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How to Manage Strategic Relations

Customers, distributors and vendors sink or swim together. One-sided relationships that maximize value for only one partner are self-defeating. They often result in the dissolution of worthwhile relationships, including the loss of key customers and the inability to access meaningful new opportunities.

Despite this, when it comes to managing relationships with vendors, distributors and customers, most companies set the bar low, and it shows during the annual planning process. Plans typically call for negotiating better rates with vendors and distributors. We often hear, “We’ll negotiate better rates and cut costs this year by one to two percent.” Or, “We’ll do more for customers and hope to increase our share of their wallet.” Or, sometimes even, “We just hope to retain the business.”

In addition to near-term planning, most organizations have traditionally managed important vendor, distributor and customer relationships through various business functions, including procurement, treasury, IT, sales and distribution, product and account management. In many cases, these functions are split by territory or division — and often even further by business line. As a result, organizations tend to manage these critical relationships in silos, quarter to quarter, seeking to maintain or marginally improve the partnerships currently in place.

Moreover, as many organizations look to expand beyond their existing footprint to increase scale, introduce innovative products and offer customers and partners engaging experiences, they often create even more silos that hurt relationships with new vendors, distributors and customers.

From a tactical approach to a strategic one

The status quo is far from ideal, and many companies are beginning to realize that successfully deploying their relationship capital can provide a significant boost to long-term revenue and profitability prospects.

Unlike traditional, siloed vendor, distributor and customer relationship management functions, strategic relationship management (SRM) views vendor, distributor and customer relationships holistically (e.g., from each perspective) and allows organizations to not only improve the terms of these relationships but also radically re-imagine them by developing new partnership models. SRM also enables organizations to streamline their total vendor and distributor footprint by focusing strategic spending on a few core partnerships.

Certain industries are rapidly adopting SRM to unlock the full value of their partnerships. The financial services, technology and professional services industries are early adopters, and we anticipate broader industry adoption as firms increasingly see their vendors, distributors and customers as strategic partners. Early adopters have begun viewing their strategic relationships as assets, with the objective of increasing long-term shared value for all parties.

See also: A New Paradigm for Risk Management?  

Organizations that have adopted SRM have seen tangible benefits from being in the cockpit with their most strategic partners. Organizations with SRM invest in partnerships by creating shared business plans and meeting regularly to discuss joint activities and coming opportunities. Enterprises and their top strategic partners have come to realize that they sink or swim together, and they focus on developing truly mutually beneficial relationships.

Examples of strategic partnership models include:

  • An insurer strikes a strategic partnership with a vendor. A global life insurer used several vendors to assist it with various strategic initiatives. Through its SRM function, the organization was able to prioritize one of the vendor firms that had a strong track record of helping the organization. Through several joint strategic partnership meetings, the two organizations defined a partnership model that could help drive shared, long-term objectives. The life insurer agreed to partner with the vendor on several strategic growth initiatives in return for taking over the vendor’s group life insurance plan (for 50,000-plus employees).
  • A strategic customer provides product feedback that increases sales and customer satisfaction. A large technology company had prioritized strategic customer accounts throughout its entire organization. By cultivating these relationships at all levels, the sales and distribution and account management teams were able to quickly relay real-time customer feedback to the product group. This transparency enabled the technology organization to make quick changes to its product offering that significantly increased sales, customer retention and satisfaction upon full product launch.
  • A partner opens the door to new markets. A regional bank used its SRM function as a foothold to expand its operations into new markets. The bank leveraged its strategic B2B partnerships, which already had operational or commercial reach, into select target markets that the bank selected based on the partners’ access to distribution channels and other opportunities to accelerate growth.
  • A large coffee retailer identifies a “win-win” opportunity with a strategic coffee supplier. Through its SRM function, a multinational coffee retailer identified a strategic partnership with one of its coffee suppliers in South America. The supplier produced top-quality Arabica coffee and needed to expand to meet the coffee retailer’s growing demands. Knowing the strategic importance of the relationship in the long term, the SRM function worked with the executive leadership team to create a mutually beneficial opportunity. The coffee retailer helped fund part of a coffee farm expansion project, and the supplier agreed to sell its product to the only retailer and work with it to develop new coffee blends. The retailer was able to build a strategic partnership that is helping to fuel its long-term growth strategy, while the coffee supplier was able to also grow its farming output.

Strategic Relationship Management approach

SRM strategically influences the lifecycle of major opportunities by focusing on four key concepts: connect, collaborate, leverage and influence.

Connect with your vendors, distributors and customers to identify their needs and develop strategies to successfully meet them.

Leverage strategic relationships to identify and prioritize growth opportunities.

Collaborate among business units, across borders and with external account stakeholders to create awareness of new opportunities.

Influence decisions where possible to increase benefits and drive growth for your customers and company.

This approach can help organizations develop joint strategies with their strategic partners to uncover mutually beneficial opportunities and create shared value. Selecting the accounts deemed “strategic” is one of the foundational aspects of setting up SRM, and companies must carefully establish the baseline criteria and other factors they’ll use to identify these accounts.

In addition, to obtain its full benefits, cross-functional executive leadership buy-in is essential to establishing effective SRM. An internal executive governance committee as well as appropriate account management processes and technology platforms will be necessary for the entire organization to effectively own and manage the targeted strategic accounts.

Conclusion: Benefits of Strategic Relationship Management

In conclusion, any organization can benefit from implementing SRM to strategically manage its most vital partnerships. Because of their scale and increased complexity, multinational organizations can stand to benefit exponentially.

Benefits for enterprise:

  • Leverage partners’ skills, capabilities and specialized knowledge as your own
  • Gain access to partners’ networks, channels and geographies
  • Create opportunities to evaluate a relationship holistically (i.e., as a buyer, vendor and distributor)
  • Lower negotiated rates with suppliers by negotiating across business units/divisions/ geographies
  • Improve revenue, margin expansion and prioritization of vendor and distributor relationships
  • Simplify relationships with fewer vendors and distributors

Benefits for strategic partners:

  • SRM-sponsored symposiums where buyers and vendors define common goals
  • Executive group partnership that incorporates global, regional and local perspectives
  • Candid and active feedback on final decisions (win or lose) within defined timelines
  • B2B business planning
  • Awareness of RFP opportunities

In short, having deeper and more meaningful partnerships with strategic partners creates transparency, trust and, subsequently, more opportunities for all parties. Moreover, the proper functions will clearly hear the voice of vendors, distributors and customers and thereby facilitate mutually beneficial, active strategic decision making.

See also: A Revolution in Risk Management  

This post was written with John Dixon, Jay Kaduson and Tucker Matheson.

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.