Author: Andrew Rothseid
For the last four to five years, rarely a week has gone by without an announcement of another reinsurance or sales transaction involving discontinued property and casualty insurance.
These types of transactions often follow a familiar path:
- A ceding company or seller decides to transfer the financial (through reinsurance) and/or legal (through sale or court/regulatory sanctioned portfolio transfer) liability for the subject discontinued insurance business;
- The seller will appoint a broker or advisor to run the process;
- The seller (or its broker) will present a submission to a select group of buyers providing them with a description of the subject business, the type(s) of transaction the seller contemplates, a listing of the materials the seller has prepared to give the buyers an understanding of the subject business, and a timetable for the prospective buyers to present non-binding indicative bids;
- The seller and its broker will review the indicative bids presented and determine which of the prospective buyers will be permitted to proceed through due diligence to prepare a final binding offer.
Up to this point in the process, the seller has most, if not all, of the leverage in the transaction. It has decided: to sell or reinsure the subject business; what resources it will use to run the process; what data it will prepare and submit to buyers to describe the business; which buyers it wants to solicit; the time frame for the reinsurance/sales process; and which indicative bid is sufficient to proceed to the final due diligence.
Then, for some reason, the seller will often relinquish all leverage by accommodating a buyer’s request for “exclusivity” in the final phases of the process.
The Cambridge Dictionary defines “exclusivity” as “the right to have or do something that is limited to only one person or organization”. In the world of discontinued insurance transactions this translates into the seller relinquishing its right to continue to engage in a competitive process between or among multiple prospective buyers and put all of its proverbial eggs in one basket.
Quite often, there are valid reasons that only one final bidder is selected. Perhaps only one prospective buyer:
- Chooses to submit an indicative bid;
- Matches the seller’s anticipated deal structure;
- Presents satisfactory financial terms;
- Can secure regulatory approval where necessary; or
- Can close the transaction within an acceptable time frame.
Similarly, there are many valid reasons why a seller would grant a request for exclusivity proposed by one bidder:
- Non-financial terms in the indicative bid may be more compelling than others;
- One buyer could be financially stronger than other buyers;
- The seller could have a history of productive arrangements with the buyer;
- The buyer could have a successful track record with the line(s) of business that are part of the submission; or
- The buyer could have a stronger industry reputation in closing similar types of transactions.
Regardless of the basis for the decision, exclusivity can place the seller at a disadvantage, or worse – the decision can paint the seller into a corner. Under almost any scenario, exclusivity to the buyer deprives the seller of leverage and control of the transaction. One buyer leaves the seller with one option – a price set by the one buyer. This ‘take it or leave it’ possibility demonstrates the seller’s lack of leverage in a one buyer transaction.
Legacy transactions are most often isolated deals rather than annual renewals. It is easier for the buyer to withdraw from the transaction - with little (perceived) reputational risk. Consequently, the seller is left to begin the process anew when the one buyer withdraws.
The recent increases in capital investment into legacy acquirers places strain and pressure on them. The investor-required return hurdles can influence the buyer to withdraw from smaller transactions present the seller with costly solutions if they elect to stay the course. Similarly, the seller can walk away themselves if the price does not meet their expectation. And if that happens, the seller is forced to renew the process, or bring in a previously excluded party. Either way, the seller loses time and the transaction can appear to the market as somewhat impaired.
The need to retain sellers’ advantage
Leverage is key - if not the key - to any negotiation. If you want – much less need - a specific product, you will find out who has that product and decide how you can secure it. If the person in possession of the product knows that you want/need that product and they have the only one available, they can dictate the terms of the transaction. And if you pass on their terms, they may not care, as someone else will want the product and will acquiesce to their terms.
The same traits apply to legacy reinsurance transactions. If the seller of the portfolio seeks a buyer, it is a clear indication of the fact that the seller needs or wants to move the portfolio. Buyers of these portfolio are aware of the dynamic just as they are aware that there are limited transactions – perhaps 50 or so during any given year – and there is a limited number of buyers.
The buyer can improve its odds of securing the portfolio if it can eliminate the competition by demanding exclusivity and provide the seller with some type of inducement to agree to the demand. Once exclusivity is in place, however, the table turns and the buyer, not the seller, controls the process.
How do sellers avoid the exclusivity quagmire?
- Start from a position of strength. Take your time. Plan your submission carefully. Select a broad array of counterparties considering rated and unrated markets. Keep the counterparties informed throughout and run an organized process.
- Manage your counterparties’ expectations. Let them know at the outset there will be a competitive process throughout. Make sure the buyers know you will not trade one party’s offer against others, and that you will set the same terms and conditions for each.
- Just say no. If your counterparty demands exclusivity and you want a competitive process, simply refuse the request. If the counterparty walks away, they are telling you they would like the portfolio, but only on their terms. If you are left with two counterparties and the one who wanted exclusivity walks away, then you know you did not have a deep enough pool of bidders at the outset.
- Know your counterparty. This market is relatively small and memories are long. Reputations typically precede those that that operate with grace.
- Engage with rated reinsurers as well as legacy acquirers. While both categories of reinsurers are focussed on the appropriate deployment of capital, rated reinsurers appear less focussed on deploying investor capital, and often appear more focussed on underwriting guidelines and risk aggregation. While there may be a cost associated with rated capital, the professional reinsurer may provide the seller with a “safe harbour” even if they advocate for an exclusive arrangement.
