ACCOUNTING CONSIDERATIONS
FOR INSURANCE ACQUISITIONS
Paul Medini, CPA, Partner, PricewaterhouseCoopers LLP
William Lowry, CPA, CLU, FLMI, Capital Decision Services LLC
April 2000
Accounting
Considerations for
Insurance Acquisitions
Discussions Topics

Business Combinations -- Purchase vs. Poolings
 Purchase Accounting
• Overview
• Purchase accounting adjustments
• Financial statement impact of purchase accounting
• FASB’s view of useful life and Goodwill
• Reserve covers
• Reserve adjustments
 Pooling of Interest Accounting
• Overview
• Pooling transactions in the Insurance Industry
• Future of pooling

Restructuring Charges
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Accounting
Considerations for
Insurance Acquisitions
Purchase vs Pooling Accounting
Purchase
Pooling
Theory
Accounting
EPS Impact
Acquisition
Fair Value
Bad
Merger
Book Value
Good
Structuring Flexibility
Yes
Limited *
* Limited flexibility refers to restrictions on certain transactions such as asset
dispositions, the issuance of options, and treasury stock repurchases.
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Accounting
Considerations for
Insurance Acquisitions
Purchase Accounting Overview

Determine the acquirer
 General rule:
• Payer of cash and monetary securities is the acquirer
 Exceptions:
• Stock for stock transactions, consider:
– Shareholder group ownership
– Composition of top management and board of
directors
– Relative values
– Imposed restricting conditions
 The determination of the “acquirer” can potentially be
different depending on legal or accounting definitions
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Accounting
Considerations for
Insurance Acquisitions
Purchase Accounting Overview, cont.

Determine the purchase price
Cash and monetary securities
+ Non-monetary consideration paid
+ Direct acquisition costs
+ Contingent consideration
= Purchase price
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Accounting
Considerations for
Insurance Acquisitions
Purchase Accounting Overview, cont.

Allocation of the purchase price
 Purpose:
• To create a new balance sheet stated at fair value.
Consider it as if acquirer purchased or assumed a
group of individual assets or liabilities
 Assets and liabilities are valued using various techniques
depending on their nature:
• Net realizable value
• Present value
• Fair value
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Accounting
Considerations for
Insurance Acquisitions
Balance Sheet Impact of Purchase Accounting
 Other assets/liabilities
 Revaluation of office buildings or
reflection of favorable/unfavorable
leases
 Deferred Taxes
 Restated for tax effect of difference
between purchase accounting basis
and tax basis
 Goodwill
 Differences between purchase price
and allocated value to tangible net
assets
 Equity

Restated to reflect purchase price
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Accounting
Considerations for
Insurance Acquisitions
P&L and Equity Impact of Purchase Accounting
P&L
 Investment Income
 Effect of amortization/depreciation of
purchase accounting adjustments to
invested assets
 Interest expense
 Effect of acquisition debt, if any
 Other expenses
 Amortization of Goodwill
 Taxes
 Current
 Deduction of Goodwill amortization,
if any, and adjustments to taxable
investment income
 Deferred
 Reflects change in differences between
purchase accounting and tax bases
Equity
 Unrealized gain/loss on
investments
 Reflects difference between historical
and purchase accounting basis
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Accounting
Considerations for
Insurance Acquisitions
FASB’s Emerging View of Useful Life

The FASB is moving toward a view that it will no longer accept
a useful life of Goodwill over 20 years

FASB has made it clear that it prefers 10 years or less

Entities will have to carefully evaluate the expected useful life
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Accounting
Considerations for
Insurance Acquisitions
Potential Disclosures
The FASB has proposed that Goodwill be shown separately on
the financial statements, as exemplified below:
Income before Goodwill charges and taxes
Income tax expense
Income before Goodwill charges
Goodwill charges (net of $__tax benefit)
Net income
EPS before Goodwill charges
Goodwill charges per share
EPS (basic)
$xxxx
xxxx
xxxx
xxxx
xxxx
xx
xx
xx
Issues and Implications
 The impact on M&A activity, shareholder value, and deal pricing is uncertain.
Preliminary reaction ranges from “little impact” to “severe adverse impact.”
Impact may be lessened due to the separate disclosure of goodwill amortization
on the face of the financial statements. However, amortization of other
intangibles will not be segregated.
 Additional disclosures bring FASB closer to cash flow EPS as a performance
measure. However, it only partially addresses on difference between net
income and cash flow.
 This proposal would not change the existing life of goodwill.
 New reporting style favors consolidated investment over minority interests since
the embedded Goodwill associated with minority investments will not be
included in the Goodwill line item.
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Accounting
Considerations for
Insurance Acquisitions
Reserve Adjustments

Insurance Industry has similar rules to Banking

Reserves should not be adjusted in Purchase Accounting

Large adjustments should be reflected as an error in prior
years financial statements, not as adjustments to Goodwill
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Accounting
Considerations for
Insurance Acquisitions
Reserve Covers

Insurance Companies are allowed to guarantee the loss
reserves of an acquired entity

Applying normal insurance rules would yield a result that
would not benefit acquiror -- retroactive accounting

GAAP provides for a solution
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Accounting
Considerations for
Insurance Acquisitions
Reserve Covers, cont. -- GAAP Solution

Provided the seller guarantees the reserves, the Buyer can
off-set adverse development with recoveries from guarantee

Recovery must be shown gross in the balance sheet along
with increase in losses
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Accounting
Considerations for
Insurance Acquisitions
Taxes in a Business Combination -- Purchase

Stock deals -- Goodwill is not tax deductible

Asset deals -- Goodwill generally is deductible

There are provisions in the tax code that allow stock deals to
have deductible Goodwill (e.g., 338 (h)10 )
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Accounting
Considerations for
Insurance Acquisitions
Pooling Accounting

Accounts for a business combination as the uniting of ownership
interests
 Reported as if the merger occurred in the beginning of the year
 Restate historical financial statements

Pooling is typically the preferable acquisition strategy from an earnings
perspective
 No step-up in target’s assets and liabilities
 No Goodwill
 Restate historical financial statements

The SEC staff for years has been increasingly scrutinizing pooling of
interests accounting
 SEC staff views are provided on a “piece-meal” basis
 FASB business combinations project
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Accounting
Considerations for
Insurance Acquisitions
Why So Few Poolings in the Insurance Industry?

Greater Flexibility

Purchase accounting allows the seller to guarantee the loss
reserves

No benefit of pooling under SAP
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Accounting
Considerations for
Insurance Acquisitions
FASB Legislative Action

FASB is contemplating a new standard that would eliminate
pooling of interest accounting as early as 2001

Why?
 Many pooling deals are economically not mergers
 Pooling creates an uneven playing field
 Eliminate comparative advantage
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Accounting
Considerations for
Insurance Acquisitions
Potential Impact of Eliminating Pooling

EPS will be substantially diluted

Deals may be rejected because of EPS decreases driven by
Goodwill

Valuation: No difference from a cash flow or EBITDA multiple
perspective
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Accounting
Considerations for
Insurance Acquisitions
Restructuring Charges

Accounting regulators do not want to allow one time charges
that relate to expense for future periods

Expenses must be recognized in the period accrued

Entities should not expense items that have future benefits
to the enterprise
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Accounting
Considerations for
Insurance Acquisitions
Restructuring Charges

Restructuring charges are expenses commonly reported in
connection with business combinations and existing activity

Some examples include:
 Termination and severance benefits
 Loss recognition for leases and other commitments
 Write-off of related intangibles
• Capitalized software costs
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