PROCEEDINGS May 15, 16, 17, 18, 2005 - Casualty Actuarial Society

THE APPLICATION OF FUNDAMENTAL VALUATION PRINCIPLES 293limited in the aggregate to 10% of the parent’s capital and surplus(adjusted to exclude any net positive goodwill, EDP equipment,and software).Assets for goodwill are generally assumed to have zero valueuntil such value emerges through future earnings.5. Provision for reinsuranceSAP produces a “provision for reinsurance” that is calculatedin Schedule F of the NAIC Annual Statement and is carried forwardto the statutory balance sheet as a liability. This provisionis intended to be a measure of conservatism to reflect unsecuredreinsurance placed with unauthorized companies and collectibilityissues with all reinsurers.In a valuation, a more detailed review of collectibility issues isworthwhile in order to estimate any additions (or further reductions)to equity to reflect a more rigorous estimate of reinsurancerecoverables.6. Tax issues regarding all of the aboveAny adjustments to the statutory balance sheet may also havea corresponding impact on the company’s federal income tax liability.The federal tax liability, or deferrable tax asset, is basedon statutory net income and a series of adjustments. Any adjustmentsmade to statutory equity for valuation should be taxaffected.In mergers or acquisitions, taxes are particularly difficult toaddress because one must consider the tax position of both parties.4.7. Hurdle RateThe hurdle rate used in a valuation should reflect the cost tothe firm of acquiring the capital necessary to make the acquisitionor perform the transaction in question. Typically, this value