Chapter 15

Question 1

ASU 2010-26: Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts (a consensus of the EITF) – Financial Services – Insurance (Topic 944)

Answer 1

specify that the following costs incurred in the acquisition of new and renewal contracts should be capitalized:
1. Incremental direct costs of contract acquisition. Incremental direct costs are those costs that result directly from and are essential to the contract transaction(s) and would not have been incurred by the insurance entity had the contract transaction(s) not occurred.

2. Certain costs related directly to the following acquisition activities performed by the insurer for the contract:
   - Underwriting
   - Policy issuance and processing
   - Medical and inspection
   - Sales force contract selling

All other acquisition-related costs – including costs incurred by the insurer for soliciting potential customers, market research, training, administration, unsuccessful acquisition or renewal efforts, and product development – should be charged to expense as incurred. Administrative costs, rent, depreciation, occupancy, equipment, and all other general overhead costs are considered indirect costs and should also be charged to expenses as incurred.

Question 2

GAAP have two important functions

Answer 2

1. First, provide a set of standards that endeavor to measure with reasonable accuracy the assets held, liabilities owed, revenue earned, and expenses incurred by the company
   * 2. Second, to ensure the comparability of financial data from year to year within each company and with similar data prepared by other companies.

Question 3

Conceptual Elements of GAAP

Going Concern

Answer 3

For accounting rules to be applied consistently, it must be assumed that the company will continue to operate in accordance with its original and continuing plan (going concern).

So long as there is a presumption of a going concern, assets should be carried at their cost basis (see the cost basis section), reduced by an allowance to provide for items such as depreciation, uncollectible account receivables, and inventory cost in excess of net realizable values.

• If a going concern assumption cannot be made, assets may have to be restated to their net realizable value.

Question 4

Conceptual Elements of GAAP

Matching Principle

Answer 4

Another conceptual element of GAAP is that items of revenue and expenses should be matched on a current basis irrespective of the timing of their realization in cash or cash equivalent. This concept is sometimes described as the recording of revenues when earned and cost and expenses when incurred.

Question 5

Conceptual Elements of GAAP

Cost Basis

Answer 5

This concept requires that the value of all products and services incurred or paid for, whether representing assets of continuing value or cost of materials and services consumed in the current operating cycle, be identified and measured on the basis of actual cost.

Question 6

Conceptual Elements of GAAP

Objectivity

Answer 6

This concept is often described as an arm’s length measurement. In the absence of comparable transactions, objectivity requires the application of those accounting rules that produce values similar to those arising from independent third party transactions.

To achieve an acceptable arm’s length measurement it is often necessary to base the transaction results upon the opinions of independent appraisers or to rely upon other unbiased business judgments.

Question 7

Conceptual Elements of GAAP

Full Disclosure

Answer 7

There is an underlying assumption that financial statements should be complete and understandable by the potential users.

Includes an assumption that there will be adequate descriptions and explanations about accounting and non accounting issues that have a significant bearing on the organization and operations of the company.

Question 8

General Reporting Standards

Revenue Recognition

Answer 8

Revenues are recognized when they are earned. If they are due before they are collected, an asset is established to reflect the uncollected amounts. If revenues are collected in advance of the due date, an unearned amount is recorded as a liability.

Question 9

General Reporting Standards

Cost Basis

Answer 9

Cost is usually measured in terms of cash or its equivalent or on the basis of the fair value of resources received or given in exchange, whichever more fairly represents the exchange value.

Question 10

General Reporting Standards

Adjustments to Cost Basis

Answer 10

Examples are:

Depreciation, Bad Debt, and impairment.

Question 11

General Reporting Standards

Impaired Loans

Answer 11

A loan is considered impaired when it is probable that the creditor will be unable to collect all amounts due, both interest and principal, according to the contractual terms of the loan agreement.

*The amount of the impairment is called a valuation allowance. A change in the amount of the impairment may be treated (but is not required to be treated) as a change in bad debt expense or, alternately, may be split between interest income and a change to bad debt expense.

Question 12

Debt and Equity Securities

Bond and Stock GAAP Accounting and Disclosures

Answer 12

• These investments will be classified into three categories as follows:
  1. Held-to-maturity Securities - Debt securities that the enterprise has the positive intent and ability to hold to maturity; reported at amortized cost.

2. Trading Securities - Debt and equity securities bought and held principally for the purpose of selling them in the near term; reported at fair value, with unrealized gains and losses included in earnings.
3. Available-for-sale Securities - All other covered debt and equity securities; reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of shareholders’ equity (net of tax effects).

GAAP requires other-than-temporary declines to be recognized as realized losses. If a determination is made that a decline is other than temporary, the entity is required to calculate a new basis (fair value) for the security and recognize the difference between the carrying value and new basis as a loss.

Question 13

FASB Statement No. 133, Accounting for Derivative

Instruments and Hedging Activities

Answer 13

All derivatives must be recorded at fair value and be recognized in the statement of financial position as either assets or liabilities depending on the rights or obligations under the contracts.

Question 14

Statutory Life Insurance Accounting Practices–Significant Departures From GAAP

Some practices that depart from GAAP, the more significant departures are:

Answer 14

• • Premium Recognition: Statutory life insurance premiums include amounts assumed to be paid to the next policy anniversary date. Since revenues should include premiums due, the amount assumed to be paid to the next anniversary date is a departure from GAAP even though its income effect is offset by an increase or decrease in life insurance reserves and an increase or decrease in life insurance expenses. Deposit-type contracts are treated in a manner similar to GAAP.

• Accrual of Investment Income: investment income due and accrued for bonds over 90 days past due and for mortgage loans in default 180 days past
due is considered a non admitted asset and recognized as a direct charge to surplus.
• Accrued Expenses
• Nonadmitted Assets
• Reserves for Policy Liabilities
• Appropriation of Surplus

Question 15

GAAP for Life Insurance Companies

Deferrable Acquisition Costs that qualify are?

Answer 15

• Costs and expenses that can be matched with expected future revenue are deferrable under the matching principle.

Deferrable Costs:
• Agent’s Commissions
• Reinsurance Commissions
• Underwriting Costs
• Issue Costs
• Overhead Costs
• Marketing Costs
• Replacement Costs

Question 16

GAAP for Life Insurance Companies

Deferrable Acquisition Costs (Agent’s Commissions, Reinsurance Commissions, Underwriting Costs, Issue Costs, Overhead Costs, Marketing Costs, Replacement Costs)

• Agent’s Commissions?

Answer 16

Commissions paid to agents for producing new premiums are deferrable. Other payments to agents for achieving production goals, such as contingent commissions, bonuses, trips, and awards, and expense reimbursements and similar amounts may also be deferrable. Payments to agents determined on a basis other than production of new business, such as training allowances and salaries, are generally not deferrable.

Question 17

GAAP for Life Insurance Companies

Deferrable Acquisition Costs (Agent’s Commissions, Reinsurance Commissions, Underwriting Costs, Issue Costs, Overhead Costs, Marketing Costs, Replacement Costs)

• Reinsurance Commissions?

Answer 17

Amounts paid to a ceding company, representing the reimbursement of agents’ commissions and other expenses that were paid by that company, qualify as deferrable costs. Amounts received from an assuming company, representing a recovery of agents’ commissions, are applied to reduce the original agents’ commissions paid. Other amounts paid to a ceding company or received from an assuming company not representing deferrable costs are charged or credited to current operations

Question 18

GAAP for Life Insurance Companies

Deferrable Acquisition Costs (Agent’s Commissions, Reinsurance Commissions, Underwriting Costs, Issue Costs, Overhead Costs, Marketing Costs, Replacement Costs)

• Marketing Costs?

Answer 18

The salary and benefit costs of employees spending full time in the production of new business are deferrable. Other costs incurred by marketing employees, such as traveling expenses, depreciation or rental of equipment, and similar costs, are also deferrable. Costs incurred by the marketing department to develop new agencies, brokerage arrangements, and the like are generally assumed to be current costs and should not be deferred.

Question 19

Post Retirement Benefits

Answer 19

• The amount to be reported as income is the service cost (the normal amortization for the reporting period)

+ plus the interest cost
- less the return on plan assets (if any) and
+ plus or minus various other amortization amounts.

Question 20

Appropriation of Surplus

Answer 20

• A portion of the surplus is appropriated to a liability account (the asset valuation reserve) to provide an allowance for possible fluctuations in the realizable values of investments. Another liability account (the interest maintenance reserve) is used to amortize capital gains/(losses).