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This section highlights the key accounting issues that entities in the insurance industry may encounter when entering into a business combination.

12.1.1 Accounting for business combinations (insurance industry)

ASC 805 and ASC 944 provide some insurance-specific guidance for business combinations. Figure IG 12-1 has an index of the industry specific guidance.
Figure IG 12-1
Index of industry specific guidance for insurance entity business combinations
Guidance
Subject
Requiring acquisition accounting for combinations of mutual entities
Considering insurance contracts acquired in a business combination as new contracts for measurement and accounting purposes
Carrying forward the acquiree’s classification of an acquired contract as an insurance or reinsurance contract or a deposit contract (and thus not evaluating whether the contracts transfer significant insurance risk)
Recognizing the fair value of the assets and liabilities arising from the rights and obligations of the insurance contract in two components
Requiring contingent commissions and claim liability guarantees to be accounted for in the same manner as other non-insurance contract contingencies
Requiring subsequent measurement of acquired insurance contract intangible assets (or other liability) on a basis consistent with the related insurance or reinsurance liability
The application of acquisition accounting to insurance transactions presents unique issues. These include:
  • distinguishing between a business combination, a reinsurance transaction (including a portfolio transfer), or an asset acquisition,
  • recognizing insurance contracts at fair value and determining the attribution between the insurance contract liabilities and related insurance contract intangible asset (or liability),
  • identifying and recognizing any other separately identifiable intangible assets at fair value, including renewal rights on short-duration contracts, customer relationships, and distribution relationships,
  • determining the post acquisition amortization approaches for the insurance contract intangible asset (or the liability) and for any other separately identified intangible assets, and
  • accounting for claims indemnification agreements entered into contemporaneously with a business combination.

12.1.2 Determining if a business combination exists

Transactions in the insurance industry may take various legal forms. In addition to the purchase of the equity shares of an insurance entity, it is not uncommon for a transaction to include one or more indemnification or novation reinsurance transactions along with the acquisition of renewal rights, the purchase of certain legal entities, the purchase of assets, or various combinations thereof. In many cases, the acquired items taken as a whole, including the reinsurance components, may meet the definition of a business (as discussed in BCG 1) and, therefore, will be accounted for as a business combination under ASC 805. Factors to consider in making that determination include whether the rights and obligations of the in-force block of insurance and investment contracts have been transferred, and whether various other components of the business have been transferred, such as the employees and staff, the policy administration function, or distribution systems.
If the transaction does not qualify as a business combination, the accounting for assuming reinsurance and asset acquisitions is applied based on the fair value determined at the acquisition date. No goodwill is recognized, and assumed reinsurance of in-force blocks of insurance/investment contracts is assessed for contract classification in accordance with reinsurance risk transfer guidance. See IG 8.10 for short duration assumed reinsurance accounting and IG 9.7 for long duration assumed reinsurance accounting. The difference between the consideration received and the assumed reinsurance liabilities recognized is often presented as an intangible asset, similar to the accounting for business combinations. Asset acquisitions include the purchase of identifiable intangible assets and other assets, which are subject to the guidance in ASC 350 and ASC 360, respectively.

12.1.3 Initial measurement of insurance/reinsurance contracts in a business combination

Consistent with business combination accounting for non-insurance assets and liabilities acquired, insurance and reinsurance contracts are recognized at fair value as defined in ASC 820 and considered to be new contracts for measurement and accounting purposes (i.e., a fresh start basis applies). However, as discussed in ASC 805-20-25-8 and ASC 944-805-25-2, there is no reassessment of the classification of contracts as insurance, reinsurance, or deposit contracts on the acquisition date (i.e., no reassessment of whether the contracts transfer significant insurance risk), unless the contracts were modified substantively in the business combination. Identification of embedded derivatives and market risk benefit (MRB) features are required to be reassessed at the acquisition date. Consistent with the general notion of acquisition accounting and fair value, deferred acquisition costs, deferred retroactive reinsurance gains, and unearned premiums that do not represent future cash flows are not considered acquired assets and liabilities as discussed in ASC 944-805-30-1.
See FV 4 for a discussion of valuation techniques and approaches. Typically, insurance and reinsurance entities are considered the market participants for purposes of determining the fair value of insurance and investment contracts and broader financial institutions are considered the market participants for MRB and embedded derivative features.

12.1.4 Initial measurement of insurance contract intangibles and related liabilities

The fair value of acquired insurance contracts is attributed between two financial statement lines items representing: (1) assets and liabilities measured in accordance with the acquirer’s accounting policies for insurance and reinsurance contracts that it issues or holds and (2) the insurance contract intangible asset (or liability) recognized for the difference between the fair value of the insurance and reinsurance contracts and the amount recognized in accordance with the acquirer’s existing accounting policies (hereafter referred to as the “insurance contract intangible asset”). Under ASC 944-805-30-1, the recognition of the insurance contract intangible asset may be an additional liability (rather than an asset) on those occasions when the fair value of the insurance contract exceeds the value of the insurance contract liability measured in accordance with the acquirer’s accounting policies. The intangible asset or liability is typically called “value of business acquired” (VOBA) or “present value of future profits” (PVFP).
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