Case

REA Reinsurance

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Problem Definition

Your client, REA, is a reinsurance company.

REA recently acquired another reinsurance company (approximatively same size): the choice of this company was notably based on its product portfolio as well as its market presence which appeared complement with REA.

However, the acquisition is not well received by the market. The acquisition price is considered too high and the transaction has not been well graded. REA management asks you to evaluate the transaction.


Comments

This is an interviewer-led case. It is split into two parts.

The first part describes more qualitative problems and includes open questions to force the interviewee into thinking about the problem and possible solutions.

The second part deals with quantitative calculations based on the previous part. The interviewee should conduct his own calculations and solve the questions.


Short Solution

The two companies are regionally complementary, so the acquisition generally makes sense.

$550,000 or 7% of the total costs can potentially be saved through the acquisition.


Detailed Solution

Paragraphs highlighted in green indicate diagrams or tables that can be shared in the “Case exhibits” section.

Paragraphs highlighted in blue can be verbally communicated to the interviewee.

Paragraphs highlighted in orange indicate hints for you how to guide the interviewee through the case.

This is an interviewer-led case. Please share the questions outlined here with the interviewee at the given moment.

I. What is reinsurance?

Share question I with the interviewee.

The interviewee should understand the market and ask questions to get a good grasp of the client problem. Possible questions:

What’s the business model?

Insure insurance companies


What are the revenue streams?

Number of clients * premiums (%) * price of original contracts


Why this acquisition?

Ensure revenues, growth, presence in Asia, complementarity of firms

II. If asked by a key player in the market, how would you describe the transaction?

Share question II with the interviewee.

The interviewee should come up with a structured answer covering the main issues at stake. The idea is to give an overview of the companies and the interest of the transaction between them. It also tests the abilities of the interviewee to create excitement and interest for the topic at hand to a third person.

You can let the interviewee brainstorm about dimensions, on which he/she would like to describe the transaction. As guidance, you can then propose the following points and let him/her comment on the respective points.

Company (Performance, Complementarity of Products, Complementarity of Market Penetration Globally), Market (Growth, Competitors, Market Shares), Financials (Financing of Acquisition, Occurring Costs)

If the interviewee prefers to use a (/another) framework, let him/her do so.

A possible answer would be:

1. Company

  • Performance? Both companies are performing well on their respective markets
  • Complementarity of products? Very good
  • Complementarity of market penetration globally? Our client is present in Europe and USA. The acquired company is present in Europe and Asia

‚Äč2. Market

  • Growth? Flourishing market
  • Competitors? The transaction should give REA a better competitive position in the market
  • Market Shares? New clients in Asia

3. Financing

  • Financing of acquisition? Cash reserves + debt
  • Occurring costs? Acquisition price, transactional costs

III. What benefits could REA expect from the transaction?

Share question III with the interviewee.

The interviewee should come up with a structured answer, which shows a good understanding of the context.

Possible answer:

Benefits revenue side:

  • Increase in revenues (Sales REA + Sales acquired company + Cross-selling)
  • Volume effect (offers better diversification of risks)
  • Higher market share (allows for better prices/margins through leadership position in the market)

A good answer would also put the beforementioned criteria into perspective and mention other aspects such as the acquisition costs and possible cannibalization effect (i.e.: common clients).

Benefits cost side:

  • Economies of scale (imagine for example product design and research)
  • Overhead costs synergies (through elimination of redundancies)

IV. Which cost related synergies could this transaction allow?

Share question IV with the interviewee.

The first step should be the identification of the companies’ costs, relevant to the reinsurance industry.

Possible answer:

  • Staff costs
  • Real estate
  • Marketing & distribution
  • IT costs
  • Travel and entertainment
  • Administration and logistics

Share the actual cost split in diagram 1 with the interviewee.

It is now interesting, how the cost structures of the two companies compare. On interviewee’s request you will provide him/her with the following information:

Share table 1 with the interviewee.

The table is called v1. The percentages for the acquired company don't add up. This seems to be a mistake!

Share table 2 with the interviewee.

With these numbers the interviewee can start his/her calculations in the next section.

V. How much could our client benefit from costs synergies?

Share question V with the interviewee.

You can ask the interviewee for a reasonable percentage of costs that can be saved through synergies. 30% would be a good estimation.

Further remarks: Marketing and Administration are included in the HQ costs, while staff, real estate, IT and travel costs only arise in the regional sites at the beforementioned percentages.

Headquarter costs
Eligible for synergies: Yes!

REA: 10% * 4,000,000 = $400,000

Acquired company: 20% * $3,600,000 = $720,000

Total = $1,120,000 (30% = $336,000 for simplification: $350,000)

Staff costs (excludes HQ)
Eligible for synergies: Rather not.

Real estate
Eligible for synergies: Arguable, assume - due to little regional overlap - not.

IT costs
Eligible for synergies: Yes!

REA: 90% * $4,000,000 * 10% = $360,000 (costs in regions * total cost * share of IT costs)

Acquired Company: 80% * $3,600,000 * 10% = $288,000

Total = $650,000 (30% = $195,000 for simplification: $200,000)

Travel costs
Eligible for synergies: rather not.

Conclusion

The transaction does indeed allow cost savings due to synergies. Since there is no information given on the acquisition price, at this point no evaluation can be made regarding the potentially high acquisition costs.

Total costs to be saved due to synergies: $350,000 + $ 200,000 = $550,000

Good candidates are looking for reference values and try to express the number in terms of the total cost:

$550,000 / 7,600,000 = 7% of total cost reduction.

Difficult Questions

Q: Please describe a potential way to determine whether the trancaction price was reasonable or not!

More questions to be added by you, interviewer!

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Case exhibits