Closed Block Acquisition Bid and Embedded Value Adjustments
A life insurer is bidding for a closed block of traditional whole life policies from another company. The block has $6.0 billion of face amount, $2.4 billion of statutory reserves, and $210 million of DAC. The seller's embedded value model projects $85 million of annual pre-tax distributable earnings for 10 years and a terminal value of $160 million, discounted at 11%, producing an EV of $560 million. The asking price is $480 million. Due diligence shows mortality has been 7% favorable to pricing for three years, but the pricing assumed 4% annual mortality improvement; lapse experience is 5.0% versus 4.0% assumed, and maintenance expenses are 6% above the model. The buyer's hurdle rate is 13% and it needs $300 million of capital, which will be strained for two years. The CFO wants to know whether to bid and at what price.
1. Adjust the embedded value for the due diligence findings and assess whether the $480 million price meets the 13% hurdle.
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At 11%, the stated cash flows are worth about $557m, so the $560m EV is internally consistent. At the buyer's 13% hurdle, the same cash flows are worth only about $508m. The due diligence adjustments matter: 6% higher maintenance expenses reduce annual distributable earnings by roughly $5m; a 5.0% lapse rate versus 4.0% changes persistency and reserve release, and for a profitable whole life block the net effect is likely negative; the 7% favorable mortality may be partly non-recurring, while the 4% improvement assumption may be too optimistic. A reasonable adjusted EV is $470m-$500m, and at 13% the value is about $430m-$455m. The $480m asking price is therefore at or above fair value and does not clear the hurdle with a margin. Bid no more than about $450m, subject to protections.
2. Recommend deal protections and pricing structure.
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Structure the price as $435m-$450m with a $40m escrow for 24 months tied to mortality and expense experience, and an earn-out if mortality stays below 95% of pricing. Require the seller to reinsure tail mortality or provide an experience refund. Negotiate a transition services agreement for administration so the 6% expense overrun is addressed, and hold back capital until the block's RBC impact is known. If the seller insists on $480m, walk away or bid only with a capital-light structure, such as a coinsurance arrangement that reduces the buyer's capital requirement. The key is not to pay for the seller's optimistic mortality-improvement assumption when the buyer bears the downside.