D.2 Mergers and acquisitions Flashcards
Challenges with valuing a going concern
going concern = a self-sustaining viable company that is worth more than the sum of its parts
challenges = capturing the value of some intangible assets; distribution relationships, geographic reach, customer loyalty
- insurance company valuations are more complicated than for other types
- long durations of liabilities
- IR sensitivity
- dynamic art of loss reserving
- reins impact
- challenge with non-market competitors
- influence of rating agencies
- different regulators by state
3 Valuation techniques used by banks
- Comparable company analysis
- based on operational and financial performances
- similar market cap size
- apply market multiples that are most significant
- develop a range of standalone values: multiply the sellers book value by the high and low multiples to develop a range
- determine change of control premium = additional amount buyers are willing to pay for control of business - comparable transaction analysis
- similar to ‘comparable company analysis’ but:
- multiples are based on multiples from comparable transactions rather than companies - discounted cash flow analysis
- project future AT SH divs paid by the seller
- develop a terminal value for the final year
- calculate PV of future AT divs from terminal value
- sensitivity testing to develop high and low PVs
Use of actuarial appraisals
AAV = Adjusted BV + Value of existing business + Value of future business
ABV = stat net worth of the insurance company with certain adjustments, like AVR
Value of inforce business = PVDE from business on the books
value of future business = PVDE from business that is projected to be written after the valuation date
AAV = EV + Value of future business
*if assumptions used are the same between AAV and EV
Total company value = AAV + ‘other items that put a value on market position, branding, general market conditions’
AAV uses:
- report is prepared for the selling company to market business
- includes projection of stat earnings and capital requirements
- sensitivity analysis
- buyers will also have their own AAV and adjust the sellers AAV to their point of view regarding discount rates, experience, NB value
- AAV can be used as an ongoing performance metric after the sale
Factors that determine the final purchase price
- Confidence in the pricing assumptions for the buyer and sellers
- desired RoR
- urgency
- economies of scale and scope
- tax benefits/consequences
- value of branding and other intangibles
- one time expenses
- other assets or liabilities at the holding company level outside the scope of the appraisal
3 components of AAV
- adjusted book value ABV
- ABV = net worth of insurance company on a stat basis w/ certain adjustments
a. add AVR to stat surplus
b. add IMR
c. subtract the admitted portion of deferred tax assets
d. add non admitted assets
e. surplus notes and other debt - need to specify if these are reflected
f. mark to market assets allocated to ABV - Value of existing business
- project stat earnings over the lifetime of the business - value of future business
- uncertainty around future business volumes
- uncertainty about profit margins in future pricing
- requires assumptions about growth, volume, and pricing assumptions
- value = mix of volume, profitability, number of years production is assumed to continue
a. assume a given [production plan for a specified number of years
b. or; project only 1 year of NB
Specific assumption considerations
- AAV uses best estimates, no PADs
- assumptions based on company experience, mgmt expectations, and industry experience based on credibility
mortality assumptions
- company and industry experience
- UW and distribution
- reflect reins
- mortality anti selection for business with high lapse rates
- mortality improvement
Morbidity
- experience and industry data
- UW and distribution
Persistency
- varies by company and product design
- dynamic models for IR sensitive products
- shock lapses driven by M+A
Investment returns and spread assumptions
- based on assumed RoR or existing asset portfolio
- yield curve assumptions may need support with sensitivity testing
- future credited IR based on mgmt strategies
- For IR sensitive business, include analysis of impact of IR movements on the AAV
- stochastic testing good for products with embedded options and gts
operating expenses
- fully absorbed unit expenses - budget of target company is spread across the inforce and nb units
- target unit expenses with an unallocated expense
- target unit expenses without an unallocated expense
Discount rate determination
- seller illustrates a range of rates
- use CAPM to determine the WACC discount rate
Cost of required capital
-reflects that an insurer will hold a multiple of required capital which cannot be distributed
NPV DE = ABV - Value of inforce and future business - cost of RC
Taxes
-taxable income is based on tax accounting
Individual life and annuity product line issues
Life insurance:
- models developed using commercial software
- flexible premium UL and VUL have various funding patterns
- mortality improvements assumption vary by company
- reins should be reflected in AAV
- XXX adds complexity
- low IR environment - concern for gtd IR
Fixed deferred annuities
- disintermediation
- reinvestment risk
- risk of not achieving required spread between earned and credited rates
- sensitivity of the block to IR scenarios
- need lapse rate assumptions
Fixed IA
- fixed CFs, non-surrenderable
- mortality based on a standard table
- mortality improvement should be considered
Variable annuities
- primary risk - future PH investment returns
- revenue depends on funds under mgmt
- cost of gtd features increase as SA returns fall
- VA carriers use hedging to limit exposure to market movements
- embedded options and gts ca be separately values with option pricing techniques
