Question
From:
(redacted)
Sent:
Wednesday, April 29, 2009 8:58 AM
To:
Johnson, Janice C.
Subject: Confirming Size of Transaction Discussion
Janice,
Thank you again for speaking with me yesterdayregarding my size-of-transaction question. I would like to confirm myunderstanding of our conversation.
The facts of the situation are as follows. Sellerowns a health plan and proposes to sell certain assets of the plan to Buyer,specifically all of the contract rights to the membership of the health plan.Buyer would pay cash for the acquired assets. Seller would retain the otherassets of the plan (e.g., cash, property and equipment) along with theliabilities. Following the sale, Seller would exit the health plan business,and in fact Seller's desire to exit the business expeditiously is themotivation for the sale.
The specific basis for my question concerns thehealth plan's liability for "incurred but not reported" claims("IBNR"). IBNR is a balance sheet liability representing healthinsurance claims by covered individuals who have already received health careservices that are covered by the plan, but who have not yet filed claims forcoverage (payment) of those services. The run-out of these claims can takeseveral months; however, the amount of the liability can be actuariallyestimated at any point in time with a reasonable degree of accuracy.
In connection with this transaction, it has beenproposed that Seller would transfer the IBNR to Buyer, along with cash equal tothe actuarial value of the IBNR. In other words, Seller would pay the Buyer to takethe liability. Sellers objective is to be able to wind up its claimsprocessing activities expeditiously, which it can do if Buyer undertakes theresponsibility to adjudicate and pay the IBNR claims. As a practical matter,Seller's "payment" to Buyer would likely be effected as an offset tothe purchase price of the acquired assets.
Thus, the question is whether the liabilitytransferred to Buyer also must be considered in establishing thesize-of-transaction, given that, although Buyer technically would be assumingthe liability, Buyer would also receive the funds from Seller to pay theliability? In other words, if the value of the acquired assets is $100, and theIBNR has an actuarial value of $25, is the transaction size $100 or $125?
Based on our conversation yesterday, myunderstanding is that, under the circumstances described, the liability wouldnot be included in valuing the transaction (in other words, the size oftransaction is $100 in my example).
If you could kindly confirm that my understandingis correct, I would be most appreciative.