The Financial Community’s Needs From Actuaries In Due Diligence A CFO’s Perspective Presented at the CAS Annual Meeting Washington, DC November, 2000 by Gayle Haskell, FCAS, MAAA CFO & Chief Actuary, Providence Washington Insurance Companies

A PERSPECTIVE ON M & A’s Consolidation to continue, P/C Industry Many reasons to pursue an acquisition Poor Industry results breed opportunities, and Risk Many (?most?) Mergers fail Failures more visible then internal failures Decisions required: fast, and at excitable point Ramifications often emerge later “ SYNERGIES” COME & GO; FINANCIAL IMPACTS LAST

FINANCIAL COMMUNITY’S NEEDS FROM ACTUARIES PERFORMING DUE DILIGENCE OF COURSE, “TRADITIONAL STUFF”: Reserve evaluation Reprinted Courtesy of ‘Schiff’s Insurance Observer’

FINANCIAL COMMUNITY’S NEEDS FROM ACTUARIES PERFORMING DUE DILIGENCE OF COURSE, “TRADITIONAL STUFF”: - Reserve evaluation - Economic valuation - Rate adequacy assessment FINANCIAL COMMUNITY SEEKS MORE !!

WHY SEEK MORE? Reserves, economic valuations often a range; buy/sell decisions aren’t Volatility of some valuation vehicles Example: “Market Value”, and Market Caps ($B) 12/9910/00 Amazon$ 36$ 10 Ins Web 1.06 AIG Marsh & McLennan Economic valuations may not reveal some important pressures Example: “Cash Is King” It’s a short-term world!

HELP THE CFO & THE COMPANY MAKE THE RIGHT DECISION Understand the audiences Understand the constraints “Put skin in the game” Can it be “fixed”? How fast? Costs? What are the risks? Timing? Solutions? To “Economic”, add nearer-term financial impacts Concisely Articulate & Stand Behind Your Recommendation!

UNDERSTAND THE AUDIENCES CEO, Board Owner(s) Rating Agencies SEC (Public) Improves Input Quality & Personal Credibility

UNDERSTAND THE CONSTRAINTS Examples: - Return horizon: “accretive to EPS by 2nd year”? - cash flow demands? Commercial Lines Companies ‘97‘98‘99 # Organizations U/W Cash Flow ( 4.3) (10.1) (17.8) Investment Inc leverage CONSTRAINTS, AND CONSOLIDATED CONSIDERATIONS, MAY OUTWEIGH TARGET’S STAND ALONE VALUE

PUT SKIN IN THE GAME $12M $200G Ranges often appropriate, BUT For Acquisition decision, not necessarily good enough CFO needs tighter range, key risks, “When”, ….. AVOID PERCEPTION MORE IMPORTANT TO NOT BE WRONG - THAN - TO BE HELPFUL

CAN IT BE “FIXED”? HOW FAST? Current and recent accident years: Trend? Expectations next 2-3 AY’s? Cash flow: To improve? Deteriorate? Asset implications? Concentration: Excessive? Implications? Data content & quality: Ability to effectively manage book Quality of Key Personnel

WHAT ARE THE RISKS? TIMING? SOLUTIONS? Asbestos? Other singular exposures? Reinsurance solutions? Developments, key state/line? How soon impact Net Income? Past successes/failures masking emerging picture? Examples: Release of previous reserve redundancies Runoff of unprofitable business masking profitable growth

TO “ECONOMIC”, ADD NEARER-TERM FINANCIAL IMPACTS AY + Reserve development potential --> projected CY performance Paid development techniques --> Cash flow projections Pricing trends and opportunities --> WP and cash flow forecasts Use DFA/other approaches to measure: - risks to financial proforma - target’s asset allocation vs. financial goals

CONCISELY ARTICULATE & STAND BEHIND YOUR RECOMMENDATION Concise, to the point: ‘due diligence’ is unlike fine wine Provide straightforward, comprehensive linkage: –Longer term: reserves, valuationwith –Nearer term: CY projections, cash flow estimates, etc. “Go beyond the numbers”: –Any ‘walk-away’ issues you encountered? –Target’s capabilities –“Fixing it”: Slam dunk? Iffy? Don’t equivocate SEEK TO BE: More than: THE TEAM’S BEST TECHNICIAN Optimally: THE TEAM’S MVP