Session 5, Latest GAAP Developments/Hot Topics in GAAP Reporting. Moderator:

Transcription

1 Session 5, Latest GAAP Developments/Hot Topics in GAAP Reporting Moderator: Presenters: Sheryl A Battit FSA, MAAA Thomas Q Chamberlain ASA, MAAA Tara J P Hansen FSA, MAAA Jason E Kehrberg FSA, MAAA

2 Society of Actuaries Valuation Actuary Symposium Sessions 5 & 15 Hot Topics in GAAP Reporting August 31, 2015 Sheryl Battit

3 Hot Topics in GAAP Reporting: PGAAP Overview Recent M&A Activity Leading Practices Issues/Solutions Relevant Literature

4 PGAAP: Overview

5 PGAAP: Overview Purchase Accounting under US GAAP (PGAAP ) Applies when a business combination occurs Business Combination occurs when: an entity acquires net assets that constitute a business or acquires equity interests of one or more other entities and obtains control over that entity or entities Business combinations include mergers, acquisitions, some reinsurance agreements Business combinations exclude joint ventures or merger of companies already under common control

6 PGAAP: Overview, continued Insurance Business Combinations Purchase of common stock of a life insurance company or a life insurance holding company Acquisition of net assets through: coinsurance assumption reinsurance Depends on if entity meets definition of business in ASC Topic 805 Merger of two life insurance companies

7 PGAAP: Overview, continued PGAAP Objective ASC : measure the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree at their acquisition-date fair values [i.e. produce a Fair Value balance sheet] Basic Steps (ASC ): Identify the acquirer Determine the acquisition date Recognize and measure identifiable assets acquired, the liabilities assumed, and any noncontrolling interests, and Recognize and measure goodwill or gain from a bargain purchase

8 PGAAP: Overview, continued PGAAP Balance Sheet Components Asset or liability for insurance or reinsurance contract measured in accordance with acquirer s accounting policies ( Day 2 balances, or PGAAP liability) Fair Value of insurance and reinsurance assets acquired and liabilities assumed Intangible asset [or occasionally a liability] often referred to as Value of Business Acquired (VOBA) represents the difference between the Fair Value of the insurance contract liabilities and the PGAAP liability. Net GAAP Liability = PGAAP liability VOBA, is the fair value of the acquired block Deferred tax assets and deferred tax liabilities are not held at fair value on the PGAAP Balance Sheet

9 PGAAP: Overview, continued Methods for calculating VOBA Appraisal Method (Method 1 in AAA Practice Note) Based on value of distributable earnings (statutory) using market based assumptions, adjusted for GAAP and statutory differences and deferred taxes, grossed up to yield a pre-tax value. PGAAP liability less Fair Value Liability (as defined by ASC Topic 820) ( Method 2 in AAA Practice Note) Feasible when a Fair Value Liability is readily available or can be reasonably determined Most companies don t have processes in place to compute the fair value of an entire block of inforce business, leading to greater use of the Appraisal Method Described in ASC Both methods will produce the same value of VOBA when predicated on the same market-based assumptions and reflection of risk.

10 PGAAP: Overview, continued General Considerations Accounting bases applicable to acquired blocks Re-Bifurcation of Embedded Derivatives (e.g. indexed annuity business) Assumptions for valuing the acquired business Market based Fair value assumptions must consider risk margins and non-performance risk Reinsurance Length of time between initial valuation and close of transaction VOBA amortization basis and recoverability Tax implications

11 PGAAP: Recent M&A Activity

12 PGAAP: Recent M&A Activity Top 10 US Insurance Deals Announced 1/1/14-12/31/14 (by value) - Excluding Managed Care Rank Month Announced Target Name Acquirer Name Sector Value ($ in millions) % of Total 1 6/3/2014 Protective Life Corporation Dai-ichi Life Insurance Company, Limited Life & Health 5, % 2 3/21/2014 Warranty Group, Inc. Wolverine Acquisition, Inc. Property & Cas ualty 1, % 3 12/16/2014 ARX Holding Corp. Progress ive Corporation Property & Cas ualty % 4 12/23/2014 Radian Asset Assurance Inc. Assured Guaranty Corp. Financial Guaranty % 5 6/23/2014 Western World Insurance Group, Inc. Validus Specialty, Inc. Property & Cas ualty % 6 1/15/2014 Wright Insurance Group, LLC Brown & Brown, Inc. Property & Cas ualty % 7 12/30/2014 Meadowbrook Insurance Group, Inc. Miracle Nova II (US), LLC Property & Cas ualty % 8 12/18/2014 High net worth personal lines insuranceace Limited Property & Cas ualty % 9 1/9/2014 Summit Holding Southeast, Inc. Great American Holding, Inc. Property & Cas ualty % 10 10/21/2014 Aurora National Life Assurance CompanRGA Reinsurance Company Life & Health % Top 10 deal value 11, % Total disclosed deal value 14, % Source: SNL Financial

13 PGAAP: Recent M&A Activity Top 10 US Insurance Deals Announced YTD July 2015 (by value) - Excluding Managed Care Rank Month Announced Target Name Acquirer Name Sector Value ($M) % of Total 1 7/1/2015 Chubb Corporation ACE Limited Property & Cas ualty 28, % 2 6/10/2015 HCC Insurance Holdings, Inc. Tokio Marine & Nichido Fire Insurance Co., Ltd. Property & Cas ualty 7, % 3 7/23/2015 StanCorp Financial Group, Inc. Meiji Yasuda Life Insurance Company Life & Health 5, % 4 6/5/2015 AmeriLife Group, L.L.C. J.C. Flowers & Co. LLC Life & Health % 5 1/20/2015 US agency businesses Alliant Specialty Insurance Services, Inc. Property & Cas ualty % 6 3/16/2015 NSM Insurance Group, Inc. NSM Investments, Inc. Property & Cas ualty % 7 5/7/2015 Warranty solutions business AmTrust Financial Services, Inc. Property & Cas ualty % 8 7/15/2015 Lender-Placed Insurance business National General Holdings Corporation Property & Cas ualty % 9 6/12/2015 MGA Business Confie Seguros Holding II Co. Property & Cas ualty % 10 1/16/2015 Ahmann & Martin Co. Associated Financial Group, LLC Multiline % Top 10 deal value 42, % Total disclosed deal value 42, % Source: SNL Financial

14 PGAAP: Leading Practices

15 PGAAP: Sell-side practices typically performed Approach the deal from a buyer s perspective; anticipate potential deal issues that bidders may identify and be prepared to address them effectively. Prepare a dataroom with accurate and relevant information to be provided to bidders; update as new information becomes available Information would include financial data, contracts, and support for other potential deal issues that bidders may identify. Phase the diligence effort and grant appropriate level of access to bidders (based on the phase of the diligence). Understand potential impacts to the purchase price adjustment mechanism in the Agreement.

16 PGAAP: Buy-side practices typically performed Have a clear vision; structure the diligence effort around that vision Effective communication: Within the company (functional owners and business owners) Between the company, advisors, target and the bankers Understand and focus on critical deal drivers. Phase the diligence efforts and prioritize information needs. Keep an issues log and ensure issues are owned by specified individuals. Be accountabile for assumptions used. Identify deal synergies but don t include that value in the purchase price keep it, it s yours! Think creatively about deal structure and sales/purchase agreement terms. Identify and address any issues that may impact integration (e.g., separation issues).

17 PGAAP: Issues/Solutions

18 Issues/Solutions Scenario Issue Solution 1 Seller s actuarial appraisal and buyers deal model don t agree to the historical statutory reserves as of the valuation date. 2 Post-close price adjustment terms and process. 3 Timing between valuation date and closing date can be as long as months. This can introduce significant volatility to the purchase price which often is adjusted post close. Buyer team identifies the issue, coordinates with the seller s actuarial team to reconcile to the financial statements and identify differences. There may be small blocks of business excluded from the appraisal. Actuarial may assist to reconcile the appraisal to the financial statements and provide buyer with guidance as to how the differences may impact the deal model. Review the draft agreement and provide feedback on the actuarial and accounting principles to be used to determine the Post close price adjustment. Consider Seller's business plans before closing. Review Buyer's post-close balance sheet, identifying any changes in the Sellers accounting policies, practices, assumptions or methodologies since the initial purchase price. Consider tax related issues that may arise as a result of the movement of business between legal entities. Accounting/Tax/HR/Actuarial review the agreement terms and provide guidance on the accounting principles to be used to limit volatility. Buyer team prepares the post-close balance sheet, identifies any changes in Sellers accounting policies, practices, assumptions or methodologies which may have impacted surplus or the ability to realize tax attributes valued in the initial purchase price. Multi disciplined support is needed throughout this process.

19 Issues/Solutions Scenario Issue Solution 4 Insurance agents/brokers transactions are generally valued off a multiple of EBITDA. In evaluating a potential acquisition of these entities, consideration should be given to the contingent commissions earned in each period, including any claw back or other provisions in the agreements as well as pricing volatility of the business which may impact future earnings. Buyer team/actuarial read the agent/broker agreement to understand the terms as it relates to the contingent commissions. Buyer team - Understand the historical accounting for the contingent commissions and the basis for recognizing the income over the treaty year. Actuarial Understand the nature of the underlying business and, where appropriate, advise as to the projected ultimate loss ratios projected for the treaty year, which may not be fully developed for many years after the end of the treaty year. Buyer team/actuarial - Understand the historical pricing trends for the products offered in the relevant markets and consider the projected trends based on historical performance. Tax Advise as to the tax implications of any claw back of contingent commissions in future tax years.

20 PGAAP: Relevant Literature

21 PGAAP: Relevant Literature ASC Topic 805 (FAS 141R): Business Combinations (effective January 1, 2009) ASC Topic 350 (FAS 142): Goodwill and Other Intangible Assets ASC Topic 820 (FAS 157): Fair Value Measurements ASC Topic 810 (FAS 160): Non-controlling Interests in Consolidated Financial Statements AAA Practice Note: Treatment of VOBA, Goodwill and Other Intangible Assets under PGAAP (October 2014) US GAAP for Life Insurers: Appendix A Purchase Accounting

22 Contact Information Sheryl Battit, Director (617)

23 Thank you 2015 PricewaterhouseCoopers LLP, a Delaware limited liability partnership. All rights reserved. refers to the US member firm, and may sometimes refer to the network. Each member firm is a separate legal entity. Please see for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors. This document is for general information purposes only, and should not be used as a substitute for consultation with professional advisors. This document was not intended or written to be used, and it cannot be used, for the purpose of avoiding US federal, state or local tax penalties.

24 2015 Valuation Actuary Symposium Sessions 5&15: Hot Topics in GAAP Reporting Indexed Universal Life Update Tara Hansen, FSA, MAAA August 31, 2015

25 Disclaimer The information or perspectives included in this presentation are solely those of Tara Hansen and do not necessarily represent the opinions or perspectives of Ernst & Young LLP. The information presented has not been verified for accuracy or completeness and should not be construed as legal, tax or accounting advice, or a substitute for detailed research or the exercise of professional judgment. Information or perspectives included in this presentation should not be relied upon for any purposes, including without limitation, for making investment decisions. Neither Ernst & Young LLP nor any of its partners, principals or employees, or other member of the global Ernst & Young organization can accept any responsibility for loss occasioned to any person acting or refraining from action as a result of any material or information or perspectives included in this presentation. Readers should seek the advice of their own professional advisors when evaluating the information. Page 2

26 Indexed Universal Life (IUL) GAAP Accounting IUL FAS 97 universal life type contract with an embedded derivative ASC provides relevant IUL GAAP guidance for embedded derivatives Guidance is similar to fixed indexed annuities (FIA) embedded derivative guidance FIAs are generally FAS 97 investment contracts IUL is a FAS 97 universal life type contract Derivatives implementation guidance (DIGs) provide examples for FIAs FIA DIG not particularly useful for IUL Page 3

27 Indexed Universal Life (IUL) GAAP Accounting cont d The investment component of the equity-indexed life insurance contract would contain an embedded derivative (the equity index-based derivative) that meets all of the requirements of paragraph for separate accounting In contrast, if the contract contained an equityindexed death benefit component that was over and above the cash surrender value that is payable to the policyholder upon surrender of the policy, that death benefit component would not meet the criterion in paragraph (c) for separate accounting. Page 4

28 IUL ED accounting Range of practice Valuation approaches for 12 companies surveyed: Approach* Count Account Value 3 Host + ED (Current Period Only) 8 Host + ED (Current and Forward Starting Options) 3 *Note: Various approaches may be in use at a single company for different products The first two approaches will create very little to no embedded derivative, while the last approach typically creates a more substantial embedded derivative value Page 5

29 IUL Case Study Generic IUL policy Reserves projected over a 10 year period Assumed option budget = 3% Minimum guarantee = 0% Reserves illustrated under various approaches Account value Host + ED (current option value) Host + ED (including forward starting options) Host (using insurance definition) + ED (including forward starting options) Page 6

30 IUL Reserve Illustration Current Practice 4,000 IUL GAAP reserves comparison 3,500 3,000 2,500 2,000 1,500 1, Account Value Host (Current Options) Host (Forward Starting Options) ED (Current Options) ED (Forward Starting Options) Page 7

31 IUL Reserve Illustration Current Practice + Alternative 4,000 IUL GAAP reserves comparison 3,500 3,000 2,500 2,000 1,500 1, Account Value Host (Current Options) Host (Forward Starting Options) Host (Insurance Alternative) ED (Current Options) ED (Forward Starting Options) ED (Insurance Alternative) Page 8

32 Jason Kehrberg, FSA, MAAA August 31, 2015

33 Too many models (FAS60, FAS97, FAS120, etc.) Current models do not reflect embedded options and guarantees DAC is not exactly a straightforward concept FAS60 change in reserve can be difficult to understand and explain FAS60 assumptions are locked in at issue 2

34 From 2008 to 2013 FASB worked with the International Accounting Standards Board (IASB) to develop a global standard for insurance accounting In 2014 FASB decided to abandon that effort and instead make targeted improvements to US GAAP The next few slides summarize FASB meetings where these targeted improvements were discussed 3

35 FAS60, FAS97 limited pay, and FAS120 contracts will update assumptions annually The assumption updates will be done in the fourth quarter No margins in assumptions Eliminate loss recognition FAS97 assumptions updated in fourth quarter FASB staff are considering various implementation methods 4

36 All contracts which currently use expected yield (e.g. FAS60) will use rate based on portfolio of high-quality fixed-income investments (e.g. AA bonds) Similar to pensions FASB will consider application of discount rate to other contracts (e.g. FAS97) at a future meeting 5

37 DAC should be amortized over the expected life In proportion to insurance in force Straight line if in force not determinable Eliminates EGPs and EGMs for DAC EGPs and EGMs still appear in other FASB rules for now 6

38 Discussed implementing the August 27, 2014 decisions on assumptions Unlock the net premium in the 4 th quarter for changes in assumptions The net premium is based on experience from the issue date to the valuation date, and current assumptions going forward The net premium is locked in for the changes in discount rate The change in reserve for changes in discount rate runs through OCI, similar to assets at FV-OCI 7

39 Future meeting on VA guarantees and SOP03-1 Future meeting on financial statement disclosures for life contracts An Exposure Draft on the proposed targeted improvements will be published by the end of 2015 at the earliest The proposed targeted improvements, if adopted, will have a significant effect on US GAAP accounting When effective, which will not be for several years, the standard will change US GAAP accounting for new business as well as all inforce policies

40 IFRS, as promulgated by the IASB, covers Europe and Canada and much of the rest of the world The IASB hopes to finish their IFRS on insurance by early The final standard will be based on the building block model of the 2013 exposure draft: Current cash flows Discount at a rate consistent with the cash flows Explicit risk margin Contractual Service Margin is solved for so that there is no profit at issue, then is written off over the life of contract Targeted effective date is