Tag Archives: TSA

Possibilities for Non-Traditional M&A

2015 was a record year for announced insurance deals, as long-anticipated industry consolidation finally started to occur. Several factors have driven consolidation, notably slow economic growth and persistently low interest rates, both of which have limited opportunities for organic growth and forced insurers to reconsider their long-term competitive strategies. Combined with record levels of corporate capital and private equity funding, these pressures have created the perfect opportunity for both buyers and sellers.

Historically, regulatory or financial pressures have driven insurance carve-outs. [An insurance carve-out is a transaction in which a seller divests part of its business (e.g., a particular customer group, product line or geographic area) rather than an acquirer buying the entire enterprise. The seller typically benefits from exiting sub-scale or unprofitable lines, while the acquirer is able to increase scale or geographic reach.] These pressures typically have included repayment of emergency funding received during the financial crisis, fulfillment of regulatory conditions for receiving state aid, divestment to free up capital and improve solvency ratios in preparation for Solvency II, or the shoring up of capital via asset sales following losses.

In recent years, we have seen the industry move away from complex multi-line business models. Insurers are exiting sub-scale business lines to improve returns and compete in an environment in which technology is disrupting tradition business drivers. There are many insurers considering carve-out transactions or IPOs as sellers, and there are even more looking to build market share by acquiring and consolidating businesses with their existing operations.

See also: Insurance M&A Stays Active in 2016  

However, insurance carve-outs tend to be more complex in both transaction structure and post-merger integration than an acquisition of an entire insurance enterprise, and require careful planning and execution to successfully separate the acquired business (“SpinCo”) from its former parent (“RemainCo”).

What should executives be aware of when they consider these types of transactions?

  • Planning and Organization
    • Confidentiality, maintaining optionality and speed of execution are critical to maximizing deal value.
    • The flexibility to execute deals via alternative structures (described below) helps maintain optionality. In addition, a thorough understanding of the M&A landscape is necessary for sellers to run a competitive sales process and for buyers to understand how to properly position themselves for success.
    • To facilitate speed of execution, executives need to simultaneously focus on multiple priorities, including deal execution, separation planning and negotiation of transitional service agreements (TSAs). Leading practices include having a transaction committee that can rapidly make decisions and a project office that guides the planning effort.
  • Transaction Structures
    • Acquisitions of an entire insurance enterprise typically involve the purchase of all of a holding company’s issued stock. The holding company, its subsidiary legal entities, assets and liabilities, products and licenses, people, technology and infrastructure transfer to the control of the acquirer at close. A carve-out requires a different approach. It is rare that the business being sold is fully contained within a single subsidiary legal entity. More frequently, the business being disposed of is written across numerous legal entities and is mingled with business that is core to, and remains with, the vendor. Therefore, carve-outs typically use a mix of strategies to separate the insurance business of SpinCo from RemainCo:
    • Renewal rights – The acquirer receives an option or obligation to renew the acquired business in its own legal entities.
    • Reinsurance – Renewal rights may be accompanied by reinsurance transferring the economics of the historical book either to the acquirer, to other entities owned by the vendor or to a third party.
    • Fronting – Certain domiciles, such as Japan and the U.S., require regulatory authorization of products or rates prior to their availability to policyholders, and such product approval frequently takes longer than regulatory approval for a change of control. When an acquirer doesn’t have regulatory approval to immediately write the business in its own legal entities, the transaction structure typically allows an acquirer to:
      • Continue to issue and renew policies using the vendor’s legal entities for a defined period of time, and
      • Assume the economics of the business via reinsurance. The acquirer frequently is responsible for administering the business (which is still the legal and regulatory responsibility of the vendor’s legal entities) via a servicing agreement.
    • Stock transactions – These are used when assets and liabilities can be segregated into legal entities (e.g. using the European Economic Area’s (EEA) insurance business transfer mechanisms), or when a legal entity, such as a specialist underwriting agency, specifically supports the business being sold.
      • Transfer of assets and contracts/TSAs – Just as the insurance business being sold may be diffused across the vendor’s legal entities, the same may also apply to the people, facilities, technology and contracts with sellers that support the business. While a certain portion of these will clearly align either to SpinCo (and will transfer at close) or RemainCo, there will be a significant subset (particularly in IT and corporate services) that support both and are not easily divisible. For such functions where SpinCo is heavily reliant on the resources of its former parent and it is not possible for the acquirer to fully replace such services prior to the transaction closing, a TSA provides the acquirer and SpinCo with continuing access to and support from RemainCo’s resources after close.

Negotiating the TSA

TSAs provide access to the resources and infrastructure of the former parent for a defined period. While in certain simpler transactions, TSAs can be for as little as three months and require only that the support provided previously be maintained at the same service levels and at the same cost basis, it is more common that acquirer and vendor during the months prior to close:

  • Understand and define the reliance of the business being sold on its parent (and vice versa);
  • Set the duration post-close for each service required under the TSA;
  • Agree on the charging basis e.g. fixed monthly fee, usage, hourly rates (for tax efficiency, each service is usually priced individually);
  • Establish service levels and post-close governance processes.

The acquirer should set realistic timeframes for exiting from individual services. The complexity of insurance policy administration systems, the frequent integration of certain capabilities (such as billing, commissions, and contact centers) across products and the need to separate networks, migrate data centers and implement replacement mainframes frequently require TSAs of 24 to 36 months.

TSAs also may cover centrally provided non-IT services, including HR/payroll/benefits administration, facilities management, procurement, compliance or financial and management and regulatory reporting. However, the duration of these TSAs tend to be shorter – usually a few months, or sufficient to support regulatory and financial reporting for the period following close.

Ideally, the acquirer should seek as much flexibility as possible with the duration of the TSA. It should have the right to terminate the TSA early, the option to extend it at pre-agreed rates and the inclusion of force majeure clauses (a natural catastrophe can significantly affect exiting from a TSA).

Contract assignment and access to shared reinsurance

An area of often-underestimated complexity in carve-outs is the need to ensure that the separated business can continue to receive the benefit of third-party contracts with suppliers, distributors and reinsurers. In most jurisdictions, contracts cannot simply be novated (the insurance business transfer mechanisms of the EEA provide certain exceptions), but instead each contract must be evaluated to determine if assignment simply requires notification to the counterparty or its express consent.

The challenges that arise in contract transfer are both:

  • Logistical – 85% of counterparties contacted typically respond at first instance. However, a recent carve-out had more than 50,000 contracts that needed to be assessed, prioritized and migrated. In this instance, chasing down the remaining 15% was a real challenge.
  • Commercial – Certain experienced counterparties, knowing the tight timeframe for most transactions, may try to renegotiate better terms either prior to the contract being assigned to the acquirer, or prior to permitting the vendor to use the contract to provide services under the TSA.

Also important in a carve-out is a clear apportionment of access to historic reinsurance programs shared between the vendor’s continuing business and the business being sold, as well as definition of the resolution process for any post-close disputes.

Executing close

Transaction close for virtually all insurance carve-outs is triggered by the receipt of one or more regulatory consents enabling the execution of fronting, reinsurance and stock transfer agreements.

When migrating staff and assets supporting SpinCo to the acquirer, supporting staff and assets are moved into a legal entity, the ownership of which transfers at close in certain cases. However, when the relevant staff are not employed or supporting assets are not owned by legal entities transferring to the acquirer at close, there will need to be arrangements for the valuation and transfer of both tangible and intangible assets (e.g. trademarks) and the offering of employment and enrollment in benefits to selected staff by the acquirer. This is a significant logistical exercise for an HR function.

See also: Group Insurance: On the Path to Maturity  

Insurance carve-outs are also particularly challenging for finance functions:

  • The combination of renewal, reinsurance and legal entity acquisition in the transaction structure complicates accounting immediately post-close.
  • Cross-border acquisitions can include acquirers and sellers with different accounting standards (e.g. IFRS, U.S. GAAP, statutory and JGAAP) that often have very different rules on the treatment of assets and liabilities.
  • The practice of closing at a month or quarter end – which in some ways can simplify the transition – may also introduce a tight and immovable timeframe for external financial and regulatory reporting.

Lastly, although there typically will be several months between the deal being agreed upon and the close, this may not be sufficient time – particularly in larger acquisitions across multiple locations – to roll out the acquirer’s networks and desktop technology prior to close. Therefore, full access to the acquirer’s IT capabilities may need to wait until later in the integration.

Post carve-out integration

While an acquisition of an entire enterprise provides a pre-existing governance structure, an insurance carve-out typically includes fewer members of senior management and requires rapid integration of functional management within the acquirer’s existing structure, the expansion of governance and compliance structures to include the acquired operations and the establishment and communication of delegations of authority and decision-making rights.

Due diligence should have provided the acquirer with initial hypotheses as to the organizational capabilities required by the combined organization, interim and end-state operating models, and opportunities for synergies.

As with any insurance acquisition, synergies in carve outs are typically realized through:

  • Functional consolidation.
  • Platform consolidation and process standardization, which enhances productivity and enables staffing efficiencies.
  • Facilities and infrastructure reduction, and
  • Reduced costs through more efficient third-party vendor selection.

PwC’s research indicates that the most successful acquisitions are those that develop momentum by demonstrating tangible integration benefits in the first 100 days. Accordingly, the acquirer should act fast but should also be prepared to revisit pre-deal assumptions and revise its integration roadmap as the two organizations integrate and new information becomes available.

Conclusion

Based on what we see in the market, notably a recent succession of P&C and reinsurance megadeals, we predict that insurance industry consolidation will continue apace. Multi-line insurers have divested themselves of numerous franchises and this trend seems likely to continue. Because these types of transactions are complex and depend on many internal and external factors, companies that are considering such moves will need to be aware of and address the many challenges and issues we describe above.

This article was written by John Marra, Mark Shepherd, Michael Mariani, and Tucker Matheson.

Confessions of Sleep Apnea Man

There are elements of medical care in the U.S. that just plumb confound me. One is the requirement of a prescription for the most mundane of items, particularly when you think about where we could be focusing our efforts.

Please indulge me a moment while I ‘splain the background on this.

I went through a sleep study back in 2002, where I was diagnosed with sleep apnea. Apnea is a condition most identified with snoring, although not all snorers are apnea sufferers. After the diagnosis, I was provided with a CPAP machine, the device most commonly used in the treatment of that particular condition.

Sleep apnea is described as a potentially serious sleep disorder in which breathing repeatedly stops and starts. What it really was, however, was a condition that kept my wife awake at night. I don’t know why the doctors didn’t treat her instead. The CPAP (Continuous Positive Airway Pressure) machine is designed to gently pressurize your airway, keeping it open, providing for a more sound sleep.

Mostly for your wife.

You see, the CPAP literature says the machine is designed to alleviate apnea episodes and reduce potentially fatal risks. The fatal risk it is most likely to alleviate is stopping your spouse from shooting you in the face with a bazooka at 3 am.

I have used the same CPAP machine since 2002, and it has performed very well. I do sleep much better using it, as does my wife. I usually take it with me in my travels, and therein lies the conundrum that has produced this missive.

My unit, now about 13 years old, is somewhat clunky for the frequent traveler. This is especially true when one does not generally check luggage. Somewhat bigger than a large box of Kleenex, the device either must be packed within my carry-on or in its own travel bag. As a medical device, it does not count as one of my two carry-on items under FAA rules, but it is nevertheless bothersome to have to tote a fairly significant extra bag around. Prior to the advent of PreCheck, it had to come out of the bag and be run through the X-ray equipment on its own. Until about five years ago, it even had to be pulled aside by TSA for explosives testing. If TSA was efficient, that would occur while I was having my prostate checked by Two Finger Lou. If not, the testing added a few minutes to every pass through security.

Today, as a government-fingerprinted “Known Traveler” with my very own “Trusted Traveler” ID number (don’t get me started on that), I always fly as a PreCheck passenger. The device no longer has to come out of the bag, so for trips of just a few days I pack it inside my carry-on. Of course, as we all really know, size does matter, and this is an issue for trips longer than just a few days. While I have become a very efficient packer and can get four or five days of clothes into a carry-on with the machine, anything longer requires that the unit be carried separately.

With that in mind, I ordered a “travel CPAP”: a machine about a quarter of the size of the one I have been using. After I placed the order with an online company, it notified me that it required a prescription for the machine to be on file before it could fulfill the order. I have a prescription for CPAP supplies on file with the company, but apparently being able to buy the supplies is different than buying the machine that uses them. According to the FDA, CPAP devices are considered Class II medical devices and require prescription by law.

The issue is that my sleep specialist, whom I have not seen in more than 12 years, changed practices a decade ago, and records no longer exist with the practice where I was diagnosed. Without those records, no prescription will be forthcoming. I frankly don’t know what my options are with the practice. I suppose I could set up an appointment, go through another two-night sleep study, spend a couple hundred in co-pays and have my insurance billed God knows what for the effort, all to get a piece of paper confirming something we already know I have.

All for a machine whose basic function is blowing air.

If we applied that logic here, you would need a prescription just to read my blog.

Can someone in the medical community take a moment to explain this to me, an admitted medical ignoramus? Have these machines been abused in some unimaginable way? Were teens buying these machines in droves to huff air? Are they somehow vital in the making of meth? For Christ’s sake, in the hands of evil men, what indeterminate hell could they unleash?

What aren’t you people telling us????

Someone should tell the FDA that CPAPs don’t kill people; drugs kill people. Maybe the FDA should focus some of its enforcement zeal toward those things that really matter. Perhaps the FDA has heard of the need for a national prescription drug monitoring database.

Unless, of course, I am mistaken, and rogue CPAPs are slaughtering more than the 20,000 people every year who die from prescription drug overdoses.

My solution to this dilemma will, I hope, be found through my primary care physician. I have made an appointment with him for the sole and single purpose of getting that magic prescription. It will cost me $30, and my insurance company significantly more, all to tell the good doc that I’m feeling fine and that there is nothing wrong. I just need one of those air-huffing, meth-cooking, chaos-reigning machines — but a small one to make my travel schedule easier to bear.

There is a chance that he will not be able to authorize one without another complete sleep study, in which event it will represent a colossal waste of resources.

In the absence of a logical explanation, this scenario simply serves to show the ridiculous waste of time, effort and resources in a system where common sense often struggles for its moment in the sun. In a world where we are trying to figure out how five or six remaining practicing physicians are going to treat 350 million people, is this really where we need to devote so much effort? It simply makes no sense to me.

But then again, there may be reasons of which I am not aware. I am sure some medical wizard out there, or a medical-equipment salesperson, should be able to enlighten me and remove my veil of ignorance on the matter. I encourage you to do so, and you don’t even need to be gentle about it.

It certainly won’t be my first time.