Assumption reinsurance: getting the bad along with the good

March 1, 2006

When health insurers buy an existing book of business, they often effect the acquisition through an asset purchase transaction known as assumption reinsurance. There are many accounting and financial issues to consider in pursuing such a transaction.

When health insurers buy an existing book of business, they often effect the acquisition through an asset purchase transaction known as assumption reinsurance. There are many accounting and financial issues to consider in pursuing such a transaction.

Because the transaction involves a transfer by the seller of significant assets as well as liabilities, it is usually appropriate for the buyer to view the transaction as an acquisition of the seller's balance sheet, either in whole or in part.

One of the first considerations deals with whether the buyer will assume the liability for existing incurred losses, or have the seller retain them. Usually, the buyer will want the seller to retain such existing losses so as to minimize its due diligence in analyzing the adequacy of reserves. If the buyer succeeds in having the seller retain the existing losses, the assumption reinsurance agreement will define "excluded" or "retained" liabilities to cover all contractual obligations arising prior to closing, including all known incurred claims, as well as claims incurred but not reported (IBNR). Typically, the seller also will retain responsibility for all extra-contractual obligations related to the issuance of the policies.

OTHER EXPENSES

With respect to other expenses associated with the book of business, the buyer will usually want to draw a bright line as of the closing date and have the seller retain responsibility for expenses related to the business prior to the closing. This division of responsibility should be addressed in the assumption reinsurance agreement and should cover expenses such as agent commissions, premium taxes, guaranty fund obligations and other expenses based on premium volume such as risk pool assessments.

In consideration for the assumption of these liabilities, the assumption reinsurance agreement will call for payment to be made at closing by the seller to the buyer equal to the amount of the reserves.

Typically, the purchase price being paid by the buyer will be netted against this amount. In small transactions, the buyer will insist on the closing payment being made in cash. In large transactions, the seller will have limitations on the ability to liquidate their invested portfolio, and consequently, the buyer will be receiving other invested assets, such as treasury bonds. Depending on the other assets transferred, the buyer may want a pre-closing evaluation of those assets.

Assumption reinsurance transactions are subject to regulatory approval by the domiciliary states of the buyer and the seller. As a result, there is often a gap between the execution of the agreement and the closing. In addition, some states have laws that give policyholders the right to object to the transfer of his or her policy. For those states, more complicated structures must be considered for effecting the transfer of the book of business.

Barry Senterfitt is a partner in the insurance industry practice of Akin Gump Strauss Hauer & Feld LLP, in the firm's Austin, Texas, office.