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The liability to pay future contract claims and expenses on the unexpired portion of the acquired contracts and the liability to pay incurred contract claims and claims expenses are acquired liabilities that should be measured in accordance with the acquirer’s accounting policies. Such accounting policies for recognized liabilities for non-life short-duration contracts typically include both an unearned premium liability relating to the unexpired portion of an insurance contract and a claim liability (for reported claims as well as for incurred but not reported claims).
There is no reassessment of the classification of contracts as insurance, reinsurance, or deposit contracts on the business combination acquisition date, unless the contracts were modified substantively in the business combination. Therefore, all insurance contracts in the seller’s past financial statements are not required to be evaluated by the acquirer to determine if they are deposits even if a substantial amount of the period of risk transfer or potential variability in cash flows has passed. However, insurance contracts acquired in a business combination are considered by the acquirer as new contracts for measurement and accounting purposes in accordance with ASC 944-805-25-1.
Question IG 12-1 discusses acquired retroactive reinsurance contracts (i.e., contracts that reinsure events under expired coverage of the underlying reinsured contracts).
Question IG 12-1
If an acquired insurer has a reinsurance contract previously accounted for as retroactive reinsurance (e.g., maintained a deferred gain and retrospectively unlocked the amortization of the gain based on subsequent recoveries of the underlying related claim liabilities), does the acquirer maintain the retroactive accounting for the reinsurance contract subsequent to the business combination?
PwC response
No. The acquirer is required to consider all acquired insurance contracts (including reinsurance contracts) as if they were new contracts for measurement and accounting purposes. Because they are considered to be newly acquired, they are considered prospective, even though the coverage relates to past events. The seller’s retroactive accounting treatment is irrelevant. Deferred gains, similar to deferred acquisition costs (DAC), are not recognized in acquisition accounting as they do not represent future cash flows. This is similar to the accounting required for a retrocession reinsurance contract entered into concurrently with the acquisition; the retrocession is accounted for as an indemnification agreement under ASC 805-20-25-27 through ASC 805-20-25-28 and ASC 805-20-30-18 through ASC 805-20-30-19, which is equivalent to prospective ceded reinsurance.

12.2.1 Acquired incurred claim liabilities

The acquired claims liability is measured at its fair value at the acquisition date. As discussed in IG 12.1.4, the fair value is presented initially in two components: the claim reserves measured consistent with the acquiring entity’s accounting policies for claim liabilities and an intangible asset (or liability) for the difference. Many claim liabilities are measured at undiscounted best estimate cash flows, resulting in the intangible asset representing the discount effects used in fair value offset by the risk premium or margin a market participant would require above best estimate cash flows.

12.2.2 Acquired liability for unexpired coverage (unearned premium)

ASC 944-805-30-1 requires the acquirer to measure the fair value of the insurance assets and liabilities in a business combination in two components. The first component is recognized in accordance with the acquirer’s accounting for policies that it issues or holds, and the second component is measured as the difference between the first component and the fair value. The first component can be determined by carrying forward the unearned premium liability from the acquiree. Another method for initially measuring the first component is to use the price the acquirer is currently charging for similar unexpired coverage. This approach results in subsequent premium revenue comparable to that of policies that were originated on the same day as the acquisition. In either approach, the amount will be amortized as premium revenue in subsequent periods in accordance with the premium recognition policy of the acquirer. While there is no prescribed method for amortizing the second component, it is required to be amortized on a basis consistent with the related insurance or reinsurance liability, and for long duration contracts, the amortization assumptions must be consistent with those used in the measurement of the liability for future policy benefits.

12.2.3 Insurance contract intangible assets—subsequent measurement

Under ASC 944-805-35-1, after a business combination, the insurance contract intangible asset (or liability) is required to be measured and thus amortized on a basis consistent with the related insurance or reinsurance liability.
For many property/casualty short-duration contracts, insurance contract intangible asset relating to the unearned premium component are typically amortized consistent with the amortization of the related unearned premium liability. The presentation of the amortization in the income statement is typically consistent with DAC amortization.
The insurance contract intangible asset associated with the claim liability is amortized over the claim settlement period, typically based on an actuarial projection of the claim settlement pattern. ASC 944-805-35-2 suggests that amortization of the insurance contract intangible asset associated with undiscounted claim liabilities using the interest method may be an appropriate method because a large component of the intangible asset includes the time value of money. In practice, amortization methods vary. Some entities use the effective yield method for amortizing the pure discount/time value of money element and a separate amortization schedule for the risk margin component, if separately determinable, under the premise that expiration of risk is not consistent with an effective yield approach.
Additionally, practice varies in subsequent periods when actual settlement patterns differ from expectations. Some entities unlock the pattern and/or term of amortization. Others establish an amortization pattern and term, and do not unlock unless there is a significant change in the expected life. When an unlocking method is used, some entities recognize the change using a retrospective method, while others use a prospective method.
Intangible assets recognized in acquisition accounting associated with long duration contracts are subject to impairment testing. Intangible assets related to unearned premium for short duration contracts are subject to premium deficiency testing. Intangible assets related to short duration claims liabilities are treated like a discount or premium on debt instruments and not subject to impairment or premium deficiency testing.
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