The race to scale up among Bermuda-based reinsurers is set to continue. While the business rationale underpinning the tactic is clear, delivery is not always straightforward. Bermuda:Re+ILS plots the path to successful company integration.
The global broker has analysed data from the past 20 years to show a correlation between softening market conditions and increased M&A activity. This, coupled with the flow of alternative third party capital into the reinsurance market has driven down prices and accelerated the onset of mergers.
Barring any market upheaval or major insured loss catastrophe, M&A activity will only accelerate.
“With these dynamics in place, absent a market catalyst or a macro-environment event, we can reasonably expect continued proliferation of M&A activity,” the report concludes.
DLA Piper partner Bill Marcoux agrees that M&A activity in the reinsurance sector is set to continue as there are simply too many players.
“There are too many in absolute numbers and a number that are doing too few things, so there is going to be a natural consolidation, whether it’s been for scale or other reasons,” he says.
However, few major company integrations run as smoothly as originally envisaged.
Joining two entities into one is exceptionally difficult: corporate cultures clash, turf wars damage morale and profits, IT systems never seem to work properly together, key employees leave, customers are alienated—the collateral damage can be widespread.
The merger deal-doers are understandably eager to talk up the numerous benefits involved. But since they rarely handle post-deal integration, these promises can be difficult to keep.
A stressful, prolonged amalgamation of the two organisations can have an impact much more pronounced than simply dealing with boardroom tensions. It can ultimately have a bearing on the share price and ultimately the bottom line.
It’s crucial therefore that the integration process is as seamless as possible, and the first consideration should be for the staff.
The possible impact of any merger on staff morale can be immense. The fear of uncertainty and change is difficult to deal with. Many, if not most, employees regard the thought of merger as an excuse for mangers to sack staff—‘downsizing’ in the business parlance.
Even if they retain a position within the organisation they don’t know if they will have the same job, whether they will be reporting to the same manger or if the team they work with will be dissolved and subsumed into a new identity containing new members of staff and operating in a different culture.
“Communication plans are vital to help reduce two of the things that people dislike the most—change and uncertainty. Effective communication involves not only content, but timing. Board members, management, staff, customers, the media and other stakeholders should receive the information they need according to a carefully planned schedule,” says David Thompson, director, KPMG Advisory, Bermuda.
Communication is key
Post-merger measures of mental health suggest merger to be a stressful life event, even when there is a high degree of cultural compatibility between the partnering organisations. So key to a successful merger is establishing a communications strategy with all members of staff.
"The strongest and most engrained elements of each culture, regardless of whether they are good or bad, fight the hardest to survive." David Thopson, KPMG
This needs to include elements such as the timing of any departmental merger. Thought should also be given to deciding upon the delivery method—email, letter, or in person.
Thompson notes that “reducing or delaying operational redundancies may actually have the effect of freeing innovators from business-as-usual activities and providing them with a safe environment to experiment and learn, which can in turn help to deliver long-term success”.
However, there will always be some staff fallout because when you merge two companies, culture clashes are inevitable. There will be people who, for one reason or another, will not like the newly-formed operation and will generally ‘self-select’ out.
As Thompson says: “When boards or CEOs in a deal get along they all too frequently assume that their companies will get along just as well, but this rarely occurs. Typically the strongest and most engrained elements of each culture, regardless of whether they are good or bad, fight the hardest to survive.
“A disintegrated culture emerges that is unlikely to be aligned with the strategy and won’t support the achievement of value creation. In this environment, especially when coupled with the inherent uncertainty, it is very often the top performers who are first out of the door, followed closely by a loss of customer and broker brand loyalty.”
Integration leaders have long struggled with how to bring cultures together. KPMG suggests undertaking an assessment that identifies cultural similarities and differences using carefully defined characteristics. “Finding ways to utilise areas of alignment, while planning how to overcome the disparities, should become a key part of the integration plan,” Thompson adds.
Post-merger, the resultant firm often ends up with two people for each role in core teams such as finance, HR, operations, and admin. Top floor executives also tend to be hit hard—a company can’t have two COOs or CFOs. Even the acquisition of a smaller broker or
re/insurer can lead to these sorts of problems, except in cases where the acquired company is free to operate as an independent entity.
The merged company’s overall leadership should be crystal clear, both internally and to the market. There is also the choice of integration leader. A ‘rising star’ is a common choice, but is also a big gamble. KPMG advises using someone who’s been there, done it and has the ‘learning scars’ to show for it.
Not having a clearly thought-out integration plan is the biggest mistake the HR team can make during this period. The integration plan must cover all aspects of the company, including product, customers, employees, finance, operations, and IT.
“Strategic pre-deal preparation improves HR’s ability to support successful transactions. Addressing the people issues in all transaction phases can ensure that the deal’s strategic and financial objectives are met,” says a spokesman for Mercer.
The pitfalls of poaching
For companies reluctant to pursue the road of a full corporate merger or acquisition, an alternative is simply poaching a skilled team from a competitor.
Such tactics also need to be carefully managed, however. If badly handled, these strategies can result in costly disputes and court cases. Indeed, a case currently winding its way through the London courts sees global broker Willis taking action against the JLT Group for allegedly poaching 32 members of its Fine Art, Jewellery and Specie (FAJS) division to Miller Insurance.
Willis says it was first aware of the mass defection on April 1 this year. QC Gavin Mansfield described the move as “a carefully planned, targeted conspiracy to take a profitable division…”
An injunction was awarded following a hearing at the Court of Appeal.
Nick Wilcox, a lawyer with London legal partnership Brahams, Dutt, Badrick and French, says the law around this issue is both “onerous and complicated” and that it is this “uncertainty that leads to disputes that eventually end in court”.
Often restrictive covenants are cited in court when the employer wants to stop and employee or group of employees from deserting. But here, again, nothing is certain.
“There is a raft of law around enforceability—but the key question is: are the restrictions reasonable? That will depend on the how senior the person is; how much contact they have with clients and for how long any restriction is in place, etc,” Wilcox says.
“The court will allow these so long as any restrictions don’t go too far—a six to 12 months non-compete clause is typical—12 months in terms of renewals for reinsurance. For broking firms, client connection is very much a ‘profitable interest’.”
In such cases a defecting employee or group of employees who want to take clients when leaving need to be aware that the clients belong to the company. In such cases the aggrieved party may look to unearth an electronic trail to uncover evidence of wrongdoing.
Making IT happen
Software amalgamation often leads to crossed wires when two companies merge. Richard Clark, business development director at Xuber, offers a quick reboot to system synchronisation.
Many mergers do not live up to expectations, because they stumble on the integration of technology and fail to put in place a well-placed strategy for IT integration. The current flux of merger and acquisition (M&A) activity has a distinct objective of ‘bigger is better’—therefore the challenges of inheriting several different solutions and the importance of harmonising IT systems have never been so important.
Richard Clark, business development director at Xuber, says that to effectively integrate IT systems during M&A, it is important to establish and harmonise the Target Operating Model and accounting structure first and then implement it. The same can be said for products—it’s all too easy to simply replicate the same systems rather than working out more efficient ways to do business.
“Newly-merged companies should focus on areas that are growth areas of the new business and then move forward in manageable chunks—for example, starting either functionally (say with underwriting) or by lines of business or territory to help achieve early wins,” Clark says.
“After choosing the appropriate applications, a definitive strategy for the migration of systems is vital. Establish the purpose of each part of the migration and beware of being overambitious—data enrichment can become complex and risky, so do not migrate for the sake of it.
“An effectively executed IT integration can help the newly-merged companies run more smoothly, help with operational alignment and duplication of resources. However, an unsuccessful IT integration can be devastating.
“A badly managed merger will simply replicate old products and models in new applications, which is arguably worse than before. This leads to poor understanding of the combined business that will literally translate into immediate loss of income and drain value from the merger.”
He adds that companies can also risk potentially missing out on what could be the biggest asset in a merger—coordinating two company’s datasets. Understanding how to make the best use of this combined data will give the newly-merged re/insurer an advantage over rivals and boost its bottom line.
“Bringing an effective IT systems strategy into the rationale for any M&A will make the difference between the IT system being an inhibitor or a facilitator,” he says.
Common HR mistakes during M&As
Certain mistakes on the human resources (HR) end can negatively affect employees’ morale. Three signs that show that the HR department has not taken the necessary steps during a merger or acquisition are:
The acquisition comes as a surprise to employees;
The organisational structures affect employees adversely; and
The acquirer is more focused on the process than the people.
The chief information officer’s role in a merger
The role of the chief information officer is critical to any merger. Richard Raysman and Francesca Morris, partners in Holland & Knight, examine the steps good CIOs will take.
A cost-effective integration of the technologies of the two companies can dramatically influence the success of a merger. It falls to the chief information officer (CIO) to seamlessly merge the technology and the technical knowledge of two sophisticated institutions. Some of the most important performance and cost issues faced by the CIO are:
comparing the technology inventories of both companies, the CIO will develop a list of duplicate or redundant licences which can be combined, or terminated, often with significant cost savings.
Which software systems survive after the merger can be the most difficult the decision the CIO will make during the merger process. The more efficient and best-tested system, is often the way to go.
Many software licences have a “no assignability” clause. In the negotiation of a licence, the stakeholders may have been most concerned about scope, performance and pricing, leaving the assignment clause to the lawyers. However, at the time of an acquisition, if a licence cannot be assigned to the acquiring company, it may create an expensive line item in the merger costs, to cover negotiations with counterparties for rights to assign the “no assign” agreements.
Scope of use
Most software licences have a “scope of use” clause which limits use by the number of servers, the number of users, or the number of devices such as desktops, laptops, ipads and smartphones. To expand or reduce scope of usage for the combined entity, the CIO may need to negotiate a change to the licence fees.
Some licence agreements or other IT contracts may need to be terminated as a result of the merger, requiring close adherence to termination provisions or a negotiation to permit an otherwise impermissible early termination.
With pressure being exerted on the CIO to cutover as quickly as possible, sometimes the CIO just has to say “no” until the systems are fully tested to avoid a system failure which could be detrimental to reputation, efficiency and profitability.
The time between announcement and close is prime for attackers to try to hack into the company being acquired and then penetrate the larger organisation once integration begins.
Bermuda:Re+ILS, David Thompson, KPMG, Bermuda