C1. Odomirok 22&23

Question 1

Compare the GAAP and SAP treatment of DAC

Answer 1

GAAP creates a DAC asset to defer the recognition of acquisition expenses, to match the recognition of earned premium.

SAP does not allow deferring the expenses. Instead, all costs are expensed as incurred.

Question 2

Describe the different intended users of SAP and GAAP

Answer 2

SAP: used primarily by regulators, and therefore focuses on the insurers ability to pay claims (surplus adequacy).

GAAP: used mainly by investors and creditors, and is therefore focuses on the measurement of earnings emergence.

Question 3

Compare the GAAP and SAP treatment of DTA

Answer 3

GAAP: fully recognizes the DTA, but creates a valuation allowance if it is more likely than not that the DTAs will not be recognized.

SAP: there is a strict admissibility test to recognize DTA, in addition to the valuation allowance.

Question 4

Compare the GAAP and SAP treatment of nonadmitted assets:

Answer 4

SAP does not consider these assets for the purpose of calculating statutory surplus.

GAAP does not have a “nonadmitted assets” category. All assets are included in the surplus calculation

Question 5

GAAP valuation rules various types of investment assets

Answer 5

Available for Sale (AFS): purchased with the intention to sell before maturity, but after a year: fair value

Held to Maturity (HTM): intent and ability to hold till maturity: amortized cost

Held for Trading (HFT): purchased with the intention of selling within hours or days: fair value

Question 6

SAP valuation rules of various types of investment assets

Answer 6

Investment grade bonds and higher rated redeemable preferred stocks are valued at amortized cost

Lower rated bonds and preferred stocks are valued at min (amortized cost, fair value)

Common stocks and higher rated non redeemable preferred stock are valued at fair value

Question 7

SAP treatment of retroactive reinsurance

Answer 7

• undiscounted ceded reserves are recorded as negative write in liabilities
• Schedule P is therefore not impacted
• a gain may be generated if the consideration paid is less than the negative write in liability. This is treated as a write-in gain as part of “other income”; and the surplus benefit is treated as “special surplus” until the paid reinsurance recovery exceeds the consideration paid

Question 8

Compare the GAAP and SAP treatment of anticipated prospective reinsurance recoveries

Answer 8

SAP records the reserves net of anticipated reinsurance recoveries

GAAP establishes an asset to recognize the ceded reinsurance recoverables

Question 9

Compare the GAAP and SAP treatment of structured settlements if the claimant signs a release:

Answer 9

• The purchase price of the annuity is recorded as a paid loss
• The claim is closed

Question 10

GAAP treatment of retroactive reinsurance

Answer 10

• the ceded reserves are treated as a reinsurance recoverable asset
• any gain is deferred, so there is no immediate income or surplus benefit.
• this gain is amortized over time

Question 11

Compare the GAAP and SAP treatment of anticipated salvage and subrogation

Answer 11

Under SAP accounting, the insurer has the option about whether to record the reserves in Schedule P gross or net of anticipated salvage and subrogation.

Under GAAP accounting, the insurer must subtract the anticipated balances.

Question 12

Compare the GAAP and SAP treatment of structured settlements if a release is not signed

Answer 12

SAP: treatment is the same as the case where there is a release. However, the insurer must also disclose the contingent liability in the Notes to the Financial Statements

GAAP: the settlement is treated like a reinsurance contract, which involves creating a reinsurance recoverable asset

Question 13

Describe GAAP treatment of goodwill

Answer 13

Assets and liabilities are recorded at fair value. Goodwill is the difference between the purchase price and the fair value of net assets. It is regularly evaluated for impairment (as opposed to being amortized)

Question 14

Describe SAP treatment of goodwill

Answer 14

Goodwill equals the difference between the purchase price and the statutory surplus. It is capped at 10% of the acquiring firms capital and surplus. It is amortized to unrealized capital gains over the period in which the acquiring rm benefits economically (up to 10 years)

Question 15

Describe the 8-K form

Answer 15

Filed to disclose certain material events, including:

• Change in principal officers or directors
• Change in the companys certified accountant
• Entering/ terminating a material denitive agreement

Question 16

Describe the 10-Q form

Answer 16

Essentially an abbreviated version of the 10-K.

Question 17

3 components of the fair value of reserves, according to the mark-to-model approach

Answer 17

1. Expected value of nominal future cash flows
2. A reduction to reflect the time value of money at the risk free rate, plus a load to reflect the illiquid nature
3. A risk adjustment to compensate for the risk associated with the liabilities

Question 18

List 2 regulations that outline the SEC reporting requirements

Answer 18

• Regulation S-X: Form and Content of financial statements

- Regulation S-K: Integrated Disclosure rules

Question 19

2 methods to estimate the cash flows from the nominal reserves:

Answer 19

1. Use a payout pattern based on the loss reserve development
2. Use the implied pattern based on the ratio of paid losses to ultimate losses by accident year

Question 20

P-GAAP

Answer 20

GAAP accounting system for business combinations

Question 21

Value of In-Force

Answer 21

In P-GAAP accounting, there are no deferred acquisition costs. Instead, an asset based on the value of business in force is established. This is based on the UEPR less the fair value of future reserves

Question 22

10 K form

Answer 22

Part 1: business description, risk factors, unresolved issues with SEC staff, properties, legal proceedings and matters subject to vote by shareholders

Part 2: financial statements, supplementary data, managers discussion and analysis of results, and controls and procedures

Part 3: directors and officer of the company, executive compensation, securities ownership by certain beneficial owners and management, and fees of principal account

Part 4: reports, exhibits and schedules from 8-K’s filed during the reporting period

Question 23

Discounting rules

Answer 23

SAP does not allow discounting apart from tabular, or if the regulator permits a non-tabular discount

GAAP allows the SAP discount to be used, but the rate can differ from the risk free rate used in SAP

Question 24

Why rent instead of buy?

Answer 24

Rental fees can be expenses, so it could reduce income tax. Furniture is a non admitted asset so it reduces surplus.

Question 25

Reserve adjustment from stat loss reserves to a fair value basis

Answer 25

• Incorporate cash flows for cost of capital
• Use payout pattern and risk free rate to discount cash flows
• Incorporate illiquidity adjustment into discounting
• Calculate unbiased estimate of expected payments
• Calculate adjustment for time value of money