It says if an appraisal value is being prepared as a sale value then it is likely to be based on realistic assumptions without margins. A purchase value maybe based on cautious assumptions that include margins. As a result the purchase value will be lower than the sale value. I was thinking the purchase value will be higher than the sale value since it has cautious assumptions for a buyout as it will also include a margin for profit for the buyer and margins for adverse experience from the acquired liabilities. Since the basis is cautious was thinking it will tend to increase the value of the liabilities. That is want I was thinking. Can someone please explain to me were am it getting wrong.
Realistic assumptions give reserves lower than when using cautious assumptions. So shareholder profits will be greater where reserves are lower. That is why appraisal value (remember it depends on the EV and EV depends largely on future shareholder profits) will be higher for realistic assumptions, and the buyer will benefit. Similarly cautious assumptions give higher reserves and reduces profit hence lower value. Someone buying would want to use this as a sale value. So it remains with the bargaining power of the either party.
The purchaser will want to pay as low a price as possible to get the business. Using cautious assumptions overvalues the liabilities, which makes the net assets lower, and so the business should be cheaper to buy. The seller will want as high a price as possible for the business they've sold. Using realistic assumptions will make the business look more profitable than the calculation I described above, so will suggest a higher price. Best wishes Mark
Hi Mark, I'd just like to clarify this bit of core reading. It says that the reserves in the EV calculation are always calculated on a supervisory basis. So then with regards to your reply about the purchase and sale price, how is it that the reserves are being calculated on a prudent or best estimate basis? Specifically the core reading says it's the projection basis under consideration but I thought that basis would be for the projection of the other cashflows in the PVFP calculation. Thanks!
An EV calculation requires two sets of assumptions: one for projecting the cashflows and one for calculating the reserves. The present value of the future profits for a without-profits contract is the discounted profit from each future year. This profit is the premium less claims less expenses plus interest on reserves less increase in reserves. The reserves in the profit calculation will always be on the supervisory basis. The insurer is generally free to use any basis it wishes to project the cashflows, ie the mortality, withdrawals, expenses which will determine the premiums paid, claims paid etc. The posts above refer to an appraisal value calculated by an investor purchasing an insurer. The reserves are calculated on the supervisory basis. The projection of the cashflows would be calculated with some prudence to place which would reduce the value of the insurer and hence its purchase price. Best wishes Mark
Hi Mark, Thanks again but I guess where I'm getting confused is when you said that using cautious assumptions overvalues the liabilities. In my mind since the reserves are already on a supervisory basis, how can they be overvalued? Thanks again for the assistance.
For an EV with have two different bases. I'm not referring to the supervisory basis for the reserves. I'm referring to using cautious assumptions when projecting the profits. For example, I'm projecting the claims using a high prudent mortality assumption, so the profit is smaller in the equation in my previous post. Best wishes Mark
