Business Combinations

Transcription

1 Business Combinations Insurance IFRS Seminar Purchase Accounting December 2, 2016 Eric Lu Session 30

2 Purchase Accounting General (IFRS 3) 1

3 Purchase Accounting ( PA ) A fresh start - prior accounting becomes irrelevant Existing reserves, DAC, etc., under IFRS 4 or US GAAP become irrelevant. Under IFRS 17, existing CSM become irrelevant. All assets and liabilities are re-valued to fair value 2

4 PA Fundamental Principle The value of the acquired business on the books of the acquirer is the amount paid for it. The purchase price is a fair price, negotiated between the seller and buyer. The purchase is merely an exchange of assets of equal worth. For the consideration paid (e.g. cash), the acquirer receives an asset or assets of equal value (e.g. all outstanding shares of the acquired company.) 3

5 IFRS 3-Acquisition Method Identify acquirer Determine acquisition date Recognize/measure assets acquired and liabilities assumed at fair value Recognize/measure goodwill or gain from bargain purchase 4

6 Some Intangibles to Consider Type Customer-related Technology-based Contract-based Example Customer Lists Software licenses Insurance contracts in force, but NOT insurance contracts expected to be written in the future. This does NOT meet the definition of an asset. 5

7 Goodwill Let NAA = value of net assets acquired Tangible and intangible assets less liabilities acquired measured at fair value For purchase of an insurance company, fair value of insurance contracts is required (IFRS 13) Let PP = purchase price Goodwill = PP NAA, an asset on the books of the acquirer. The total value of the acquired business is therefore NAA + GW = PP 6

8 Goodwill Goodwill is typically positive as part of the price may relate to future new business. If Goodwill is Negative, Review identification and valuation of assets acquired and liabilities assumed; If still negative, taken as a gain in the income statement. 7

9 Portfolio Transfers (Assumption Reinsurance) The selling company transfers a portfolio of insurance contracts and the supporting assets. On the books of the acquirer, the fair value of the liabilities assumed is equal to the fair value of the assets transferred. There is no goodwill. 8

10 IFRS 4 - Insurance Contracts 9

11 IFRS 4, Paragraph 31 Permits an insurer to split the fair value of acquired insurance contracts between: (a) A liability under insurer s existing accounting policies, and (b) An intangible asset equal to the difference between the FV of the rights/obligations assumed and (a) The intangible asset goes by many names VOBA, VIF, PVIF 10

12 IFRS 4, Paragraph 31 Subsequent measurement of the intangible asset shall be consistent with the measurement of the related insurance liability. Many companies use US GAAP principles for their insurance contract accounting. In this case VOBA would be amortized based on premiums, gross profits, etc. Historically, VOBA calculated bottom up, consistent with liabilities held IFRS guidance - VOBA may be balancing item to FV net liability In theory, two approaches should be consistent 11

13 IFRS 17 Tentative Decisions 12

14 Initial Measurement The purchase date is the date of initial recognition for acquired contracts i.e. a fresh start. The consideration received is a pre-coverage cash flow (initial premium). The consideration received is equal to The cash received in a portfolio transfer The fair value of the contracts in a business combination 13

15 Relationship to Fair Value Case 1: FV > Fulfillment Cash Flow Then FCF FV < 0 and CSM = FV FCF Total initial liability = FCF + CSM = FV Case 2: FV < Fulfillment Cash Flow Then FCF FV > 0 and CSM = 0 Total initial liability = FCF + CSM = FCF This is an exception to the general purchase accounting rules and requires IFRS 3 be amended 14

16 Guidance In a business combination, the initial liability measurement is used to determine goodwill ED gets to same answer as the 2010 ED. An insurer shall measure a portfolio of insurance contracts acquired in a business combination at the higher of the following: (a) the fair value of the portfolio. (b) the present value of the fulfillment cash flows, i.e. best estimate plus risk margin, but not residual margin. 15

17 Guidance (cont d) In the case of (a): The excess of that fair value over the present value of the fulfillment cash flows establishes the CSM at initial recognition. In the case of (b): The excess of fulfillment cash flows over the fair value increases the initial carrying amount of goodwill recognized in the business combination. 16

18 Example Example 9 Measurement of a portfolio of insurance contracts acquired in a portfolio transfer An insurer acquires a portfolio of insurance contracts in a business combination. The fair value of the portfolio is CU30. Present value of fulfillment cash flows is In Example 9A, CU20, which is lower than the fair value. FCF + PCCF = (10). The contractual service margin is CU10 In Example 9B, CU45, which is higher than the fair value. FCF + PCCF = 15. The contractual service margin is zero At initial recognition, the insurer measures the insurance contract liability as follows: Example 9A Example 9B Present value of the fulfillment cash flows Contractual Service Margin 10 0 Liability at initial recognition Loss at initial recognition

19 Example Example 10 Measurement of a portfolio of insurance contracts acquired in a business combination An insurer acquires a portfolio of insurance contracts in a business combination. The fair value of the portfolio is CU30. Present value of fulfillment cash flows is In Example 10A, CU20, which is lower than the fair value. FCF + PCCF = (10). The contractual service margin is CU10 In Example 10B, CU45, which is higher than the fair value. FCF + PCCF = 15. The contractual service margin is zero. Goodwill is CU15 higher than it would have been had fair value been used as the initial measurement At initial recognition, the insurer measures the insurance contract liability as follows: Example 9A Example 9B Present value of the fulfillment cash flows Contractual Service margin 10 0 Liability at initial recognition Loss at initial recognition

20 Implications No more VOBA FV calculation Insurance contracts are exempted from FV measurement However, comparison to FV needed Also needed for goodwill analysis Other intangible assets remain, e.g. bank assurance distribution rights 19

21 Thank You