

“[AXA] has postulated an annual M&A budget of ~€1bn, potentially hitting the S-II ratio by between 3%pts (mature markets) and 6%pts (growth

markets). Clearly a sale of AXA UK would add up to nearly €1bn to its M&A fire power.” (Autonomous analyst comment, reacting to Bloomberg story

shortly before deals were announced)

Swiss Re: Sale of US Admin Re to Prudential (May 2012)

US GAAP loss of $0.4b, but ‘economic’ gain of $0.3b, and $0.9b of capital freed up

“Redeploying the funds freed up through this transaction within the Swiss Re Group will have a beneficial impact on all three of our financial targets

in the future, that is to say return on equity, earnings per share and economic net worth growth.” (Michel M. Liès, Group CEO)

“A positive for the company, even if the deal multiple is low. The deal is likely to free up economic capital, which allows either faster growth in non-

life or eventual higher distribution to shareholders.” (Morgan Stanley analyst comment)

Axa: Sale of its UK wrap platform & offshore investment bonds business (April-May 2016)

Agenda







Incompatible cultures 5.60

Inability to manage target 5.39

Unable to implement change 5.34

Synergy nonexistent or overestimated 5.22

Did not anticipate foreseeable events 5.14

Clash of management styles/egos 5.11

Acquirer paid too much 5.00

Acquired firm too unhealthy 4.58

Need to spin off or liquidate too much 4.05

Incompatible marketing systems 4.01

People Considerations that Impact Deal “Value Realisation”


Source: 2009 Global Pulse Survey.

Open communicating with employees

throughout the transition

Influencing effectiveness of

senior leadership

Deploying workforce effectively

pre-, during & post-transition

Creating & implementing strategies

to retain key employees

Creating and implementing staffing

strategies aligned with talent strategy

Assigning best resources

to the integration team

Cultural alignment

Very successful

deals focused onLess successful

deals focused on

Early, intense focus on people issues

Source: Survey of Forbes 500 CFOs. Assessed on a scale of 1 to 7, where 7 is high.

19%

20%

26%

19%

32%

40%

15%

38%

39%

47%

41%

56%

65%

42%

15%

42%

40%

41%

19%

47%

26%

39%

20%

38%

19%

56%

65%

32%

Rank

Top Ten Pitfalls in Achieving SynergiesNegative

Impact

Private Equity

Sovereign Wealth Funds

New investors from

emerging markets e.g. Asia

Alternative

Business

Partners

Capital and solvency

measures

Cash flow and

restructuring impact

Optimising financial

position

Financial

Strategy

Consolidation

Targeting emerging

markets

Innovation and

alternative distribution

mechanisms

Themes from Today


Business

Strategy

People Issues Key Consideration in Deal Planning


Workforce and integration planningPeople programs and financials

Financial

Issues

Material people-related balance sheet and P&L items

e.g. retirement benefits, leave provisions, termination

indemnities

Review any areas of HR non-compliance and

estimate remedial costs

Labour law implications e.g. severance triggers,

changing employing entity, new contracts

Financial run rate of compensation and benefit plans

Executive change in control / severance

provisions and valuation of financial impact

Assessment of executive compensation

competitiveness

Assessment / benchmarking competitiveness of

compensation and benefits

Synergy realization timing and restructuring costs

People Issues

Summary of compensation, benefits and people

programs

High level review of competitiveness

of people programs

Review of employment contracts, union/enterprise

agreements

Design executive compensation options

dealing with transition issues e.g. retention,

public to private, change of roles

Review of succession plans

Executive transition roadmap

Retention design for key talent

Review of company labour environment and anticipated

transition / operating issues

Workforce profile e.g. attrition, roles, service, gender mix

Review of employee research data

Cultural alignment to business strategy

Review of HR service delivery mechanisms

Summary of key issues and mitigation for input to

integration planning

Key to deliver deal

value

Focus on maintaining

BAU

Implementation

Executive compensation and retention

People issues included

as a key consideration in

deal objectives

Target Identification

Key financial exposures from people plans

and programs

Leadership, talent change-in-control risks

and retention

Early Stage Due Diligence

Successful acquirers

build an integration plan

based on deal objectives

Pre-Close Planning


Conclusions

#WTWLife16

External environment

The significant M&A activity seen to date could even accelerate.

The main deal drivers going forward will be capital and consolidation.

There is good buyer interest in European life insurance companies/books, including new types of buyers.

The thought process for the potential seller

Consider the value to optimise vs. sale of the business? At minimum this gives the Board an indication of your

“walk-away price” if you go down the sale route.

You need to consider the impact of a disposal on a number of metrics: Statutory Cashflow Basis, Economic

Capital, MCEV and IFRS.

How your external stakeholders will react if you sell

Embedded value is no longer an important metric for the investment community.

It’s all about cashflow and dividends.

You can have transactions at below EV, which still increase your company’s stock market valuation

Conclusions


HR considerations are key to ensure the deal delivers value

At the earliest phase of deal cycle – be clear on deal objectives and the key HR implications.

Financial due diligence focused on quantification of key financial exposures from HR programs, identification of

key leadership risks and highlighting other material deal-critical factors.

Implementation planning starts before close, building on DD findings. Implementation then balances integration

activities with maintaining BAU.

QuestionsLife2016


#WTWLife16