Acquisition & Demutualisation

Hi guys !
I have a few clarifications to make, pertaining M&A and Demutualization:

1. When determining the M&A price, there is usually 2 approach either via the EV approach or the Solvency ll technical provision approach.
However, the EV method will be the purchasing company paying the selling company while the Sol ll method is the selling company need to transfer the asset to the purchasing company? If i assume that under Solvency ll regime, MCEV is used, both should be equivalent, eg:
Asset 100
SCR = 20
RM= 10
BEL=50
*ignoring any adjustment to be made to assumptions, synergies and any profit arising beyond contract boundaries

if using EV approach : EV = Solvency ll Onw Funds = Free Surplus + Capital requirement= 40 (Purchasing Com paid 40 to Selling Com)
if using the Solvency ll technical provision = 60 (Selling Comm transfer 60 to purchasing com)

however, this is on existing business, the total purchase price should also be take into account future new business which could be valued on New Business Embedded Value or PV(Income) - PV (outgo) for NB? together they will form the appraisal value.
is my understanding correct?

2. Additionally notice there is not any material or past questions covering process of demutualisation and the price determination if any. Kindly let me know if this is out of scope. Thanks !

 

Hi

A few things I think I should clarify from my understanding first:
- The M&A price could be based on a different approach. EV and Solvency II are two possible approaches.
- The target company itself may have a published EV besides its published Solvency II TPs. So, the EV and SII values could be calculated by the target company. The buying company will also make its own calculations, including possibly using EV and SII approaches but with its own adjustments. Each of the companies will make its own calculations and use these in the negotiation.
- MCEV is market consistent EV. MCEV and Solvency II are both based on market consistent approaches eg use of risk free rates. Solvency II does not use MCEV. Since both use market consistent approaches, there is less 'embedded value' that a company may find in its MCEV calculation beyond what could already be identified in the Solvency II results, if someone knew where to look in the Solvency II disclosures.

Having said that, what you have set out under 1 makes sense to me. The future new business can be thought of as part of 'goodwill' of the company being bought.

2. I think demutualisation could still come up in an exam. If you search 'demutualisation' in the study text, it comes up in a couple of chapters.

Tutors please clarify or correct any of the above as needed.

 

Hi Retrieva,

thanks for your reply.
So i can assume that if we are using the Solvency ll TP method, the buying company would wish for the TP to be transfer by selling company to be larger so they can also profit as well? Let me know if you disagree.

Any tutor that could assist on this?
Thanks !

 

Yes. That is my understanding. The buyer would want TPs to be valued as high as possible as this would mean the buyer is taking on larger liabilities and should have a larger compensation for this baked into the deal. The seller would want the TPs to be valued as low as possible for the opposite reason.

 

wow Retrieva, thanks for the quick responses. Good discussion

Additionally, one more thing to clarify, if say the selling company is seeking to sell one of its already closed block of business. The there will not be any "good will" to be be paid to the selling company right. Since the selling company is not writing any more new business.

But if the company does have new business to be sold, im assuming the "additional amount" could be determine either based on the expected new business embedded values or simply the PV(Income-Outgo) from the new business ?

let me know if you disagree

 

Happy you've found this helpful.

Goodwill in closed book: I agree that the new business item would not be part of the consideration. There may be other items though.
- Eg for a with-profits fund, I expect that the size of the estate would be considered.
- Eg for any business, if the seller thinks persistency on the book is higher than industry normal, this could be a selling point if high persistency increases profits.

Additional amount for new business: Either of EV of future new business or PV(income less outgo) look fine as starting points to me. That said, I expect the value actually determined for these in the transaction will be materially lower than a pure calculation of EV of future new business or PV(income less outgo) to allow for the real risk that this business may not come in reality.

I should clarify that I am basing all this on what I have picked up on the course. I don't have practical work experience in M&A.

 

Hi both,
thanks for the great discussions, however, wanna crystalize something pertaining with profits since you guys mentioned pertaining the policy vs sh share.

When selling for a with profits business, if we consider the Sol ll-TP methods. Then the fair value to be pass on to the buying company will be the asset share + Cost of Guarantee (broadly speaking) , but this is only the policyholder liabilities, the estate in a way is also belonging to the policyholder (90/10). Hence we need to consider how the own funds should be separate out, within the own fund, there will be a PVTS portion reflected in the future bonuses expected to be declared. This amount will likely be recalculate by both parties (selling / buying) based on their own future bonus philosophy. Let deem this PVST = X, So next step we need to determine how much belongs to the policyholder. Which the first step i could think of is Own fund less PVST(X) times 90%.

So the asset amount to be transfer to the buying company would be (Own Fund - PVST)*90%+Technical Provision.

However, they can be some adjustment, eg : whether the selling company wanna have a estate reattribution exercise, the future bonus philosophy for the buying company might be different, the buying company might want to have a one off distribution of the Own Fund / Estate before they sell it to buying company which increases the TP amount, so not big of differences i guess. Those would be a sensible adjustment?

Additionally, was wondering if you guys happen to have an example on how demutualization works? Even high level is fine. Was going through to dig some question but seems like not too much of insights.

Thanks !

 

Goh Ze Liang, I will wait for a tutor or someone else to answer. In the meantime, can you clarify what PVTS OR PVST is? Is that present value of shareholder transfers? If it is, why is the policyholder share of own funds 'Own fund less PVST times 90%' and not 'Own funds - PVST'?

On a minor note, and to make sure am following, you say PVST = X, so am taking it that PVST(X) is the same as just saying PVST or just saying X. Let me know if I have I missed something.

 

Hi Retreva,

Yes PVST = Present Value of Shareholder Transfer and yes you may ignore the X as i tot i would be easier to explain (but turns out not so).

To answer your question on why we need to deduct PVST is because the TP only covers the future bonus payouts for policyholder. And while we declare a bonus to PH, we will also be declaring for SH as well. Say we declare $10 so, the SH say will be 10/9 =1.11. the $10 is included in the TP but not the 1.11, so the 1.11 must be included as part of own funds and are 100% entitled to the SH. The remaining amount of the own fund will consists of estate that has yet to distribute the the shareholder & Ph hence if i assume wihtout any shareholder reattribution exercise. this will simply be 90% of the policyholder shares.

And given that the M&A is to transfer the PH's share to another commpany i will assume thar the asset to be transfer will be (Own Fund less PVST) *90% + Sol ll TP.

 

I don't think am following but you've given me some food for thought.

In the context of Solvency II, surplus assets in the WP fund above TPs are own funds for the WP fund. Some of these belong to the shareholders as they will be part of the estate and may also be PVST.

I think you're right to consider PVST but I think that needs to be treated carefully. I think it is probably best to consider it separately from surplus assets. If I remember correctly, I think the course notes say, in solvency assessment, these future shareholder transfers are already excluded from the TP calculation and are shown elsewhere in Solvency II balance sheet as own funds. So, PVST is already outside the TPs as you say.

So, I think we have two figures we should consider when thinking about the shareholder's stake of the WP fund. One is the PVST under Solvency II, which is 100% for the shareholders. The second is 10% of the estate. There may be an overlap between the two as we are valuing one under a Solvency II balance sheet and the other on an internal with-profits fund valuation - probably more statutory basis than Solvency II.

We probably need a tutor to iron this out.

 

As discussed, I see your point now, and I agree. If we are taking PVST as calculated under Solvency II, then policyholder transfer value is [Own Funds - PVST] *0.9 + TPs. This assumes that there is no estate distribution plan in place, ie BEL and PVST do not include the estate.