Recording The TransactionUnder Financial Accounting Standards Board No. 141, pooling of interests is no longer an option for recording an acquisition, thus, creating a level playing field for the accounting of insurance agency acquisitions. This level field, however, has some complications.
First, the acquirer must allocate the price to intangible assets, with the balance of any unallocated purchase price being accounted for as goodwill. It is not as simple as labeling an arbitrary percentage as book of business, or expiration list.
FASB Nos. 141 and 142 state that the identifiable intangible assets, which in the case of an insurance agency consist primarily of the customer list and expirations of the agency, must be an allocated portion of the purchase price and amortized over the useful life of the book of business.
Goodwill, the unallocated portion of the purchase price, will remain at cost until it is determined that its value is impaired. If the value is impaired, it must be written down by the impairment.
It is important to note that this discussion is related to the financial statement reporting of transactions and does not impact the tax accounting methodologies, past, present, or future. For tax purposes, except in the case of tax-free mergers or the purchase of stock of another entity, all intangible assets continue to be amortized on a straight-line basis over 15 years. As such, do not be concerned that you will need to adjust tax returns–past, present, or future–as a result of the new rule.
The intangible value of an insurance agency includes any covenants not to compete and the value of book of business. The value of any covenant and its useful life is often specified in the definitive agreements.
The value of the acquired book of business is more difficult to value and is determined by the following factors:
Earnings of the book of business. The book of business value is driven by the cost structure of the agency necessary to retain the business.
Retention rate of the book of business.
The rate of attrition directly impacts the revenue of the book of business. The revenue impacts the cash flow of the book. Both commission and contingent income, discounted over the useful life of the book, creates the value.
Inflation of the premium or the expo-sure base.
The inflation within the economy and the changes in premium rates inflate or deflate the commission associated with the book of business.
Discount Rate.
The risk associated with the book of business and the cost of capital impact the valuation of the business.
After analyzing these factors, forecasting the cash flow and the related valuation are merely a financial exercise. Once the value of identifiable assets has been determined, the value of the remaining in-tangibles is allocated to goodwill.
Recalling that the book of business and other identifiable intangible assets must be amortized over the useful life of the book, it should be noted that the useful life is dependent upon the rate of attrition. There are many factors that influence attrition and the rate can vary by line of business.
Furthermore, if there is an impairment in excess of the rate of attrition being used for amortization of the book of business, the value of the identified intangibles must be adjusted for the impairment.
The values of the intangible assets are amortized over their useful lives. If circumstances change, i.e., the loss of producers, insurance companies, or major customers, the carrying value of the identifiable intangible asset may exceed market value. In that case, an impairment loss must be recognized. Such changes may also require an impairment loss on the goodwill.
Reproduced from National Underwriter Edition, July 7, 2003. Copyright 2003 by The National Underwriter Company in the serial publication. All rights reserved. Copyright in this article as an independent work may be held by the author.
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