Business Combinations - actuaries.org.hk · Purchase Accounting Business Combinations Insurance...
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Purchase Accounting
Business Combinations
Insurance IFRS Seminar
December 2, 2016
Eric Lu
Session 30
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Purchase Accounting – General
(IFRS 3)
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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
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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.)
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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
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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.
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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
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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.
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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.
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IFRS 4 -
Insurance Contracts
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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
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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
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IFRS 17 Tentative Decisions
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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
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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
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Guidance
• In a business combination, the initial liability measurement is used to
determine goodwill.
• 2013 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.
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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.
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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 20 45
Contractual Service Margin 10 0
Liability at initial recognition 30 45
Loss at initial recognition 0 15
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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 20 45
Contractual Service margin 10 0
Liability at initial recognition 30 45
Loss at initial recognition 0 0
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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
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Thank You