New Books For Your Company s Financial Statements and Financial Library IAS US GAAP M&A An hour and a half presentation on the directions, outcomes and timetables for International Accounting Standards and An introduction of the new content in two new Society of Actuaries textbooks U.S. GAAP for Life Insurers, Second Edition and Insurance Industry Mergers & Acquisitions Presented by R. Thomas (Tom) Herget, FSA, MAAA PolySystems, Inc. therget@polysystems.com January, 2006
Introduction Education University of Illinois Fellow of Society of Actuaries Employment Two larger insurers CPA firm PolySystems Volunteer work American Academy of Actuaries SFAS 97 testimony Financial Reporting Council Society of Actuaries Financial Reporting chair Board of Governors Strategic Action Team Knowledge Management My firm PolySystems Employees Locations: Chicago and Philadelphia Clients Products Software Installation Consulting Specialties Valuation Projections Financial reporting Experience Measurement Asset Liability Management 2
Financial Reporting Evolution Balance sheet Retrospective or prospective Significant estimates for insurance Income statement Estimates impacting timing of profits, not actual profits Operating income or below the line Investors needs in 1970 U.S. statutory good year was a bad year; bad year was a good year Needed focus on earnings Initial GAAP focused on revenue/expense matching Investment-oriented products (1980s) SFAS 115 and shift from income statement to balance sheet orientation Concern that GAAP value does not come close to market capitalization 3
U.S. GAAP Today F.A.S.B. Financial Accounting Standards Board Authority SEC (created by Congress) has authority for financial accounting and reporting standards SEC created FASB in 1973 and delegated this authority to it Is independent of all business and professional organizations Composition Seven members Serve for 5 years From public, private and academic; diverse backgrounds sought Members must sever connections with prior firm Terms staggered so one or two new members each year Selection by oversight body (Financial Accounting Foundation) Staff Nearly 70 professions from public accounting, industry, academia and government Project management, research, roundtable meetings, analysis of comments, recommendation preparation Funding from two sources Fees assessed against issuers of securities Fees for publications and securities 4
U.S. GAAP Today Shapers, users and environment of U.S. GAAP and financial reporting today SEC FASB AICPA Company management Stock analysis Rating agencies Accounting firms Fair Value Direction Desire to consider FV direction (stated in SFAS 115, paragraph 56) Should conform to International Accounting Standards (IAS) 5
IAS Inception to Date IASB (International Accounting Standards Board) Independent, privately funded (200 organizations), London-based Why common standard? Widely different practices in different countries Globalization of business and capital markets Objective develop accounting standards that result in Clear financial statements Understood by knowledgeable users Can be compared across countries and companies Earlier Accomplishments in Insurance Started 1997 1999 Issues paper generated 138 comments which led to 2001 Draft Statement of Principles Not do-able by 2005, so split into Phases 1 and 2 Allowed to use existing GAAP as long as it had loss recognition and more disclosures provided IFRS 4 a temporary standard (International Financial Reporting Standard) IAS 39 Financial Instruments (International Accounting Standard) 6
IAS Inception to Date IFRS 4 a temporary standard Defined insurance risk Defined insurance contract Disclosures information that helps users to understand the amount, timing and uncertainty of future cash flows from insurance contracts Key assumptions Effect of changes in assumptions RM objectives Analysis of risks, including concentration, interest rate and credit risk Information about guarantees Sensitivity analyses Definition of significance Par products treated similarly to insurance products Product classifications significant insurance risk must be present IAS 39 Financial Instruments Covers valuation of financial instruments that don t meet definition of insurance GICs, term certain annuities, Pure unit-linked (variable annuities without guarantees) Initial measurement at FV Subsequent measurement either at FV or amortized cost Recent/current accomplishments Phase 2 started mid 2004 IASB taking fresh look Past work a useful resource, but will not by bound by it Can learn from national or industry practices, but not bound by it 7
IAS On the Table Will need to address Number of models single model for all contracts? Gain or loss at inception any restrictions? Model parameters unlocking, PADs, scenarios, taxes Policyholder behavior should models include expectations of future renewal premiums? Discount rate risk free, adjustments, insurers own assets, entity s own credit standing Identification and deferral of acquisition costs A deposit floor Treatment of discretionary participation features Discounting non-life claim reserves with interest Methods for calculating liabilities (four) Two are historical cost-based» Similar to SFAS 60» Locked in» Loss recognition testing Entry value Exit value 8
Entry and Exit Values Entry Value The amount an insurer would charge a policyholder today for a contract with the same rights and obligations as the existing contract Assumption estimates are unlocked at each reporting date, using current assumptions Margins stay locked No gain at issue Exit Value The amount an insurer would expect to pay today to sell or transfer all its remaining obligations for a policy Estimates are unlocked at each reporting date, using current market conditions Margins unlocked to calibrate to external value 9
Comparative Financial Statements for a Single Product Term Life Description of Product Term life insurance Economic and business environment Start with no business; issue business in year one; no issues in year two No taxes Scenario 1: assumptions emerge as priced for Scenario 2: increase in interest rates in year 3 Presentation of Balance Sheets and Income Statements under U.S. statutory Chinese statutory Chinese statutory with embedded value U.S. GAAP (SFAS 60) IAS Entry value IAS Exit value 10
Comparative Financial Statements for a Single Product Term Life Fair Value Example Details Product data: Issue age 30 Male Non-smoker Face amount $1,000,000 Annual mode policy with $70 policy fee U.S. Statutory Assumptions Reserve Method Mortality Interest rate Statement Method 1999 XXX 80 CSO Male Non-smoker with 20 year select factors (x factors for deficiency) 4.5% Monthly interpolated mean reserve 11
Comparative Financial Statements for a Single Product Term Life US GAAP Assumptions Duration Interest Rate 1000xMortality Rate 100x Lapse Rate Current Gross Premium Commissions Per policy Maintenance Expense Per policy Acquistion Expenses 1 6.00% 0.096 12 539.00 120.00% $50.00 $200.00 2 6.00% 0.120 10 539.00 20.00% 50.00 0.00 3 6.00% 0.156 10 539.00 2.00% 50.00 0.00 4 6.00% 0.186 9 539.00 2.00% 50.00 0.00 5 6.00% 0.204 9 539.00 2.00% 50.00 0.00 6 6.00% 0.234 8 539.00 2.00% 50.00 0.00 7 6.00% 0.258 7 539.00 2.00% 50.00 0.00 8 6.00% 0.288 6 539.00 2.00% 50.00 0.00 9 6.00% 0.330 5 539.00 2.00% 50.00 0.00 10 6.00% 0.360 4 539.00 2.00% 50.00 0.00 11 6.00% 0.408 4 539.00 2.00% 50.00 0.00 12 6.00% 0.456 4 539.00 2.00% 50.00 0.00 13 6.00% 0.516 4 539.00 2.00% 50.00 0.00 14 6.00% 0.594 4 539.00 2.00% 50.00 0.00 15 6.00% 0.654 4 539.00 2.00% 50.00 0.00 16 6.00% 0.750 4 539.00 2.00% 50.00 0.00 17 6.00% 0.828 4 539.00 2.00% 50.00 0.00 18 6.00% 0.924 4 539.00 2.00% 50.00 0.00 19 6.00% 1.068 4 539.00 2.00% 50.00 0.00 20 6.00% 1.218 90 539.00 2.00% 50.00 0.00 21 6.00% 4.068 7 4,292.40 2.00% 50.00 0.00 22 6.00% 4.482 7 4,723.60 2.00% 50.00 0.00 23 6.00% 4.896 7 5,184.20 2.00% 50.00 0.00 24 6.00% 5.436 7 5,703.60 2.00% 50.00 0.00 25 6.00% 5.958 7 6,281.80 2.00% 50.00 0.00 26 6.00% 6.732 7 6,928.60 2.00% 50.00 0.00 27 6.00% 7.452 7 7,732.20 2.00% 50.00 0.00 28 6.00% 8.226 7 8,663.20 2.00% 50.00 0.00 29 6.00% 8.982 7 9,662.80 2.00% 50.00 0.00 30+ 6.00% Not shown 7 Not shown 2.00% 50.00 0.00 12
Comparative Financial Statements for a Single Product Term Life Chinese Statutory Assumptions Reserve Method Mortality Interest rate FPT; Benefit and premium are payable for 20 years only Same as GAAP 6.0% 13
Comparative Financial Statements for a Single Product Term Life Embedded Value Assumptions Embedded Value is the present value of Statutory Insurance profits discounted at 9%. Projection Assumptions Projection assumptions are the same as the GAAP assumptions. Earned Rate Target Surplus Initial Assets 6% 5% of premium plus 0.15% for net amount at risk plus 2.5% of reserves $5,000 14
Comparative Financial Statements for a Single Product Term Life U.S. Statutory Scenario 1 Balance Sheet Assets Invested Assets 4,827 5,404 5,992 6,568 7,146 7,724 Total Assets 4,827 5,404 5,992 6,568 7,146 7,724 Liabilities Reserve 3,276 3,343 3,331 3,304 3,617 4,056 AVR 10 20 32 46 60 75 Total Liabilities 3,286 3,364 3,364 3,350 3,677 4,131 Surplus 1,541 2,040 2,629 3,218 3,469 3,593 Target Surplus 1,420 1,287 1,166 1,067 985 923 Free Surplus 121 753 1,463 2,151 2,484 2,670 Comments: $5,000 seed money needed to support ultraconservative U.S. reserve standards. AVR (asset valuation reserve) change goes below the line. The U.S. stat reserve is based on alt min for first 4 years then switches to higher basic reserve. Insurance profits is total net income less interest on surplus. Income Statement Revenues Premium Collected 527 464 417 375 342 311 Investment Income 278 309 343 376 408 441 Total Revenues 805 773 760 751 750 752 Costs Death Benefits 96 106 124 133 132 138 Reserve Increase 3,276 67-12 -27 313 439 Comm & Exp 882 90 48 43 39 36 Total Costs 4,255 263 160 149 484 613 Net Income -3,450 510 600 603 266 139 Interest on Surplus 79 93 126 145 147 157 Insurance Profits -3,529 417 474 458 118-18 Net Income -3,450 510 600 603 266 139 Change in AVR 10 11 12 13 15 16 Change in Capital & Surplus -3,459 499 588 589 251 123 15
Comparative Financial Statements for a Single Product Term Life Chinese Statutory Scenario 1 Balance Sheet Assets Invested Assets 4,827 5,404 5,992 6,568 7,146 7,724 Total Assets 4,827 5,404 5,992 6,568 7,146 7,724 Liabilities Reserve 3 240 417 552 658 740 Total Liabilities 3 240 417 552 658 740 Surplus 4,823 5,163 5,576 6,016 6,488 6,984 Target Surplus 1,343 1,214 1,097 1,002 916 845 Free Surplus 3,480 3,949 4,478 5,013 5,573 6,139 Comments: The same starting assets are used for all six accounting bases. Income Statement Revenues Premium Collected 527 464 417 375 342 311 Investment Income 278 309 343 376 408 441 Total Revenues 805 773 760 751 750 752 Costs Death Benefits 96 106 124 133 132 138 Reserve Increase 3 237 176 135 106 83 Comm & Exp 882 90 48 43 39 36 Total Costs 982 433 348 311 277 256 Net Income -177 340 412 440 473 496 Interest on Surplus 277 292 314 338 364 392 Insurance Profits -453 48 99 102 108 104 16
Comparative Financial Statements for a Single Product Term Life Chinese Statutory with Embedded Value Scenario 1 Balance Sheet Assets Invested Assets 4,827 5,404 5,992 6,568 7,146 7,724 Embedded Value 726 740 702 658 604 550 Total Assets 5,553 6,144 6,694 7,225 7,750 8,275 Liabilities Reserve 3 240 417 552 658 740 Total Liabilities 3 240 417 552 658 740 Surplus 5,550 5,903 6,278 6,674 7,092 7,534 Target Surplus 1,343 1,214 1,097 1,002 916 845 Free Surplus 4,207 4,689 5,180 5,671 6,176 6,689 Comments: Embedded Value (EV) could be deemed Fair Value. EV is present value of distributable earnings. Renewal year profits are primarily due to discount rate of 9% and earned rate of 6%. Income Statement Revenues Premium Collected 527 464 417 375 342 311 Investment Income 278 309 343 376 408 441 Total Revenues 805 773 760 751 750 752 Costs Death Benefits 96 106 124 133 132 138 Reserve Increase 3 237 176 135 106 83 Comm & Exp 882 90 48 43 39 36 Decrease in Embedded Val -726-14 38 44 54 54 Total Costs 255 419 386 355 331 310 Net Income 550 354 374 396 419 442 Interest on Surplus 277 292 314 338 364 392 Insurance Profits 273 62 61 58 54 50 17
Comparative Financial Statements for a Single Product Term Life U.S. GAAP (SFAS 60) Scenario 1 Balance Sheet Assets Invested Assets 4,827 5,404 5,992 6,568 7,146 7,724 DAC 760 751 711 678 649 624 Total Assets 5,587 6,155 6,703 7,245 7,795 8,349 Liabilities Reserve 233 430 591 726 848 953 Total Liabilities 233 430 591 726 848 953 Surplus 5,354 5,725 6,113 6,519 6,946 7,396 Comments: The insurance profits are a level percent of premium, consistent with SFAS 60 objectives. Income Statement Revenues Premium Collected 527 464 417 375 342 311 Investment Income 278 309 343 376 408 441 Total Revenues 805 773 760 751 750 752 Costs Death Benefits 96 106 124 133 132 138 Reserve Increase 233 197 161 135 122 105 Comm & Exp 882 90 48 43 39 36 - Increase in DAC 760-9 -40-34 -29-24 Total Costs 451 402 372 345 323 303 Net Income 354 371 388 406 427 449 Interest on Surplus 303 324 346 369 393 418 Insurance Profits 51 47 42 38 34 31 Net Income 354 371 388 406 427 449 Other Comprehensive Income 0 0 0 0 0 0 Change in Retained Earnings (Surplus) 354 371 388 406 427 449 18
Comparative Financial Statements for a Single Product Term Life Entry Value Fair value reserve is the PV cash flows using a discount rate of 3%. Assumptions are the same as GAAP. Margin as a percent of mortality is set so there is no gain or loss at issue. 19
Comparative Financial Statements for a Single Product Term Life IAS Entry Value Scenario 1 Balance Sheet Assets Invested Assets 4,827 5,404 5,992 6,568 7,146 7,724 DAC 0 0 0 0 0 0 Total Assets 4,827 5,404 5,992 6,568 7,146 7,724 Liabilities Reserve -470-219 17 212 382 522 Total Liabilities -470-219 17 212 382 522 Surplus 5,297 5,622 5,975 6,356 6,764 7,202 Comments: Reserves are negative in order to force no profit at issue. Insurance profit is negative first year because reserves are negative, which generates negative interest. Income Statement Revenues Premium Collected 527 464 417 375 342 311 Investment Income 278 309 343 376 408 441 Total Revenues 805 773 760 751 750 752 Costs Death Benefits 96 106 124 133 132 138 Reserve Increase -470 252 236 195 170 141 Comm & Exp 882 90 48 43 39 36 - Increase in DAC 0 0 0 0 0 0 Total Costs 508 448 407 370 341 315 Net Income 297 325 353 381 409 438 Interest on Surplus 300 318 338 359 382 407 Insurance Profits -3 7 15 22 27 31 20
Comparative Financial Statements for a Single Product Term Life Exit Value Assumptions are the same as the GAAP assumptions including the mortality. Fair value reserve is the PV of cash flows discounted at 3% plus a margin which leads to a gain at issue. 21
Comparative Financial Statements for a Single Product Term Life IAS Exit Value Scenario 1 Balance Sheet Assets Invested Assets 4,827 5,404 5,992 6,568 7,146 7,724 DAC 0 0 0 0 0 0 Total Assets 4,827 5,404 5,992 6,568 7,146 7,724 Liabilities Reserve -937-688 -454-261 -91 49 Total Liabilities -937-688 -454-261 -91 49 Surplus 5,763 6,092 6,447 6,828 7,237 7,675 Comments: A buyer really likes our company and is willing to pay for it. Income Statement Revenues Premium Collected 527 464 417 375 342 311 Investment Income 278 309 343 376 408 441 Total Revenues 805 773 760 751 750 752 Costs Death Benefits 96 106 124 133 132 138 Reserve Increase -937 248 234 194 169 140 Comm & Exp 882 90 48 43 39 36 - Increase in DAC 0 0 0 0 0 0 Total Costs 42 444 405 369 341 314 Net Income 763 329 355 382 409 438 Interest on Surplus 325 346 365 387 410 434 Insurance Profits 438-17 -11-5 0 4 22
Comparative Financial Statements for a Single Product Term Life U.S. Statutory Scenario 2 (see page 15 for Scenario 1) Balance Sheet Assets Invested Assets 4,827 5,404 5,992 6,630 7,277 7,929 Total Assets 4,827 5,404 5,992 6,630 7,277 7,929 Liabilities Reserve 3,276 3,343 3,331 3,304 3,617 4,056 AVR 10 20 32 46 60 76 Total Liabilities 3,286 3,364 3,364 3,350 3,677 4,132 Surplus 1,541 2,040 2,629 3,280 3,600 3,797 Target Surplus 1,420 1,287 1,166 1,067 985 923 Free Surplus 121 753 1,463 2,213 2,614 2,873 Comments: The only impact is a higher earned rate on new investments leads to a higher profit in last 3 years. Income Statement Revenues Premium Collected 527 464 417 375 342 311 Investment Income 278 309 343 438 476 515 Total Revenues 805 773 760 814 818 826 Costs Death Benefits 96 106 124 133 132 138 Reserve Increase 3,276 67-12 -27 313 439 Comm & Exp 882 90 48 43 39 36 Total Costs 4,255 263 160 149 484 613 Net Income -3,450 510 600 665 334 213 Interest on Surplus 79 93 126 169 172 183 Insurance Profits -3,529 417 474 496 162 30 Net Income -3,450 510 600 665 334 213 Change in AVR 10 11 12 13 15 16 Change in Capital & Surplus -3,459 499 588 652 319 197 23
Comparative Financial Statements for a Single Product Term Life Chinese Statutory Scenario 2 (see page 16 for Scenario 1) Balance Sheet Assets Invested Assets 4,827 5,404 5,992 6,630 7,277 7,929 Total Assets 4,827 5,404 5,992 6,630 7,277 7,929 Liabilities Reserve 3 240 417 552 658 740 Total Liabilities 3 240 417 552 658 740 Surplus 4,823 5,163 5,576 6,078 6,619 7,188 Target Surplus 1,343 1,214 1,097 1,002 916 845 Free Surplus 3,480 3,949 4,478 5,076 5,703 6,343 Comments: The only impact is a higher earned rate on new investments leads to a higher profit in last 3 years. Income Statement Revenues Premium Collected 527 464 417 375 342 311 Investment Income 278 309 343 438 476 515 Total Revenues 805 773 760 814 818 826 Costs Death Benefits 96 106 124 133 132 138 Reserve Increase 3 237 176 135 106 83 Comm & Exp 882 90 48 43 39 36 Total Costs 982 433 348 311 277 256 Net Income -177 340 412 503 541 569 Interest on Surplus 277 292 314 394 425 458 Insurance Profits -453 48 99 108 116 112 24
Comparative Financial Statements for a Single Product Term Life Chinese Statutory with Embedded Value Scenario 2 (See page 17 for Scenario 1) Balance Sheet Assets Invested Assets 4,827 5,404 5,992 6,630 7,277 7,929 Embedded Value 726 740 705 668 620 570 Total Assets 5,553 6,144 6,697 7,298 7,896 8,499 Liabilities Reserve 3 240 417 552 658 740 Total Liabilities 3 240 417 552 658 740 Surplus 5,550 5,903 6,281 6,746 7,239 7,759 Target Surplus 1,343 1,214 1,097 1,002 916 845 Free Surplus 4,207 4,689 5,184 5,744 6,323 6,913 Comments: Changed EV discount rate to 11% at year-end 3. Income Statement Revenues Premium Collected 527 464 417 375 342 311 Investment Income 278 309 343 438 476 515 Total Revenues 805 773 760 814 818 826 Costs Death Benefits 96 106 124 133 132 138 Reserve Increase 3 237 176 135 106 83 Comm & Exp 882 90 48 43 39 36 Decrease in Embedded Value -726-14 35 37 48 49 Total Costs 255 419 382 348 326 305 Net Income 550 354 378 465 492 520 Interest on Surplus 277 292 314 394 425 458 Insurance Profits 273 62 64 71 67 63 25
Comparative Financial Statements for a Single Product Term Life U.S. GAAP (SFAS 60) Scenario 2 (see page 18 for Scenario 1) Balance Sheet Assets Invested Assets 4,827 5,404 5,153 5,791 6,438 7,090 DAC 760 751 711 678 649 624 Total Assets 5,587 6,155 5,864 6,469 7,086 7,714 Liabilities Reserve 233 430 591 726 848 953 Total Liabilities 233 430 591 726 848 953 Surplus 5,354 5,725 5,274 5,743 6,238 6,761 Comments: Other Comprehensive Income (OCI) is below the line. There is an inconsistency ( mixed attribute ) between assets and liabilities. Assets are reported at Fair Value and liabilities at historical cost. Income Statement Revenues Premium Collected 527 464 417 375 342 311 Investment Income 278 309 343 438 476 515 Total Revenues 805 773 760 814 818 826 Costs Death Benefits 96 106 124 133 132 138 Reserve Increase 233 197 161 135 122 105 Comm & Exp 882 90 48 43 39 36 - Increase in DAC 760-9 -40-34 -29-24 Total Costs 451 402 372 345 323 303 Net Income 354 371 388 469 495 523 Interest on Surplus 303 324 346 430 458 488 Insurance Profits 51 47 42 39 37 35 Net Income 354 371 388 469 495 523 Other Comprehensive Income 0 0-839 0 0 0 Change in Retained Earnings (Surplus) 354 371-451 469 495 523 26
Comparative Financial Statements for a Single Product Term Life IAS Entry Value Scenario 2 (See page 20 for Scenario 1) Balance Sheet Assets Invested Assets 4,827 5,404 5,153 5,791 6,438 7,090 DAC 0 0 0 0 0 0 Total Assets 4,827 5,404 5,153 5,791 6,438 7,090 Liabilities Reserve -470-219 -139 55 226 371 Total Liabilities -470-219 -139 55 226 371 Surplus 5,297 5,622 5,292 5,737 6,211 6,718 Comments: Discount rate increased to 5% at year-end 3. Both assets and liabilities are marked to market. In our example, the liabilities have a shorter duration than assets leading to a loss when interest rates increase. Income Statement Revenues Premium Collected 527 464 417 375 342 311 Investment Income 278 309 343 438 476 515 Change in Market Value of Assets 0 0-839 0 0 0 Total Revenues 805 773-79 814 818 826 Costs Death Benefits 96 106 124 133 132 138 Reserve Increase -470 252 80 193 172 145 Comm & Exp 882 90 48 43 39 36 - Increase in DAC 0 0 0 0 0 0 Total Costs 508 448 251 369 343 319 Net Income 297 325-330 445 475 507 Interest on Surplus 300 318 338 419 446 474 Insurance Profits -3 7-668 26 29 32 27
Comparative Financial Statements for a Single Product Term Life IAS Exit Value Scenario 2 (See page 22 for Scenario 1) Balance Sheet Assets Invested Assets 4,827 5,404 5,153 5,791 6,438 7,090 DAC 0 0 0 0 0 0 Total Assets 4,827 5,404 5,153 5,791 6,438 7,090 Liabilities Reserve -937-688 -473-283 -114 28 Total Liabilities -937-688 -473-283 -114 28 Surplus 5,763 6,092 5,626 6,074 6,552 7,062 Income Statement Revenues Premium Collected 527 464 417 375 342 311 Comments: Investment Income 278 309 343 438 476 515 Change in Market Value of Assets 0 0-839 0 0 0 Total Revenues 805 773-79 814 818 826 Discount rate increased to 5% at year-end 3. Costs Death Benefits 96 106 124 133 132 138 Reserve Increase -937 248 215 190 168 142 Comm & Exp 882 90 48 43 39 36 - Increase in DAC 0 0 0 0 0 0 Total Costs 42 444 387 366 340 316 Net Income 763 329-466 448 478 510 Interest on Surplus 325 346 365 451 478 507 Insurance Profits 438-17 -831-3 0 3 28
IASB Future Activities Speculate on dates October 2006 Insurance Discussion paper April 2008 Exposure draft April 2009 Final standard January 2012 Effective 29
Key Players IASB s Insurance Working Group comprises senior financial executives, analysts, actuaries, auditors and regulators IAA International Actuarial Association Subcontracted to do International Association of Insurance Supervisors (IAIS) what is their role? CFO Forum CFO s from Europe s leading life and P/C companies In the U.S. FASB Agreed on convergence Is letting IASB take the lead Will circulate IASB literature Will initiate its own due process AAA will react, probably through FASB SoA also will monitor and react ACLI no current plans to be an advocate Group of North American Insurance Enterprises Group of 12 U.S. companies And large companies from Japan Proactive in presenting principles and examples Individual companies 30
New from SoA 2 nd Edition of US GAAP for Life Insurers How/when written Eleven authors A year to write 1,000 hours 200 new pages 100 new spreadsheets 31
New from SoA 2 nd Edition of US GAAP for Life Insurers New topics Sales Inducements (from SOP 03-1) [3.11, 6.9, 7.5] (Trad, UL, Ann) Initial bonus interest, day-one bonuses, persistency bonuses, enhanced crediting rates Assets or liabilities; establish using new rules 20 year term with high lapse rates [4.9] The product has 80% lapse rate in year 20 Unusually high reserves and DAC at that point Can produce negative reserves Can a negative liability exist? 32
New from SoA 2 nd Edition of US GAAP for Life Insurers Profits followed by losses, including Excess Death Benefits (from SOP 03-1) [6.12. 8.2.3.2, 8.2.4] Where losing periods follow gains periods Establish a liability, funding from assessments Excess Annuitization and Death benefits (from SOP 03-1 and SFAS 133) [7.4.3, 8.2.3.2, 8.2.4, 8.2.5] For benefits in excess of fund value Use multiple scenarios to determine possible values Fund with level % benefit ratio Always update 33
New from SoA 2 nd Edition of US GAAP for Life Insurers Equity Indexed Annuities [8.3] A new product since the first edition From SFAS 133 and DIG Contains point-to-point and ratchet examples Search for Embedded Derivatives (from SFAS 133 and DIG) [13.12] Defines what is subject to SFAS 133 Discusses how to search by product type 34
New from SoA 2 nd Edition of US GAAP for Life Insurers Business combinations and Goodwill (SFAS 141 and SFAS 142) [new 15] Rules for when an acquisition occurs; no more pooling Goodwill amortization and impairment testing Intangible Assets, including VOBA Methods for producing liabilities Foreign Products Added new countries [16.5] Japan, Korea, Singapore, Malaysia, Taiwan, China, Philippines How SOP 03-1 applies [16.7] Reinsurance From SOP 03-1 [17.7] From SFAS 133 and DIG B36 [17.8] Bifurcation of embedded derivatives that may exist in modco and funds withheld reinsurance treaties Several examples 35
New from SoA 2 nd Edition of US GAAP for Life Insurers Fair Value reporting [18.3] SFAS 133 requirements FASB directions Demutualizations [18.4] updated from draft SOP to actual SOP 00-3 Financial Statement presentations [19] Show 3 balance sheets and 2 income statements Different economic scenarios and new business levels Shows presentation of actual calculations Nine different product lines nine companies Index Last index done on the train This time, a professional indexer 36
New from SoA Insurance Industry Mergers & Acquisitions textbook Background the need, the sponsor, the plan Writers 2 editors, 10 authors How written 3 face-to-face meetings; write, discuss, debate, party Unique Aspects P&C Actuary addressed Property & Casualty and Life companies Purchase multiples price to earnings, price to book value ratios PGAAP chapter many examples of different approaches Tales from the crypt 80 stories on what happens when you don t follow the textbook advice 37
New from SoA Insurance Industry Mergers & Acquisitions textbook Chapter 1 Introduction What is Insurance? Industry Characteristics Regulatory Bodies Insurance Rating Agencies Insurance Accounting Taxation Distribution A few Words about Actuaries Overview Chapter 2 M&A Process Overview Introduction M&A Drivers: An Overview Preparing to Sell Pre-Marketing Marketing Evaluating the Opportunity on the Buy Side Negotiating the Definitive Agreement The Path to Closing Conclusion 38
New from SoA Insurance Industry Mergers & Acquisitions textbook Chapter 3 Financing Introduction Sources of Funds Financing Instruments M&A Financing Considerations Summary Chapter 4 Valuation Techniques Introduction: Valuation Techniques for Insurance M&A General Valuation Techniques The Actuarial Appraisal Basis for Assumptions Components of the Actuarial Appraisal Life company valuation issues P&C company valuation Issues Summary 39
New from SoA Insurance Industry Mergers & Acquisitions textbook Chapter 5 Due Diligence 3 6 weeks to confirm all criteria that affect value & success of deal Create buyer s appraisal Construct final bid with price, conditions & transition issues The team outside actuary, accountant, investment banker, legal The team inside all key areas; should include members of integration team Confirm strategic, financial & operational values Strategic Identify complementary products, markets or distribution Alternative to building technology Cheaper than building market share Financial Analyze Balance Sheet Overvalued assets, undervalued liabilities, reserve margins Analyze Income Statement Opportunities for expense savings; parent expense allocations Analyze appraisal assumptions Other tax, controls, risk management Operational Review each line of business Integration issues key staff, culture Systems Conversion expenses 40
New from SoA Insurance Industry Mergers & Acquisitions textbook Chapter 6 Corporate Benefits & Insurance Programs Overview Employee Benefits Corporate Insurance & Risk Management Programs Other P&C Risk Management Issues Chapter 7 Taxation Overview Taxation of Insurance Companies In General Consolidated Federal Income Tax Returns Federal Income Tax Considerations in Acquisitions of Insurance Companies Acquisition of a Mutual Insurance Company Use of Losses in Insurance Company Acquisitions Tax-Based Valuation and Due Diligence Concerns State Taxes Taxes on Valuation 41
New from SoA Insurance Industry Mergers & Acquisitions textbook Chapter 8 Accounting Introduction US GAAP Purchase Accounting Business Combination Identifying the Acquiring Entity Purchase Accounting Market Value of Investments (Including Derivatives) and Other Assets Deferred Taxes Liabilities and Reserves Identification of Intangible Assets Acquisition Reserves Goodwill Comparison of HGAAP to PGAAP Example A Determine Purchase Price and Goodwill Example B Purchase Price and Goodwill Calculation Assumption and Indemnity Reinsurance Statutory Accounting Principles Purchaser s Accounting Acquired Entity Accounting Goodwill Admissibility 42
Value Opportunities Value Delivery VALUE Target Acquirer Acquisition costs Distraction Disruption Integration cost Cultural impact Degree of integration People selection Planning Timing Communication Leadership alignment Speed of integration Brand synergy Competitive synergy Improved distribution channel access Access to new/ better technologies Access to new products Cross-selling opportunities Expand customer base Elimination of duplication Economies of scale in reinsurance, commissions Best practices/ combined learning Product and technology rationalization Lower cost distribution channel Technology improvement Workforce rationalization Investment portfolio economies of scale Improved cash management techniques Intellectual Property Improved asset liability management Lower financing costs Less earnings volatility Increased diversity of insurance risk Increased purchasing power Value Created for Acquirer's Shareholders Premium to Target's Shareholders Original Target Value Original Acquirer Value Pre-acquisition Value (Excluding Premium Paid) Acquisition Related Costs Integration Strategy and Management Revenue Growth Operating Expense Reduction Asset Efficiency Cost of Capital Reduction Value of New Company Value-Creation Opportunities Source: Deloitte & Touche LLP 43
Consider the Importance of Culture Humanize the Merger Commitment Organization Momentum Early euphoria Change is exciting Our company is taking a bold step What does this mean for me? What are my priorities now? Fear/ uncertainty Paralysis Adaptation It is the right thing to do We will succeed The train is leaving, I better get on It s hard, but we can do it Withdrawal I can t act with all this uncertainty My highest priority is to stay on top of the integration news Departure This is not something I want to be a part of I ll do what is necessary to survive 85% of all integration failures have cultural undertones. 44
New from SoA Insurance Industry Mergers & Acquisitions textbook Chapter 9 Merger Integration Integration team organization, management; often doing regular job too No committees to select best practices Don t slash & burn need institutional knowledge Communicate to employees constantly Incentives for key people to stay Every deadline will seem aggressive Celebrate success Define new culture Key off relationship building from due diligence Financial PGAAP appraisal models versus actual Financial get help first six months 45
New from SoA Insurance Industry Mergers & Acquisitions textbook Appendix Confidentiality Agreement Bid Process Letter Preliminary Bid Letter Form A Form E Actuarial Standard of Practice Sample Due Diligence: Life Insurance Company Information Request Sample Due Diligence: Employee Benefits Information Request Sample Due Diligence: Corporate Insurance Programs Information Request 46
Questions & Answers therget@polysystems.com