IRLA ACADEMYMERGERS, ACQUISITIONS & OTHER OPTIONS FOR FINALITY

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DISCLAIMERThe views and opinions expressed in the written and oralpresentations made today do not necessarily representthe views or opinions of the speakers or of the firms bywhom they are employed or engaged. IRLA and thepresenters do not guarantee the accuracy of the dataincluded, and accept no responsibility for anyconsequence of their use.

RESTRUCTURING

INTRODUCTION TO THE PROGRAMMEPaul CorverChairman, IRLA Learning & Development Ambassador

In partnership with

Private & Confidential

RESTRUCTURING

M&A TRENDS AND OUTLOOKKevin GillPartner, Ernst & Young LLP

Agenda

• Review of the year to date

• Review of the past decade

• Wider market trends

• Pricing drivers

• Sources of capital

• Future drivers of transaction activity

Legacy deals announced in 2017 – Review of the year to dateKey observations

► Of the 22 deals announced in 2016 and 2017 to date:

─ Compre completed 7 deals, of which 3 related to acquisition of Ridgwell Fox & Partners (RFP) pool legacy reinsurance business from various parties

─ R&Q completed 7 deals, of which 2 related to acquisition of captives, others related to run-off portfolio transfers

─ Axa LM, Catalina, Armour Re, Enstar, Darag also complete one or more transactions during the period.

► Some further deals expected to be announced before the end of the year

► UK Employers’ Liability (UKEL) deals have dominated the run-off deals in recent times since the Aviva/Swiss Re Reinsurance deal in 2015

► Continuation of some key legacy themes in 2016 and 2017 to date:

─ The majority of the deals were in the UK – 13 in total

─ There is a strong European deal volume emerging with: 3 transactions were in Germany

─ Other transaction jurisdictions include Sweden, Ireland, Belgium, Italy, Guernsey, Liechtenstein and Norway

Buyer Target SellerAnnou

May

April

February

January

January

January Clariant AG

Axa Insurance (Employers' and public

liability legacy business)

RSA UK (Employers' liability legacy business)

Wüstenrot & Württembergische

(Ridgwell Fox & Partners pool of RI business)

AG Insurance (UK run-off insurance and

reinsurance business)

Clariant Insurance

Ikano GroupIkano Forsakring AB

AXA Insurance UK

RSA Insurance

Wüstenrot & Württembergische

AG

AG Insurance SA

January

RW Gibbon (Underwriting Agencies) Limited and RW Gibbon

& Son Limited

Swiss Re International SE

► An active transaction market in UK / Europe across a broad range of deal sizes

► Combination of auctions and off-market processes

► Emergence of more external business transfers:

─ Tried and tested precedents

─ Significant further scope given scale of run-off in UK/ European portfolios

─ Use of whole account reinsurance to accelerate economic/ operational finality as a bridge to portfolio transfer

► Reducing population of legacy entities remaining and fewer readily available legal entities left – thus predicting rise of portfolio transfers

► Transfer of books into a single entity as part of vendor restructuring could be a source of further company disposals

Volume of transactions

European M&A activity in the last decade – by legal form

YTD

112 2

46

11

3

8

3

76

4

1

1

3

11

19

57

6

7

5

7

7

2

710

2

0

2

4

6

8

10

12

14

16

18

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Novation Portfolio Transfer Retrospective reinsurance Share sale

France and BeNeLux

9%Scandinavia

12%

Southern Europe3%

UK&I57%

Germany, Switzerland,

Austria17%

CE1%

Others1%

8

► Cultural barriers remain, but being broken in key countries

► The number of subsidiaries for disposal, particularly in the UK, is reducing.

► Emergence of regional consolidators in Europe (AXA, DARAG, Compre, R&Q, Armour)

► More blue-chip exits required in Continental Europe to further endorse seller engagement with the legacy buyer market

57%of disclosed European transactions in the last decade took place in the UK

Volume of transactions

European M&A activity in the last decade – by jurisdiction

YTD

1 1 12

4

12

12

22

14

3

3

1

8

6

5 78

7

6

5

2

6

12

4

11

3

8

3

2

33

1

1

11

1

0

2

4

6

8

10

12

14

16

18

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

France and BeNeLux Scandinavia Southern EuropeUK&I Germany, Switzerland, Austria CEOthers Isle of Man

A wide pool of liabilities potentially eligible for sale… … falling under the scope of more proactive management strategies

48%Passive liability management

52%Proactive liability management

Wider market trends

Sources: Darag, industry surveys, EY analysis

€250bn

The long-term opportunity in Europe remains promising

Illustrative market

maturityprofile

Latent Emergent Mature

Southern Europe

BeNeLux

GermanySwitzerland

UK

Nordics

Wider market trends

Key drivers of pricing

► Equity – PE / Hedge funds / Institutional: Public / Private

► Debt – leverage, but on what terms?

► Reinsurance – as leverage, for tax arbitrage

► Tax – use of losses, profit optimisation

► Capital – can optimise via internal transfer

Standalone features Strategic value (“in the eye of the beholder”) Cost of capital / financial engineering

Drivers of pricing

► Existing knowledge of business / relationships

► Plays to existing expertise / diversifies expertise / market entry platform...

► Scale synergies in terms of capital, asset management, operations

► Run-off strategy – to expiry, commutations, schemes, reinsurance...

► Capital and reserving adequacy

► Strength of reinsurance

► Investment portfolio credit quality, returns, liquidity

► Non-insurance attributes/ risks

► Quality of data

Buyer-specific differentiators

Sources of capital Incumbent consolidators

Reinsurance

Debt

Private equity

Hedge funds

ILS investors

Quasi / near trade

Overseas trade

Sources of capital

New entrants

The run-off market has access to a broad range of capital sources, and continues to attract further capital via direct equity ownership, financial leverage and funds/side vehicles

Future drivers of transaction activityDrivers

Transaction themes

Typical issues

Non-core

Management distraction

Volatility / risk

Cost

Capital optimisation

Value-based management

Corporate strategies

Greater reporting & disclosure

Shareholder scrutiny / activism

Greater visibility

Proactive legacy management units

Tried and tested route

Propensity to sell

More confidence in buyer market

Focus on core business

Legal entity rationalisation

X X X

Rating enhancement

Pricing attractive

Emergent jurisdictions

Diversified deal-flow

Good book / bad book

splits

Partnering & structuring

Secondary market

Buyer consolidation

ANY QUESTIONS?

Private & Confidential

RESTRUCTURING

REINSURANCE FOR MERGERS & ACQUISITIONS

Efe TokmenVP, Swiss Re

Reinsurance complements traditional M&A solutions

Reinsurance solutions are competitive to equity in terms of cost of capital. Financing through reinsurance does not increase financial leverage.

Enhanced financialflexibility

The reinsurer can provide unique expertise to a bidder assessing unfamiliar portfolios. Due diligence performed by the reinsurer provides a third party view by an aligned partner.

Market and portfolioknowledge

Reinsurance optimises overall risk diversification and can ring-fence a specific portfolio of concern. Protecting future earnings and capital helps to deliver on post-deal performance goals.

Risk/returnoptimisation

Reinsurance provides efficient capital relief under regulatory and rating agency frameworks. It can accelerate the extraction of locked-in capital.

Capital relief &extraction

Preliminaryphase

Non-bindingphase

Bindingphase

Completionphase

Value through reinsurance at different M&A stages

Integrationphase

Pre-transactionphase

• Carve out non-core or legacy portfolios

• Extract locked-in capital

• Protect capitalisation of entity up for sale

• Risk/return optimisation

• Carve out non-core or legacy portfolios

• Streamline post-deal reinsurance structure

• Capital management solutions with focus on capital relief at target or buyer

• Reinsurance based (cash) financing solutions

• Expertise on specific markets & portfolios

Buyer’s perspectiveSeller’s perspective

Reinsurance for M&A | June 2017

Selected case studies

18

Situation Client objective Reinsurance solution

1 Company up for sale faces downgrade by A.M. Best which could be a deal breaker

Seller wants to strengthen A.M. Best capital adequacy prior and during sales process to avoid downgrade

"Out-of-the-money" Adverse Development Cover structured for efficient A.M. Best capital relief

2Unlisted company considering various acquisition financing options

Non-life entity to partially finance acquisition by upstreaming extra-ordinary dividend to holding, while keeping solvency ratio at target levels

Multi-line, multi-year Quota Share with upfront commission in cash

3 Buyer not entirely comfortable with some of the acquired risks, seller cannot provide adequate indemnity

Secure a ”sleep easy cover” against potential adverse reserve developments in the future

Adverse Development Cover signed on day of acquisition

The different roles of Reinsurance in M&A

Selected case studies

Client retention

Reference story

Maximising deal certainty & size by protecting the credit ratingClient situation

• Company is being up for sale but has a weak A.M. Best capital position

• A.M. Best considering downgrading the company to below A level if they do not take any action

• A.M. Best rating is crucial for writing new business

Seller’s objectives

• Relieve A.M. Best capital in order to avoid downgrading, which would be a deal breaker for financial buyers

Reinsurance solution

• "Out-of-the-money" Adverse Development Cover that relieves sufficient amount of A.M. Best capital to maintain the target company's rating

• Cost of capital optimised through the use of structural features

Benefits

• Target company maintains A.M. Best rating

• Seller maximises deal proceeds and buyer retains full new business potential

Illustration of coverReserves

Target company reserves

"Out-of-the-money" ADC80% Swiss Re share

Share (%)

Exit point

Booked reserves

Entry point

Situation Benefits

1

Reference story

Providing acquisition financing under Solvency II Client situation

• Medium sized, unlisted client with limited financial market access is considering an acquisition

• Client looks at various M&A financing options to keep Solvency II ratio at target levels post acquisition

Buyer’s objectives

• Non-Life entity to upstream an extra-ordinary dividend to holding to partially finance the acquisition

• Strengthen post-dividend Solvency II ratio at non-life entity and secure some cash pre-financing

Reinsurance solution

• Multi-line, multi-year Quota Share

• Funds withheld structure limits client’s liquidity outflow

• Upfront reinsurance commission in cash provides additional liquidity

Benefits

• Efficient and sustainable protection of capital adequacy post acquisition

• Required capital relief is smaller than dividend due to leverage effect from 140% Solvency 2 ratio

• Reinsurance support locked-in for several years

Illustration

03/ 2015 Dividend QS Post dividend

SCR Available Capital

139% -14% 140%+15%S2ratio

Situation Benefits

2

Reference story

Providing buyer with a "sleep-easy" coverClient situation

• Client searching for acquisition in order to grow mid-market P&C commercial business

• Seller indemnity was not available

Buyer’s objectives

• Seeking a "sleep-easy cover" to prevent negative surprises in the future from acquired reserves

• Budgeting the cost of the cover into the economics of the acquisition

Reinsurance solution

• Adverse Development Cover attaching above the reserves of the acquired reserves

• Structured to buyers’ needs, e.g. sub-limits for certain exposure categories

• Reinsurance and share purchase agreements signed on the same day

Benefits

• Containment of acquired legacy risks for a single one-off price, included in the cost of the acquisition

• Reduced capital requirements in the acquired entity

Illustration of cover

Assets

Equity

Liabilities

Reserves

ADC reinsurer share

Target Entity's Balance Sheet

Retention

Loss Corridor

Situation Benefits

3

ANY QUESTIONS?

Private & Confidential

RESTRUCTURING

PART VII TRANSFERS; THE REGULATORS EXPECTATIONS

Gerry QuirkPartner, BLP LLP

Summary

• Regulators’ role

• Guidance

• Engaging with the regulators

• Timetable

Regulators’ roles - PRA

• Leads on transfers• Approval of independent expert• Approval of independent expert report• Approval of legal notice• Solvency certificate• Certificate re consultation with EEA supervisors

• Consultation with FCA

• Assessment in light of objectives

Regulators’ roles – FCA

• Input through consultation with PRA

• Assess in light of statutory objectives• Threat to operational objective• Duty to promote competition• Inconsistent with strategic objective

• Conduct risk

• Communication strategy

Guidance

• PRA Statement of Policy• PS7/15 The PRA’s approach to insurance business

transfers

• FCA• SUP 18 of Handbook• Guidance consultation

Engaging with the regulators

• Memorandum of understanding

• Initial discussions• Rationale for transfer• Commercial terms• Timetable• Candidate for independent expert• Any headline issues

Engaging with regulators

• Engagement with IE• Initial meeting• Regular engagement

• Submission of documents• Timetable• Iterative process

• IE report• Scope• Supplemental reports

Involvement in hearings

• Two hearings• Directions• Sanction

• Preparation of reports

• PRA and FCA entitled to be heard at sanction hearing

Timetable

• Timetables have extended

• Large volume of transfers

• Preparation phase key

• Take account of guidance

Preparation Directions hearing

Notifications and publicity

Sanction hearing

Post sanction notices

ANY QUESTIONS?

REFRESHMENT BREAK.PLEASE RETURN IN 15 MINS.

Private & Confidential

RESTRUCTURING

LEGAL PERSPECTIVES; INSURANCE BUSINESS TRANSFER, M&A OR REINSURANCE?Martin MemberyPartner, Sidley Austin LLP

The principal options for acquiring/disposing of a portfolio of insurance business:

• Insurance business transfers / Part VII transfers

• M&A deal

• Reinsurance

SIDLEY AUSTIN LLP

Insurance Business Transfers / Part VII Transfers• EU-wide legislation enabling a statutory novation of insurance policies without policyholder

consent• UK regime for transferring long-term and general insurance business, governed by Part VII of

Financial Services and Markets Act 2000 ("FSMA") • Allows the whole or part of an insurance business to be legally transferred from one entity to

another• Terms of the transfer are set out in a scheme document, which is approved by the Court and then

becomes binding• Liability for the transferring policies passes from transferor to transferee so that the

policyholders are treated, from the effective date, as if their contracts had always been with the transferee

• Assets related to those policies, including reinsurance, are also transferred• Once completed, the transferor is completely "off the hook" and is no longer liable for claims

under the transferred policies

SIDLEY AUSTIN LLP

Part VII Transfers

• Under the UK Part VII regime, the transfer must relate to:– Business carried on by a UK firm in the EEA;– Reinsurance business carried on in the UK by an EEA insurer; or– Business carried on in the UK by a non-EEA firm.

• Transferee must carry on the business in the EEA• Process:

– Independent Expert– Involvement of regulators– Advertising of the scheme to policyholders– Court approval– Timeframe is typically between 6 and 12 months

SIDLEY AUSTIN LLP

Mergers and Acquisitions• Share sale (alternatives: asset sale / transfers of business)• Auction process or single bidder• Key Documents:

– Share Purchase Agreement– Disclosure Letter – Transitional Services Agreement

• Process and timeframe depends on:– Number of bidders– Negotiations– Due diligence process– Regulatory and competition filings

SIDLEY AUSTIN LLP

Mergers and Acquisitions

• The whole of the business transfers under a share sale including the liabilities, assets and employees of the target

• Conditions precedent to closing are required:–Regulator's approval–Competition clearance– Internal re-organisation–Third party consents

• Warranties and disclosure

SIDLEY AUSTIN LLP

Reinsurance• Risk mitigation tool• Reinsurer indemnifies the cedant for all of or a proportion of any losses sustained

beyond a certain limit in exchange for a premium• Allows the cedant to write more business and provides protection from

significantly large claims• Cedant remains liable for claims under the relevant policies, but will seek

recovery from the reinsurer• Reinsurance mechanisms available:

– Loss Portfolio Transfer– Adverse Development Cover– Bulk annuity cover for closed books of life business

SIDLEY AUSTIN LLP

Reinsurance• Diligence process in respect of underlying policies• Reinsurance agreement will be negotiated between the parties the terms of which will

cover:– the point at which the reinsurer becomes liable under a claim– the premium payable– any warranties– any conditions– any exclusions

• Reinsurance can also be used as part of an M&A transaction– E.g. bidders on a business teaming up with a reinsurer as part of overall strategy– On the life side, reinsurer may retain certain exposure and enter into back-to-back

longevity reinsurance

SIDLEY AUSTIN LLP

Advantages and Disadvantages for Buyer/Seller

SIDLEY AUSTIN LLP

Part VII Transfers• Advantages

– Policyholder consent is not required for the transfer– Streamlined process facilitating transfers within EEA states– Transferor is fully released from any ongoing obligations– Part or all of the business may be transferred

• Disadvantages– Lengthy and costly procedure, e.g. legal fees, IE’s fee, advertising fees– Heavy involvement of the regulators– Transferor relinquishes client relationships– Portfolios cannot be transferred outside the EEA using this procedure

SIDLEY AUSTIN LLP

Mergers and Acquisitions• Advantages

– Clean break for the Seller (subject to warranty clauses) if structured as a share sale– The Buyer is able to purchase a fully functioning business including staff, IP rights and property – The Buyer may become more dominant in the relevant market– Acquisition enables the Buyer to diversify its risk profile

• Disadvantages– Potential competition issues– Change in control approval required– Lengthy process– Environment of uncertainty for policyholders and employees– Acquisition may bring a non-EEA parent company within the scope of Solvency II– Liabilities involving pension schemes, litigation etc.

SIDLEY AUSTIN LLP

Reinsurance• Advantages

– Cedant is able to maintain client relationships– Cedant can increase its underwriting capacity by transferring risk– Protects the Cedant's balance sheet against larger losses– Flexible – reinsurance can be arranged to fit any particular type of risk– Speed of process– Achieves economic finality

• Disadvantages– Counterparty risk must be considered– Cedant retains the primary liability for claims to policyholders– Ability to obtain reinsurance depends on market conditions – hard market will mean higher premiums and

more stringent conditions– Some regulatory uncertainty over extent of credit for reinsurance

SIDLEY AUSTIN LLP

Credit for Reinsurance• Commission Delegated Regulation (EU) 2015/35 contains details of the effect of risk-mitigation

techniques, including reinsurance• Contractual requirements

– Qualitative criteria (Article 209(1)) – e.g. contractual arrangements and transfer of risk must be legally effective and enforceable in all relevant jurisdictions

– Effective transfer of risk (Article 210) – e.g. contractual arrangements shall ensure that the extent of cover is clearly defined

• To gain credit, reinsurance counterparty must be either:– EEA reinsurer– Reinsurer based in a Solvency II-equivalent jurisdiction– Reinsurer with a credit rating of step 3 or better (i.e. BBB)

• Consider counterparty default risk, this can be offset with collateral• Collateral will only be recognised if it meets certain criteria (Article 214(1))

SIDLEY AUSTIN LLP

ANY QUESTIONS?

Private & Confidential

RESTRUCTURING

DUE DILIGENCE CONSIDERATIONSDilipe Arul & James AldridgeErnst & Young LLP

Agenda

• Due diligence overview

• Parties involved in due diligence

• Key due diligence areas of focus

Due diligence overviewBidder objectives

► Evaluate the information provided by the company / vendor

► Provide all queries to the vendor in a timely manner and manage due diligence exercise efficiently

► Refine valuation and funding / structuring

► Capture legal risks and considerations for inclusion in SPA

► Mark up the SPA and provide final offer

Vendor objectives

► Ensure information is consistent with Information Memorandum and other data sources

► Minimise impact on management time, and maintain confidentiality

► Release the information to bidders for diligence

► Respond to any bidder queries in a timely manner

► Support bidder evaluation with additional site access / management presentations

► Obtain marked-up Sale and Purchase Agreement (SPA) and final offers from bidders

► Evaluate information received from bidders with regards to sale objectives (e.g. economic, people, reputation, execution capability..) to base final decision to select a final bidder

Outputs / actions from due diligence process

Valuation Legal contracts Post deal / integration plans

Parties involved in the due diligence process

Target management

Buy side advisers► Financial

advisers► Tax/accounting► Lawyers

Bidder 1

Sell side advisers► Financial

advisers► Commercial

advisers► Lawyers► Accountants

(optional)

Meetings / access to dataroom

Buy side advisers► Financial

advisers► Tax/accounting► Lawyers

Bidder 2

Other parties► External actuarial team (HH

letter)► External auditors (HH letter)

Vendor

Key due diligence areas of focus

Key areas of focus

Reserving Capital adequacy Capital optimisation

Reinsurance asset Investments Other financial items

Cash flows Operations & IT Regulatory

People Tax Commercial

Reserving sufficiency – approach

► Obtain and read actuarial reports

► Benchmark against other portfolios

► Highlight key uncertainties

► Management discussions to obtain insights and understanding of key issues

Phase 1

► Depends on scope

► Would typically re-project reserves on certain classes (that could cover in the order of 60/70% of the portfolio)

Phase 2

► Re-project the vast majority of the portfolio

Phase 3

Margin

IBNR

Case estimates

Reserving sufficiency – case estimates

► Historical performance of booking case estimates, reviewing the levels of historic sufficiency / deficiency

Review the triangles of paid and incurred claims

Claims files reviews

Changes in the process over time

“Claims process improved and we are hitting claims earlier” vs actual deterioration in the claims

► Identification and review of static claim estimates:

A portfolio in run-off may have a number of claims that have not been looked at for some time

There is the possibility of potential redundancy in claims reserves, but equally the possibility of insufficient claims reserves

Focus on claims handling processes

Margin

IBNR

Case estimates

Reserving sufficiency – IBNR

► Understand the methodology applied by management in setting IBNR

Obtain and review the internal actuarial team’s report on how the best estimate has been derived

Discussion with the auditors (once a hold harmless letter has been obtained)

Understand the analysis undertaken by the external actuary

Obtain and review the external actuarial report (which is typically prepared annually, if there is one …)

► Look at specific large losses

► Focus on particular key uncertainties (e.g. APH, other Long Tail liability exposure)

► Comparison to market benchmarks where possible to determine if loads fall in or out of range

Understand the process of setting the IBNR

Margin

IBNR

Case estimates

Reserving sufficiency – Margin

► If there is an explicit margin, we would seek to obtain a margin paper from management

► If there is an implicit margin, we would look to understand the quantum, the basis for it and how it has changed over time

Understand the approach taken to setting a margin

Margin

IBNR

Case estimates

58

FKJF

Reserving sufficiency – point estimate

The ‘Range’

75th percentile25th percentile

Best Estimate(Mgmt.)

Margin(Mgmt.)

BestEstimate

(DD)

Conclusion:“There is marginin the reserves”

Conclusion:“Under reserved –

ammunition forprice discussion”

BestEstimate

(DD)

95th percentileStress test

Capital adequacy

Capital issues

► Sufficiency of capital headroom (regulatory and rating agency requirements)

► Impact of Solvency II on capital headroom and status of model approval

► Use of debt instruments

► Process for generating capital requirements

► Potential synergies

► Trapped cash/capital

► Stress testing

Capital optimisationReturn on equity enhancements

Reducing Run Off Capital Requirements

► Use of Internal Models to capture diversification and risk profile

► Use of innovative Own Funds items

Contingent Capital available under S2

► Pooling risks across Legal Entities, accessing capital locked in subsidiaries

Business Transfers / Intra-group Reinsurance

Improving returns

► Stepping Up investment income –

Property, debt and alternative investment strategies

► Taking on Financial Leverage –

Debt Capital Funding

Group Structures / Internal RI

► Addition of new portfolios

Underwriting return

Investment return

Tax rate

Leverage / gearing

Regulatory capital required

Rating capital required

Own assessment of capital position

Amount of own funds

Location of own funds

“R”Returndrivers

“E”Capitaldrivers

AssetsReinsurance asset

Reinsurance programme

► Understand the RI programme, in particular the balance between proportional and non-proportional reinsurance arrangements

► Investigation required of the approach taken to estimating non-proportional RI recoveries – management may have been cautious and only taking credit where reasonable certainty of recovery

Bad debts

► Obtain break down of the bad debt provision, by reinsurer and understand methodology applied

► Assess whether credit ratings have changed and determine whether the bad debt provision is sufficient

Reinstatement premiums (inward / outward)

► Understand level of credit taken and whether there is any exposure

Investment portfolio

► Investment profile – asset allocation, credit quality, returns

► Investment management – manager, strategy

► Liquidity – maturity profile, encumbrance (e.g. trust funds?)

Financial

62

Quality of earnings

► One-off / non-recurring items (e.g., FX)

► Expenses / potential synergies

► Drivers of forecast profitability

► Accounting policies

Quality of net assets

► Investment portfolio exposures

► Reinsurance asset recoverability

► Impairments and other areas of judgement

► Asset/liability mismatches

► Sufficiency of working capital

► Contingent liabilities

► Pension related exposures

► Tax assets

Cash flows

Group holdco

Company A Company B

Debt► Capital repayments► Interest

repayments

Cash flow constraints► Group solvency► Credit rating agency

solvency► Bank covenants► Distributable reserves► Liquid resources

Cash flow constraints► Solvency

requirement► Bank covenants► Distributable

reserves► Liquid resources

Portfolio 1

Portfolio 2

Portfolio 3

Portfolio 4

On acquisition of portfolio 4 …► Potential release of capital in Company B due to …

Capital synergies (increasing diversification benefit) Release of margin Operational synergies

Operations and IT

► Understand the current operating model, IT applications and infrastructure and the associated operating costs (fixed vs variable)

► Review any available operational and IT strategy associated with the run-off

► Scalability of the IT infrastructure (e.g. if intend to retain)

► Availability and quality of MI to assess and manage risk post SII

► Identify / assess the possible operational strategies to manage the cost base through run-off and any potential issues to realising these, for example:

Increasing the variability in the cost base (e.g. outsourcing functions)

Managing resources in line with reduced activity (e.g. redundancy implications)

Migration to a common / lower cost platform

► Identify any operational and IT performance issues which may require investment or lead to increased operating costs in the future

► Identify constraints to migration to common platform / outsource provider (e.g. legacy system technology, functionality gaps,stability issues, data quality issues)

Key considerations

Other areas of due diligenceRegulatory

► FCA ARROW visit findings

► Corporate governance weaknesses

► Risk framework weaknesses

► Assessment of regulatory approval required

People

► TUPE – cost/benefit analysis of any potential redundancies

► Need for retention bonuses to incentivise key employees

► Change of control policies

► Other employment policies

► Pension-related issues

Taxation

► Assessment of effective tax rate

► Transfer pricing issues

► Other exposures

► Effectiveness and risks of tax structure

Commercial diligence

► Market opportunity – jurisdictions covered, legacy transaction drivers, owners of run-off and propensity to sell, transaction pipeline…

► Regulatory framework – approach to finality mechanisms, change of control, capital extraction…

► Competitive position – benchmarking against key competitors, SWOT, key differentiators…

► Track-record – deals completed, deals turned down / lost, return on investment…

► Strength of the team – management team and wider employee base…

► Achievability of business plan – assessment of whether the business plan is achievable in light of the above factors…

► Exit options – exit to trade, exit to private capital, IPO…

Key considerations for an incoming funder of a run-off consolidator

Key considerations when preparing legacy business for saleWe have a tried and tested approach to advising owners of legacy on preparing business for sale. Set out below are some of

the typical considerations that we apply when advising clients on the transfer of P&C legacy business to third-parties

Area Description EY InsightsData quality

► Data quality needs to be validated (reserving granularity, claims data, reinsurance programme, source reconciliations, etc.) and addressed

► Data also needs to be as up-to-date as possible and capable of being updated throughout the process to support bidder pricing and operation of the agreed roll-forward mechanism

► We apply buy-side due diligence disciplines to ‘get the data right’ and anticipate the approach which buyers will adopt

► We will gather data in a structure which anticipates a virtual dataroom structure, so as to enable efficiencies subsequently when moving to subsequent phases of the disposal

► We advise where data is of insufficient quality and propose any appropriate remediation measures

Capital and Regulatory

► Appraising the regulatory capital impact of the transaction structures being considered

► Identification of the regulatory considerations/risks/challenges within the relevant jurisdictions

► We are able to assist in either calculating or reviewing the vendor’s calculations to determine the stand alone capital requirements for the legacy liabilities together with the incremental impact on capital of removing these liabilities from the ongoing portfolios (as applicable)

► It is now important to consider both the Solvency II capital implications of the liabilities (which looks over a one year time horizon) and also to consider the capital implications looking to the ultimate settlement of all the claims

► Where multiple jurisdictions are involved, a package of transactions is likely to be necessary to cover all contracts, each of which will have its regulatory and capital implications

► We typically consider both the capital required in the parties to the transaction, and potential efficiencies in the provision of the required capital due to diversification and arbitrage

► Regulators are likely to focus on the impact of any proposed transaction on the security provided to the ultimate beneficiaries

► The regulators will also consider the potential impact on other policyholders of the parties to the transaction

Financial/actuarial

► Preliminary evaluation of reserving adequacy► Evaluation of any guarantees/reinsurance structures which

may need unwinding as part of a disposal► Identifying pockets of value in the reserves to support

preliminary views on buyer appetite and valuation► Indicative impact on financial accounts

► It is key to identify specific risks and pockets of value as this will frame the articulation of the opportunity to bidders via the IM and future interactions

► We can provide an early indication of the impact of varying views on reserving on financial results and likely deal pricing

Key considerations when preparing legacy business for sale (cont.)We have a tried and tested approach to advising owners of legacy on preparing business for sale. Set out below are some of

the typical considerations that we apply when advising clients on the transfer of P&C legacy business to third-parties

Area Description EY InsightsOperational ► Carve-out of legacy business from various systems to

support the provision of data and ultimate migration to a purchaser

► Identification of people issues (e.g., in-scope staff for TUPE, ability to support Transitional Support Agreements, etc.)

► Location and accessibility of paper records (e.g., policies)

► Our operational experts have considerable experience of working at the early stages of transactions to identify operational risks and help deal teams navigate through these

► Our operational experts will in due course interact with the legal analysis and our teams have strong experience of this interface to ensure a smooth process

Tax ► Appraisal of tax impacts/risks to transaction structures being developed

► Managing the vendor’s tax exposures post-completion

► Consider the tax impact of the transfer of assets and liabilities and reserve releases► Identify the character of the assets being transferred and their historic accounting and tax treatment in

order to determine if any taxable gains or losses arise from the transaction► Consider the potential impact on tax cost base of assets to the extent that the transaction results in an

exit of a company from a tax consolidated group► Consider the impact on intra-group transactions including transfer pricing► Indirect tax (VAT and GST) implications of the transaction► Stamp taxes consideration► Employment tax considerations if employment contracts are transferred along with the insurance

business► Consider the availability of any tax clearances

Legal ► TUPE issues in respect of any staff falling in-scope► Risks around material contracts► Protection of the vendor’s legal exposures post-completion

► We ensure the internal diligence work carried out around legal/operating risks is appropriately captured in considering how the legal contracts may need to be structured

► We are able to comment on legal advice received and in particular the extent of representations and warranties which it is expected the vendor may need to give, based on our experience of what is ‘market’ practice

Transaction strategy

► Reconciling and prioritising transaction options with the vendor’s objectives (e.g., legal/economic finality, price, reputation, execution, people, etc.)

► Prospects of attracting a sufficiently deep pool of suitable bidders to create a competitive process

► Guiding the vendor on what experts/resources are typically required at different junctures of a transaction

► Our Insurance Run-off M&A specialists have considerable experience of advising on transactions, working to vendors’ objectives. We can therefore anticipate at the feasibility stage some of the key transaction management considerations which a vendor should be cognisant of early on

ANY QUESTIONS?

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APPROACH TO VALUATIONDilipe Arul James BoltonErnst & Young LLP Director, Quest Group

We were previously introduced to the following key diligence areas….

Key areas of focus

Reserving Capital adequacy Capital optimisation

Reinsurance asset Investments Other financial items

Cash flows Operations & IT Regulatory

People Tax Commercial

Buy-side considerations – Observations and pricing trends/driversFor typical legacy deals, the overhang of capital on the buy-side relative to deal flow continues to provide an attractive pricing

environment for sellers

Key observations► Buy-side competition remains strong relative to opportunities, as seen from the active level of participation in auctions

► New entrants considering options to deploy capital, and incumbent players continuing to raise funds for acquisition

► We have seen a recent resurgence of activity and improved pricing for vendors. Wide auction processes continue to evidence the robustness of competition amongst buyers

► Pressure on buyers to continually fine-tune their structure, business model and sources of capital in order to achieve returns

► Equity – PE / Hedge funds / pension fund

► Debt – leverage outside SII jurisdiction

► Reinsurance – as capital leverage, for tax arbitrage

► Tax – use of losses, profit optimisation

► Capital – diversified via reinsurance/ transfer

Standalone features

Strategic value (“in the eye of the

beholder”)

Cost of capital / financial

engineering

► Existing knowledge of business / relationships

► Plays to existing expertise / diversifies expertise / market entry platform...

► Scale synergies in terms of capital, asset management, operations

► Run-off strategy – to expiry, commutations, schemes, reinsurance...

► Capital and reserving adequacy

► Reinsurance leverage and nature of counterparties

► Investment portfolio credit quality, returns, liquidity

► Non-insurance attributes/ risks

► Quality of data

Buyer-specific differentiators

Drivers of pricing

Currency: £ mReported position

Reserve strengthening Commutations ULAE uplift

Pro-forma position

Assets

Cash 200 (15) 185

Other assets 50 50

Total assets 250 (15) 235

Liabilities

Claims outstanding 60 10 70

IBNR 80 20 (20) 80

Other liabilities 10 10

Total liabilities 150 20 (20) 10 160

Equity 100 (20) 5 (10) 75

Reported to pro-forma position example:

DCF

Pro-forma position established

Determine key sensitivities/variables

Run-off period

Payment patterns

Investment strategy

Transaction structure

Model P&L/BS/cash flows on the base case, over run-off period

Assume a dividend distribution policy

Price to achieve target return

Modelling the run-off

INTERNAL RATE OF RETURN (IRR)

What is IRR?• Most common measure of profitability of an

investmentHow is IRR calculated?• Discount rate at which the net present value of costs

equals the net present value (NPV) of cash inflows. • ie the discount rate at which the NPV is zero.

CALCULATION OF THE IRR

Investor Cashflow Investment Dividends Exit Total

$ '000 $ '000 $ '000 $ '000

Yr 0 (30,000) (30,000)Yr 1 10,000 0 10,000Yr 2 10,000 0 10,000Yr 3 10,000 0 10,000Yr 4 10,000 0 10,000Yr 5 0 10,000 10,000

Project IRR 20%

CALCULATION OF THE IRR Debt Funding improves the IRR result

Investor Cashflow Investment Dividends Debt Exit Total

$ '000 $ '000 $ '000 $ '000 $ '000

Yr0 (20,000) (20,000)Yr1 10,000 (5,400) 0 4,600 Yr2 10,000 (5,200) 0 4,800 Yr3 10,000 0 0 10,000 Yr4 10,000 0 0 10,000 Yr5 0 0 9,400 9,400

Project IRR 23%

“You can’t eat IRR”• Most complaints are summed up with this commonly recited phrase.• Be wary of rating mutually exclusive projects by IRR alone:

Example A Example B

IRR 17.00% 22.90%Multiple 1.6x 1.3xCash FlowsYr 0 -100 -100Yr 1 0 100Yr 2 0 20Yr 3 160 10

Project A has a lower IRR but generates twice the shareholder value than Project B

Summary – how buyers make money in run-off

79Insurance run-off M&A trends and considerations

Buyers have a range of levers to generate attractive returns in the legacy P&C market

Buying well Managing well Structuring strategically Follow-on opportunities

► Vendor relationships

► Due diligence

► Pricing (discount to NAV?)

► Regulatory process

► Proprietary liability management strategies

► Investment optimisation

► Servicing synergies/ cost reduction

► Debt funding and third-party reinsurance

► Internal reinsurance

► Tax optimisation

► Capital optimisation & extraction

► Leverage as run-off consolidation platform

► Exit (secondary market under-developed)

► Recycle capital to support alternative strategies

Price paid

Opening NAV

ANY QUESTIONS?

CASE STUDYDUE DILIGENCE AND VALUATION CONSIDERATIONSDilipe Arul & James AldridgeErnst & Young LLP

BREAK FOR LUNCH HOURDon’t forget to order your discounted copy of Part VII transfers guide – Catherine has the code

DISCLAIMERThe views and opinions expressed in the written and oralpresentations made today do not necessarily representthe views or opinions of the speakers or of the firms bywhom they are employed or engaged. IRLA and thepresenters do not guarantee the accuracy of the dataincluded, and accept no responsibility for anyconsequence of their use.

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PERSPECTIVES FROM THE ‘SELL’ SIDENick Crossley, Executive Director, E&Y LLP

FROM THE ‘BUY’ SIDETony Tilley, Manager, RSMLJames Bolton, Director, Quest Group Paul Corver, Head of European M&A, R&Q

Process overview

Preparation Marketing (“Round 1”)

Diligence(“Round 2”)

Contract negotiation

Change of control process

2-3 months 3-4 weeks 6-8 weeks 4-6 weeks 2-3 months...or more!

Key stages

Typical timeline for a share transfer

2-3 months 3-4 weeks 6-8 weeks 4-6 weeks 24 months +

Typical timeline for a Part VII process

Preparation phase – seller activities

Define transaction perimeter Plan deal structure (share sale/ transfer/ RI)

What we are selling & how?

Project mobilisation

Data preparation

Buyer engagement strategy

What’s it worth? Identify value drivers / risks / issues Internal modelling / valuation

Align stakeholders, define objectives Budgeting & resource allocation Appoint advisers? (M&A, legal..) Develop a process timetable

Preparation of data (capture, cleanse, reconcile..) & dataroom Preparation of marketing materials (Information Memorandum, actuarial

reports, triangles, process letter, etc.)

Type of sale – auction vs. bilateral? Buyer identification

Some key considerations

Is the business and domicile of the target in line with acquirers strategy?

Can we make money out of the acquisition? Can we extract the surplus quickly / easily?

Regulatory approvals or additional regulatory requirements Financing

Investment strategy Collateral (LOC) or guarantee (e.g. ILU) obligations

Modelling the run-off Exit planning

Early buyer considerations

Marketing phase (“Round 1”)

Approach bidders, sign NDAs Issue marketing materialsBuyer engagement

Preparation for next phase

Indicative offers & bidder selection

Q&A Respond to preliminary bidder Q&A

Ongoing data preparation (e.g. populating dataroom)

Receipt of non-binding indicative offers Assess offers against key criteria, clarify offers as necessary Select a shortlist of bidders for the next stage Communicate status to bidders (turned down / taken forward)

Diligence phase (“Round 2”)

Bidder access to dataroom Site access (own premises / TPA..) Management presentations

Bidder access

Legal

Final offers & bidder selection

Bidder due diligence

Support Q&A process

Provide draft legal documentation (SPA/ BSA/ Reinsurance Agreement…) to bidders

Receipt of final offers Receipt of marked-up legal documentation Assess offers against key criteria, clarify offers as necessary Select preferred bidder for the next stage Communicate status to bidders (turned down / taken forward)

Contract negotiations

Bidder to complete any final confirmatory due diligenceFinal diligence

Legal

Regulatory Communicate transaction status / parties to regulator

Negotiation of legal contracts (effect of sale, Transitional Services Agreements…)

Signing of legally-binding contracts (completion subject to Conditions Precedent)

Change of control / completion

Regulator to evaluate buyer’s application Regulator to grant approvalRegulatory

Transition planning

Other CPs Satisfaction of any other Conditions Precedent

Ongoing planning of post-completion transition (e.g. data migration, file transfer, transition of key contracts…)

Completion Completion and flow of funds

ANY QUESTIONS?

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RELEVANT LEGAL ISSUES Bob HakenPartner, Norton Rose Fulbright LLP

Overview

• Key differences between asset sales and share sales• Valuation• Conditions to completion• Warranties • Disclosure• Limitations on liability• Transitional services

Key differences between asset sales and share sales

• Identification of assets and liabilities• Regulatory issues (Part VII may be required)• Transfer mechanics (delivery / assignments / court order)• Employees • Taxation

Valuation

• Locked box v completion accounts– Usage evenly balanced– Disputes– Risk and reward

• Locked box typically preferred where– Target is packaged for sale– Business is owned by private equity/financial investors

• Earn outs

Conditions to Completion

• Regulatory conditions• Competition and anti-trust• Timing• Obligations to obtain approval• Conditional approvals• “Hell or high water” clauses• Waiver of conditions• MAC clauses

ExamplesThe sale and purchase of the Sale Shares is conditional on the [PRA] having given notice in writing [in a form acceptable to the Buyer] that it [unconditionally] consents or has no objection to the Buyer becoming a “controller” of the Target or in the absence of notice the PRA being treated as having approved the Buyer in accordance with section 189(6) of FSMA.

The Buyer undertakes to use its [best / reasonable / all reasonable] endeavours to ensure that the Conditions are satisfied as soon as possible after the date of this Agreement and by no later than the Longstop Date.

Where the satisfaction of any Condition is subject to the satisfaction of any condition imposed by a [Regulator] on the Buyer or the Target Group, the Buyer shall comply and, from Completion, shall procure the Target Group complies with any such condition.

Warranties

• Importance of diligence• Effect of warranting and representing

– measure of loss– right to rescind

• Warranties v. indemnities– Loss - foreseeability / remoteness; duty to mitigate; pound for pound– Indemnity basis

• Repetition • W&I insurance

Disclosure

• Why? • Seller’s knowledge• Buyer’s knowledge• General disclosures• Data rooms• Fair disclosure

Example“fairly disclosed” means disclosed in such manner and in such detail

as to enable a reasonable buyer, having received the assistance, information and advice received by the Buyer, to make a reasonable

assessment of the matter concerned.

Seller Limitations

• What do the limitations apply to? all claims / just warranties• Financial thresholds and caps• Time limits• Conduct requirements• Boxing warranties

Transitional Services

• Separation and integration• IT, software and systems• IP licences including use of trademarks and branding• Access to records and historic data• Back-office / head office functions• Property

ANY QUESTIONS?

REFRESHMENT BREAK.PLEASE RETURN IN 15 MINS.

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FINANCING THE ‘BUY’; ASSESSING THE ‘SELL’David Barclay-Watt, Senior DirectorThe Royal Bank of Scotland

Agenda1. What are we financing – the bank perspective2. Lending Principles3. Risk Factors4. Debt Structures

What are we financing – the bank perspective

• Not standard lending• Capital within regulated entities• Associated cash flows• Subordination

Lending Principles – Balance Sheet Structure

• Price?• Dividend flows• Settlement timing• Risk factors• Debt Capacity

$M Dec-16Investments 450Reinsurance assets 100

Claims reserves 300Net assets 250

Regulatory requirement 150

Lending Principles – Capital Release Evaluation

1. Short-term bridge to existing regulatory surplus

2. Capital reduction off claims settlement3. Technical profits

Relative certainty

Lending Principles – Key Risk Factors

• Investment • Reserving• Reinsurance• Regulatory

Lending Structures –Holding Company v SPV

Hold Co

Ins Co 1 Ins Co 2 Ins Co 3

RCF SPV

Ins Co

Amortisingterm loan

• Flexibility• Acquisitions• Multiple dividend sources

• Substantial reg surplus• Rapid amortisation• Single dividend source

ANY QUESTIONS?

CASE STUDYREVIEWING OFFER LETTERS FROM BUYERS

Dan Cordina

Manager, Ernst & Young LLP

The IRLA Board would like to thank the following people for their involvement

Paul Corver of Randall & Quilter Investment Holdings

Kevin Gill, Nick Crossley, Dilipe Arul, James Aldridge & Dan Cordinaof Ernst & Young LLP

James Bolton of Quest Group

Efe Tokmen of Swiss Re

Tony Tilley of RSML

Bob Haken of Norton Rose Fulbright LLP

Martin Membery of Sidley Austin LLP

David Barclay-Watt of The Royal Bank of Scotland

Gerry Quirk of BLP LLP

Course administration provided by: AMS (Outsourcing) Services Ltd

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FEEDBACK AND CLOSEDon’t forget to order your discounted copy of Part VII transfers guide – Catherine has the code