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GH Specialty > Objective 3 > Flashcards

Objective 3 Flashcards

1
Q

Circumstances that lead to a proper fit between a seller and a buyer of a block of insurance

A
  1. Non-core busines
  2. High admin costs
  3. Poor management
  4. Seller’s reputation
  5. Conservative reserves
  6. Regulatory fire sales
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2
Q

The role of the actuary in the merger and acquisition process

A
  1. Active member of due diligence review team
  2. Interviewing management
  3. Interfacing with regulators, reinsurers, investors
  4. Acting as a general advisor to management regarding m and a process
  5. Creating an actuarial appraisal
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3
Q

Code of Professional Conduct criteria for an actuary to perform appraisal services

A
  1. Actuary’s ability to act fairly is unimpaired
  2. Disclosure of any conflict to all principals whose interest would be affected
  3. All such principals have expressly agreed to performance of the actuarial services by the actuary
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4
Q

Steps for calculating the value of in force business

A
  1. Develop a projection model (windshield, intermediate detail, or full-blown)
  2. Determine starting in force values (reflect impact of actions already taken)
  3. Create set of assumptions reflecting reasonable expectations
  4. Project
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5
Q

Items included in the actuarial appraisal report, in accordance with ASOP 19

A
  1. Scope and intended use
  2. Reliances and limitations
  3. Description of business being valued
  4. Actuarial appraisal value
  5. Methodology and assumptions
  6. Validation techniques and results
  7. Adjustments made when valuing net worth
  8. How federal income taxes were considered
  9. Annual projection results
  10. Any deviations from ASOPs
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6
Q

Challenges in determining the value of an insurance company

A
  1. Long duration of liabilities
  2. Sensitivity to interest rate fluctuations and performance of capital markets
  3. Subjective art of loss reserving
  4. Cyclical nature of insurance
  5. Impact of reinsurance recoverables
  6. Challenges associated with non-market competitors (i.e. state funds)
  7. Varying state and sometimes federal regulations
  8. Impact of statutory accounting on operational decisions
  9. Influence of rating agencies
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7
Q

Techniques used by investment bankers to determine the value of a company

A
  1. Comparable company analysis
  2. Comparable transaction analysis
  3. Discounted cash flow analysis
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8
Q

Formulas for using a discounted cash flow analysis in an actuarial appraisal

A
  1. Act. appraisal is a discountet cash flow analysis
  2. Actuarial appraisal value = PV (distributable cash flows)
  3. Distributable cash flow = after-tax earnings - increase in required capital
  4. Discount rate is WACC from CAPM
    Normal formulas for r_E and WACC
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9
Q

Components of the actuarial appraisal value

A
  1. Adjusted book value
  2. Value of in force business (adjusted for cost of capital)
  3. Value of future business capacity (adjusted for cost of capital)
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10
Q

Uses of an actuarial appraisal

A
  1. Help value the company
  2. Form basis for alt. accounting methods for cross-border transactions
  3. Adjusted to calculate pro forma earnings and establish opening purchase GAAP bal sht
  4. Measure ongoing performance after acquisition
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11
Q

Assumptions needed for actuarial appraisals

A
  1. Mortality
  2. Morbidity
  3. Persistency
  4. Investment returns and spreads
  5. Operating expenses
  6. Discount rate
  7. Cost of required capital
  8. Taxes
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12
Q

Components of the adjusted book value of an insurance company

A
  1. Capital and surplus
  2. Asset valuation reserve
  3. Interest maintenance reserve
  4. Deferred tax asset
  5. Non-admitted assets
  6. Surplus notes and other debt
  7. Mark-to-market on assets allocated to adjusted book value
  8. Adjustments to assets the user values differently
  9. Adjustments to liabilities the user values differently
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13
Q

Approaches for using reinsurance to sell a block of business

A
  1. Assumption reinsurance
  2. Indemnity coinsurance
  3. Modified coinsurance
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14
Q

Techniques for estimating property and casualty loss reserves

A
  1. Loss development
  2. Expected loss
    a) Expected loss = forecasted exposure * expected ultimate loss rate
    b) Expected loss = earned premium * expected loss ratio
  3. Bornhuetter-Ferguson method: for each accident year,
    Reserve = [1 - (1 / PLDF) ] * expected loss
    where PLDF is from loss development (1) and expected loss is from (2)
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15
Q

Diagnostic tools for evaluating claim reserve estimates

A
  1. Assessing the convergence of various loss reserving techniques
  2. Analyzing various reserving statistics (i.e. dev triangles of settlement rates, dev patterns of avg size claim)
  3. Testing runoff of prior reserve estimates
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16
Q

Formulas for market value of equity

A
  1. MV(E) = MV(A) - MV(L)

2. MV(E) = FV + MV(TA) - PV(L) + PO

17
Q

Formulas for calculating embedded value (for a block of business, or the company as a whole)

A

For a block of business:
1. Embedded Value = PV after-tax profits + cost of capital
2. Cost of capital = PV future tied capital releases minus increases + PV after-tax investment income earned on tied capital - tied capital
For the company as a whole:
1. Embedded value = PV after-tax profits + cost of capital + tied capital + free capital

18
Q

Uses of embedded value for a block of business

A
  1. To set a value on the block for sale or purchase
  2. As part of the calculation of the value of the company. Would also include value of future new business
  3. To ensure that new business sold is generating an increase in value
  4. To determine compensation for sales staff
  5. To measure the impact of specific management actions on long-term value of company
19
Q

Definition of embedded value

A
  1. Calculation of the value of a block of business, based on the present value of surplus distributable to shareholders
  2. Based on current in-force business only
  3. Equals the value of in force business plus the value of free capital (in excess of regulatory capital requirements)
20
Q

Formulas for calculating embedded value for a company

A

Two methods are equivalent. PV discounted using hurdle rate.

  1. Profits to shareholders method
    a) Embedded value = free capital + PV (profits to shareholders)
    b) Profits to shareholders = after-tax profits + after-tax investment income on capital - increase in locked-in capital
    c) After-tax profit = premiums + investment income - benefits - expenses - increase in statutory reserve - tax on income
    d) Tax on income = Tax rate * (premiums + investment income - benefits - expenses - increase in tax reserve)
  2. Cost of capital method
    a) Embedded value = free capital + locked-in capital + PV (after-tax profits) - PV (cost of capital)
    b) Cost of capital = h * locked-in capital - after-tax investment income on capital
21
Q

Formulas illustrating the change in embedded value over time

A
  1. Embedded value (t+1) = embedded value (t) + normal increase in embedded value + value added by new sales - dividends paid + unexpected change in embedded value
  2. Normal increase in embedded value = (embedded value (t) - free capital) * (1+h) + free capital (1 + i), where i is the after-tax investment income rate
  3. Value added by new sales = PV (future after-tax profits on new sales) - PV (future cost of capital to support those sales)
  4. An unexpected change in embedded value could occur for various reasons, such as actual experience differing from expected, change in an embedded value assumption, or capital injection

GH Specialty (5 decks)

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