Purchase GAAP

Question 1

define and summarize P-GAAP

Answer 1

P-GAAP is the accounting system used for business combinations

• assets and liabilities of the purchased entity are stated at fair value
• implied capital (assets less liabilities) is compared to the purchase price
  
  • capital < purchase price, a goodwill asset is established for the difference
  • capital > purchase price, the difference is immediately recognized as an operating gain

Question 2

three components of estimation of fair value of loss and LAE reserves

Answer 2

• expected value of undiscounted future cash flows for loss and LAE
• reduction to reflect time value of money at the risk-free interest rate plus a load for illiquidity
• risk adjustment to compensate for risk, commonly estimated using the cost of capital approach

Question 3

how risk adjustment for estimating fair value of LLAE reserves is estimated

Answer 3

present value of future returns in excess of risk-free rate plus an illiquidity premium that an investor would require
(R - i) * SUM [ C_t / (1 + i)^t ]

Question 4

define fair value

Answer 4

price at which an orderly transaction to sell the asset or to transfer the liability would take place between market participants under current market conditions

Question 5

two approaches for establishing cash flows for LLAE reserves

Answer 5

• based on LDFs actuary would have selected when reviewing reasonableness of recorded reserves
• implied pattern based on the ratios of paid loss to ultimate by accident year

Question 6

how to calculate value of business in-force (VBIF)

Answer 6

• use an ELR to estimate the nominal expected liabilities from the unearned premium
• obtain a fair value of these liabilities with the same approach as for LLAE reserve
• include policy maintenance costs in the first year cash flows
• subtract from UEPR to obtain VBIF