Chapter 20 - Mergers and Acquisitions Flashcards
Valuing an Insurance Company
two quantitative approaches?
two quantitative approaches are often employed:
- market appraisals and
- actuarial valuations.
Valuing an Insurance Company
Market Appraisal
The market appraisal method determines value by comparing the target company with similar companies that have been acquired. The comparison is usually expressed as a multiple of book value and/or earnings to purchase price.
For this purpose, book value and earnings are usually based on GAAP. For example, the multiples for a company with a GAAP book value of $8 million and GAAP earnings of $1 million which sells for $12 million would be 1.5 times book value and 12 times earnings
Valuing an Insurance Company
Actuarial Valuation
An actuarial valuation assumes that the value of an insurance company is equal to the sum of the fair value of its assets.
This value is generally determined based on a projection of the future statutory profits of the company, which have been discounted at an appropriate risk-adjusted rate of return.
This approach generally identifies the primary assets of an insurance company as follows:
- Adjusted statutory net worth.
- Insurance in force.
- Agency force or distribution system.
- Other intangible assets.
Valuing an Insurance Company
Actuarial Valuation (primary assets of an insurance company for actuarial valuation) • Adjusted Statutory Net Worth • Insurance in Force • Agency Force or Distribution System • Other Intangible Assets
Adjusted Statutory Net Worth?
company’s tangible assets less liabilities.Generally, net worth is equal to the company’s statutory capital and surplus reflected on its Annual Statement, adjusted for certain items.
adjustments include differences between:
• book value and market value,
• nonadmitted assets: excluded
• contingent reserves
Valuing an Insurance Company
Actuarial Valuation (primary assets of an insurance company for actuarial valuation) • Adjusted Statutory Net Worth • Insurance in Force • Agency Force or Distribution System • Other Intangible Assets
Insurance in Force?
The value of insurance in force is equal to the present value of future statutory profits on the acquired insurance policies. (Computed as the present value of future profit from past sales)
To determine the value of insurance in force, statutory profits must be projected for each major line of insurance business acquired. Projected profits are then discounted to the date of acquisition.
An actuarial valuation of insurance in force requires numerous assumptions regarding • morbidity and mortality, • lapses, • expenses, • commissions, • taxes, • reinsurance, • interest and • discount rates.
Valuing an Insurance Company
Actuarial Valuation (primary assets of an insurance company for actuarial valuation) • Adjusted Statutory Net Worth • Insurance in Force • Agency Force or Distribution System • Other Intangible Assets
Agency Force or Distribution System?
The value of the agency force or other distribution system is most often computed as the present value of future profits expected to be produced from future sales.
(Conversely, the value of insurance in force is computed as the present value of future profit from past sales.)
Valuing an Insurance Company
Actuarial Valuation (primary assets of an insurance company for actuarial valuation) • Adjusted Statutory Net Worth • Insurance in Force • Agency Force or Distribution System • Other Intangible Assets
Other Intangible Assets?
Other intangible assets may include state charters and licenses, going concern value, company name, trade names, and computer application software.
Acquisition Techniques and Their Tax Consequences
Acquisition Methods
Once the target company’s value has been determined, an acquisition technique must be chosen.
- Purchase of assets (assumption reinsurance).
- Purchase of stock treated as an asset purchase (Section 338 treatment elected).
- Purchase of stock treated as an asset purchase (Section 338(h)(10) treatment elected).
- Purchase of stock not treated as an asset purchase (Section 338 treatment not elected).
- Statutory merger or reorganization (type A reorganization).
- Stock-for-stock acquisition (type B reorganization).
- Stock-for-asset acquisition (type C reorganization).
Acquisition Techniques and Their Tax Consequences
Acquisition Methods
• Purchase of assets (assumption reinsurance). Tax Treatment?
Ceding Company
The ceding company recognizes income on an assumption reinsurance transaction to the extent of the ceding commission received, or, if the ceding commission is offset against the assets transferred, to the extent that the liabilities transferred exceed the market value of the assets transferred.
Assuming Company (Reinsurer) The assets and liabilities received by the assuming company in an assumption reinsurance transaction are accounted for as premium income and an increase in the tax reserve deduction, respectively.
- Generally, all purchased intangible assets, including goodwill, are now capitalized and amortized over a 15-year period. This new intangible provision, Section 197, applies to assumption reinsurance transactions but not to indemnity reinsurance transactions. Thus, in an assumption reinsurance transaction, the ceding commission, less the amount required to be capitalized as policy acquisition expenses must be capitalized and amortized over a 15-year period.
Acquisition Techniques and Their Tax Consequences
Acquisition Methods
• Purchase of assets (assumption reinsurance).
Policy Acquisition Expenses?
Policy acquisition expenses capitalized amounts are often referred to as deferred acquisition costs (DAC).
- Under an assumption reinsurance agreement, the DAC amount calculated by the assuming company will be subtracted from the ceding commission. The difference, if any, will be the Section 197 asset that is amortized over 15 years, while the DAC amount is amortized over 10 years.
- ceding commissions paid under an assumption reinsurance agreement should be capitalized and amortized over a 15-year period to the extent of the amount not capitalized under the DAC rules.
Ch 12: Generally, the amount of policy acquisition expenses to be capitalized in a year is equal to specific statutory capitalization rate applied against the net premiums of specified insurance contracts. The resultant capitalized amount is generally amortized over 120 months, except certain small companies are entitled to use a 60-month amortization period.
Acquisition Techniques and Their Tax Consequences
Acquisition Methods
• Purchase of stock treated as an asset purchase (Section 338 treatment elected)?
Under Section 338, a corporation making a qualified stock purchase can elect no later than the 15th day of the 9th month after it makes the purchase, to treat the stock purchase as a purchase of assets for federal income tax purposes.
Although the target is deemed dissolved for tax purposes with the assets of the target being acquired by a new corporation, there has been no change to the legal and corporate identity and history of the target, nor have assets legally been transferred.
A general selection 338 election generates a double layer of tax consequences, whereas the Section 338(h)(10) election creates a single tax effect at the target company.
Acquisition Techniques and Their Tax Consequences
Acquisition Methods
• Purchase of stock treated as an asset purchase (Section 338 treatment elected)
Qualified Stock Purchase?
A qualified stock purchase occurs if 80 percent or more of the voting power and 80 percent of the total value of the stock of the corporation are acquired by purchase during one 12-month period (the acquisition period).
Acquisition Techniques and Their Tax Consequences
Acquisition Methods
• Purchase of stock not treated as an asset purchase (Section 338 treatment not elected).
The purchase of an insurance company’s stock without making a Section 338 election allows the insurance company to retain its attributes and avoid taxable gain on the deemed sale, recapture taxes, and Phase III tax. This treatment may be particularly attractive when the target company has a tax basis in excess of the fair market value of its assets, substantial operating and capital loss carryovers, credit carryovers, or a large PSA balance.
Acquisition Techniques and Their Tax Consequences
Acquisition Methods
• Purchase of stock not treated as an asset purchase (Section 338 treatment not elected).
The purchase of an insurance company’s stock without making a Section 338 election allows the insurance company to retain its attributes and avoid taxable gain on the deemed sale, recapture taxes, and Phase III tax. This treatment may be particularly attractive when the target company has a tax basis in excess of the fair market value of its assets, substantial operating and capital loss carryovers, credit carryovers, or a large PSA balance.
Acquisition Techniques and Their Tax Consequences
Acquisition Methods
• Statutory merger or reorganization (type A reorganization).
is a merger or consolidation following state law. The acquired company’s shareholders exchange their stock for stock of the purchaser or its parent.
The use of voting stock is not required, nor is a transfer of “substantially all” the assets to the purchaser.
- In its most basic form, one corporation can merge into another, or two corporations can combine into a third.
- In a forward triangular merger, the target company is merged into a controlled subsidiary in exchange for the stock of the parent corporation.
- In a reverse triangular merger, a subsidiary of the purchaser is merged into the acquired company with the acquired company surviving the merger, again in exchange for the stock of the parent company.
