Feldblum (Surplus)

Question 1

Balance sheet definition of surplus

Answer 1

Surplus = Assets - Liabilities

Question 2

Income statement definition of surplus

Answer 2

Surplus = prior years surplus + current year’s income

Question 3

Why do the balance sheet definition and income statement definition surplus differ at times?

Answer 3

Because not all balance sheet transactions flow through the income statement.

Question 4

How do you reconcile the income statement definition surplus with the balance sheet definition surplus?

Answer 4

Adjust the income statement definition surplus for transactions that do not flow through the income statement. These are either:

• Direct credits (increases) to surplus
• Direct charges (reductions) to surplus

Question 5

What will cause a direct charge or to surplus?

Answer 5

• An increase in nonadmitted assets; an adjustment can be made using the Exhibit of Nonadmitted Assets
• Provision for Reinsurance
• Premium Deficiency Reserve

Question 6

Two accounting methods for nonadmitted assets:

Answer 6

• Method 1: write off the nonadmitted assets as an expense (in the income statement); more complicated - requires that the insurer keep a separate set of books for GAAP & Stat Accounting
• Method 2: classify the asset as nonadmitted and charge surplus directly; requires that insurer only keep GAAP books and stat surplus can be identified by subtracting out the portion of the assets that are classified as nonadmitted.

Question 7

Examples of nonadmitted assets

Answer 7

• Interest due & accrued over 90 days overdue
• 10% of the unsecured Accrued Retrospective premium that is due to the insurer
• The permanent excess of book over the market value

Question 8

What will cause a direct credit to surplus?

Answer 8

Unrealized capital gains - Note that the deferred tax liability arising out of these gains is a direct charge to surplus.

Question 9

Cost of holding capital

Answer 9

Considered when valuing an insurer; estimates can vary from the cost of Double Taxation to the difference between the cost of equity capital & after-tax investment yield.

Question 10

Cost of double taxation

Answer 10

An additional amount that investors need to pay by investing in securities via the insurer. To encourage investors to invest in the insurer, this lost yield needs to be paid by the policyholders.

Question 11

Paid through premiums

Answer 11

Part of the profit margin component since there are no direct transactions between investors and policyholders; money collected from policyholders to cover the cost of double taxation to investors. Since it is paid through the profit margin in the premiums (UW income), there is another layer of tax involved

Question 12

How to derive the margin needed on the premiums as a percentage of investment yield for cost of double taxation

Answer 12

(investment yield * corporate tax)/(1 - corporate tax)

Question 13

How to derive the margin needed on the premiums as a percentage of premium for cost of double taxation

Answer 13

Capital * investment yield * margin % (investment yield formula)/premium

Question 14

Total amount of capital subject to the cost of holding capital

Answer 14

Surplus + Equity in the unearned premium reserves (UEPRacquisition cost %) + equity in the undiscounted reserves (undiscounted reservediscount rate) (DTA should be subtracted from this amount

Question 15

Atkinson & Dallas Formulae

Answer 15

Modify the margin equations to reflect the additional cost that arises because of the investment constraints of insurers.