Odomirok Flashcards

Question

How are bonds classified under GAAP? How are they recorded?

Answer 1

Available-For-Sale (AFS): Acquired with intent to hold for > 1 year but sell before maturity; fair value Held-To-Maturity (HTM): Acquired with intent to hold until maturity; amortized cost Helf-For-Trading (HFT): Acquired with intent to hold only for hours or days; fair value ## Footnote Odomirok 22/23 (Battleacts Odomirok 7)

Answer 2

1. Overall company expenses directly affect pricing of its insurance products (affecting competitiveness and/or profitability) 2. If relative allocation of expenses across functions/products is not accurate, it may lead to subsidies between products that can skew the true profitability of those products ## Footnote Odomirok 8 pg 44

Answer 3

**A**sset recognition: SAP - Asset is recognized when expense is incurred; GAAP - May defer recognition to achieve matching of revenue & expenses (as with DAC) **R**einsurance in loss reserves: SAP - loss reserves are recorded NET of reinsurance; GAAP - loss reserves are recorded GROSS of reinsurance **T**axes: SAP - taxes (mostly) not deferred; GAAP - tax can be deferred ## Footnote Battleacts Odomirok 8/9, references Odomirok 22/23

Answer 4

EP - Current AY Losses - Change in Past AY Losses - LAE - Other Exp ## Footnote Battleacts Odomirok 8/9

Answer 5

Net Investment Income Earned + Net Realized Capital Gains [Net Investment Income Earned = Revenue - Expenses - Non-Federal TLF] ## Footnote Battleacts Odomirok 8/9

Answer 6

Agents' Balances Charged Off + Service Fees + Aggregate Write-Ins ## Footnote Battleacts Odomirok 8/9

Answer 7

EP = WP - change(UEP) ## Footnote Battleacts Odomirok 8/9

Answer 8

UW Income + NI Income + Other Income - Dividends to Policyholders - Fed/Foreign Taxes Incurred ## Footnote Battleacts Odomirok 8/9

Answer 9

Previous Year Surplus + Net Income + Direct Changes to Surplus ## Footnote Battleacts Odomirok 8/9

Answer 10

Other Surplus Changes: * Changes in Unrealized Capital Gains * Changes in Unrealized Foreign Exchange * Changes in Deferred Income Tax * Cumulative Effect of Changes in Accounting Principles * (-) Changes in Nonadmitted Assets * (-) Changes in Provision for Reinsurance Additional Capital Contributions: * Change in Surplus Notes * Change in Gross Paid-In & Contributed Surplus (-) Stockholder Dividends ## Footnote Battleacts Odomirok 8/9

Answer 11

When the UEP reserve won't cover the (expected) losses & expenses for the unexpired portion of the related policies ## Footnote Battleacts Odomirok 8/9

Answer 12

**C**hange in incurred Loss & LAE **A**sbestos and Environmental Reserves **R**einsurance **D**iscounting of Unpaid Loss & LAE **P**remium Deficiency Reserve ## Footnote Odomirok 10 pg 62

Answer 13

**S**ummary of Significant Accounting Principles **H**igh Deductibles **I**nterpooling Companies **E**vents Subsequent (Type 1, new development on old claim, Type 2, completely new claim) **S**tructured Settlements ## Footnote Odomirok 10 pg 62

Answer 14

The purpose of the interogatories is to provide information on: **C**ontrols (both internal and external) **O**perations **B**usiness Practices ## Footnote Battleacts Odomirok 11

Answer 15

**R**egulatory Exams **M**erger activity **E**xemptions from regulations **S**ales Commissions - whether they're excessive just to acquire business **S**uspension of licenses - if applicable ## Footnote Battleacts Odomirok 11

Answer 16

**A** - Real Estate B - Morgage Loans BA - Other long-term invested assets **D** - Stocks and Bonds DA - Other Short-term investments DB - Derivatives DL - Securities Lending **E** - Cash & Cash Equivalents **F** - Reinsurance **P** - Losses & LAE Reserves **T** - Premium Writings by State **Y** - Organizational Structure ## Footnote Odomirok 13

Answer 17

**1** - Assumed Reinsurance (premiums, losses, commissions, collateral) **2** - Premium Portfolio reinsurance (orig and reinsurance premiums) **3** - Ceded Reinsurance (Provision for Rein./RBC) **4** - Issuing or Confirming Banks for Letters of Credit **5** - Interrogatories for Schedule F, part 3 (commisison rates, loss recoverables) **6** - Restatement of Balance Sheet ## Footnote Odomirok 14

Answer 18

**Affiliated Insurers** * U.S. intercompany pooling * U.S. non-pool * other (non U.S.) **Other U.S. Unaffiliated Insurers** **Pools & Associations** * mandatory pools * voluntary pools **Other Non-U.S. Insurers** ## Footnote Odomirok 14

Answer 19

* Provides the total assumed reinsurance balances by reinsured * Enables an understanding of the risks associated with reinsurance transactions as of the current year. ## Footnote Odomirok 14

Answer 20

Provides a detailed listing of portfolio reinsurance transactions effected or canceled during the current year (Portfolio insurance is the transfer of policies-in-force, or the transfer of liabilities remaining on a block of the insurer's business) ## Footnote Odomirok 14

Answer 21

* The first 20 columns detail the ceded reinsurance balances * Columns 21 through 36 calculate credit risk charge on ceded reinsurance * Columns 37 through 53 provide the aging of ceded reinsurance * Columns 54 through 69 provide the calculation of the Provision for Reinsurance for Certified Reinsurance * Columns 70 through 78 provide the Total Provision for Reinsurance (authorized, unauthorized, total) ## Footnote Odomirok 14

Answer 22

Provides a listing fo the issuing or confirming banks for letters of credit as collateral reported in Schedule F, Part 3, Column 22 Confirming banks are those that provide a guarantee on a letter of credit such that the confirming bank will pay if the original bank issuing the letter of credit does not) ## Footnote Odomirok 14

Answer 23

Has 2 tables with interogattories for Part 3 ## Footnote Odomirok 14

Answer 24

Restates the balance sheet Gross of reinsurance ## Footnote Odomirok 14

Answer 25

A portion of premium due to the reinsurer that is witheld by the ceding company to pay claims (Liability for the insurer, asset for the reinsurer) ## Footnote Odomirok 14

Answer 26

A line of credit issued by a bank in favor of a reinsurer if the reinsurer is unable to fulfill its obligations ## Footnote Odomirok 14

Answer 27

The transfer of policies in force, or transfer of liabilities remaining on a block of an insurer's business ## Footnote Odomirok 14

Answer 28

* Discontinue a line of business * Remove risk of the liabilities * Surplus Relief (in the form of discounted premium) ## Footnote Odomirok 14

Answer 29

* Discontinue a line of business * Intercompany Cessions to share risk across related companies * Cession to a regulated pool ## Footnote Odomirok 14

Answer 30

**Identifies** gross Assumed Losses **Identifies** Slow-Paying (Authorized) reinsurers for futhur scrutinty **Measures** Significance of reinsurance against surplus **Provides** Financial Strength information of reinsureds and reinsurers ## Footnote Odomirok 14

Answer 31

They Identify relationships of heightened importance to regulators **Special Code 2** Cessions of 75% or more of subject premium (indicator of fronting to avoid regulatory scrutinty) **Special Code 3** Counterparty Reporting Exception for Asbestos and Pollution Contracts **Special Code 4** IBNR Losses on Contracts in force prior to July 1, 1984 Exempt from: Statutory Provision for Unauthorized Reinsurance ## Footnote Odomirok 14

Answer 32

a minimum reserve (calculated under SAP) that reflects estimated uncollectible reinsurance recoveries ## Footnote Odomirok 14

Answer 33

Asset: * Reinsurance Recoverable on Paid Loss & LAE Liabilities: * Reinsurance Payable on Paid Loss (when assuming reinsurance) * Unearned Premium for Ceded Reinsurance * Ceded Reinsurance Premiums Payable * Funds held under Reinsurance Treaties * Reinsurance Provision ## Footnote Odomirok 14

Answer 34

* Schedule F tracks reinsurance transactions, calculates a reinsurance provision, and shows the effect on the insurer's balance sheet of cancelling all reinsurance contracts. * Quality of reinsurance impacts risks of uncollectibility from reinsurer, which impacts solvency of the insurer * (Schedule F only provides a narrow scope of solvency, because there are many other risks factors besides reinsurance) ## Footnote Odomirok 14

Answer 35

**Strengths**: * RP is formulaic - easy to compare across years & companies * RP is formulaic - hard to manipulate because inputs are numbers from financial statements * RP accounts for reinsurer credit risk with penalties for unauthorized reinsurers (often foreign) * RP accounts for reinsurer credit risk with penalties for slow-paying reinsurers * Schedule F shows impact to surplus if reinsurance contracts are canceled **Weaknesses**: * RP is formulaic - may mask management's better informed estimate of collectability risk * RP is formulaic - but no statistical basis for formula - may not represent true collectability risk * RP penalizes unauthorized reinsurers regardless of their financial strength * RP penalizes slow-paying reinsurers regardless of their financial strength and slow-payer threshold is arbitrary * *In General*: Schedule F doesn't directly measure reinsurer's solvency which is the true source of uncollectability risk * *In General*: Schedule F doesn't measure the quality of an insurer's reinsurance management ## Footnote Odomirok 14

Answer 36

**Disclose** details of reinsurance arrangements **Include** management input of uncollectability risk **Include** Reinsurer ratings **Replace** 20% slow-pay threshold with a sliding scale and consider reasons for slow-pay ## Footnote Odomirok 14

Answer 37

An Unauthorized Reinsurer is one that does business where it is not leagally permitted to do so *For Example, a reinsurer authorized to conduct business only in Maine would be unauthorized to sell reinsurance to an insurer in Texas* ## Footnote Odomirok 14

Answer 38

RP = T - C + 20% x (P(N>90) + T(D)) T = Total Recoverable C = Collateral (Offsets to RP) P(N>90) = Recoverable not in dispute 90 days past due T(D) = Total reinsurance recoverable in dispute ## Footnote Odomirok 14

Answer 39

SPR = P(N>90) / (P(N) + Received in past 90 Days) P(N>90) = Recoverable not in dispute 90 days past due P(N) = Total recoverable not in dispute ## Footnote Odomirok 14

Answer 40

*If Not Slow-Paying* RP = 20% x (P(N>90) + P(D>90)) *If Slow-Paying* RP = 20% x max(T - C, P(N>90) + P(D>90)) P(N>90) = Recoverable not in dispute 90 days past due P(D>90) = Recoverable in dispute 90 days past due T = Total Recoverable C = Collateral ## Footnote Odomirok 14

Answer 41

* non-U.S. reinsurers domiciled in a jurisdiction designated by the NAIC as a Qualified Jurisdiction (i.e., Bermuda, France, Germany, Ireland, Japan, Switzerland and the United Kingdom) * one that would have been categorized as unauthorized prior to 2012 * one that has attained certification from the reporting entity's domiciliary state ## Footnote Odomirok 14

Answer 42

**J**urisdiction of reinsurer **R**ating from a rating agency **R**egulatory History **F**inancial Positioin **C&S** Capital and Surplus ## Footnote Odomirok 14

Answer 43

**Table 1**: * Identifies 5 largest reinsurer commission rates (where ceded premium > $50,000) * The purpose is to identify companies using reinsurance to conceal high operating leverage **Table 2**: * Identifies 5 largest loss recoverables from (Col 15) and whether the reinsurer is affiliated with the reporting entity * The purpose is to assess concentration of insurance risk ## Footnote Odomirok 14

Answer 44

The Reporting entity is not penalized as heavily (= reinsurance provision is lower) The Reinsurer can post collateral of less than 100% of its U.S. claims ## Footnote Odomirok 14

Answer 45

**Collateral Defficiency [RP64(CD)]** = A19(recov) - Cr63(recov) A19(recov) = net amount recoverable from reinsurer Cr63(recov) = credit allowed for net recoverables **Overdue Reinsurance [RP69(OR)]** = min[20% x MAX(PN90 + PD90, F), CR63(recov)] Pd90 = recoverable on Paid loss loss & LAE > 90 days past due in dispute Pn90 = recoverable on Paid loss & LAE > 90 days past due not in dispute F = net unsecured recoverable for slow payers for which credit is permitted Cr63(recov) = (Col 57) + (Col 58) x (Col 61) (Col 57) = Catastrophe Recoverables Qualifying for Collateral Deferral (Whatever the heck that is...we're just going to assume this equals 0!) (Col 58) = Net Recoverables Subject to Collateral Requirements for Full Credit (Col 61) = Percent Credit Allowed on Net Recoverables Subject to Collateral Requirements ## Footnote Odomirok 14

Answer 46

**D**evelopment of reserves over time attributable to specific years and lines (2,3,4) **T**rends in frequency and severity (1,2,5) **-** calculate **R**BC loss-sensitive discount (7) evaluate **A**dequacy of recorded reserves (2,5) determine **P**ayment patterns for discounting (3) I observe split between actual reserves (**I**BNR) and case reserves (4,5) **D**isclosures for SAO (1) ## Footnote Odomirok 15

Answer 47

**1** *tables* of everything by AY (losses, expenses, premiums, claim counts) **2** *triangles* of Ultimate Losses **3** *triangles* of Paid Losses **4** *triangles* of IBNR Losses **5** *triangles* of Claim Counts **6** *triangles* of Earned Premium **7** *tables & triangles* for loss-sensitive contracts ## Footnote Odomirok 15

Answer 48

* Talk to people: numbers don't tell whole story, need to talk to management to get better idea of what is going on at the company (Schedule P is net of reinsurance, does not reflect credit risk) * 10 years: maximum number of years carried in Schedule P, not enough for long tailed line tail factors * Pooling: internal/voluntary/involuntary pools can distrot data (many pools report IBNR as case reserves) * Commutation: can cause sudden increase in net reserves * DCC: Parts 2,3,4 include DCC, which means you can't separate DCC trends from loss trends * Preparation of Schedule P: Person preparing it has a certain amount of choice regarding allocations and presentations ## Footnote Odomirok 15

Answer 49

* Detail underlying loss & LAE reserves from balance sheet * Includes 10 years of Loss & Defence & Cost Containment It allows outside parties to evaluate a company's reserve adequacy ## Footnote Odomirok 15

Answer 50

1-4 have a summary section (subparts A-T show LOB detail) 5-7 do not have a summary section ## Footnote Odomiork 15

Answer 51

* Mix of Business * Claim Settlement Practices * Reserving Practices * Rapid Premium Growth/Shrinkage * Retentions * Policy Limits * Intercompany Pooling * Definition of Claim Count * Commutations ## Footnote Odomirok 15

Answer 52

No No. Also most recent pooling percentages should be reflected in all AY ## Footnote Odomirok 15

Answer 53

**Opinion**: provide the appointed actuary's opinion on reserve items in SAO scope **Inform**: inform readers/regulators of significant risk factors regarding reserves **Advise**: advise whether risk factors could lead to MAD (Material Adverse Deviation) in reserves ## Footnote Odomirok 16

Answer 54

**I**dentification **S**cope **O**pinion **R**elevant comments **A** - Recorded amounts for items in scope(loss reserves, reinsurance...) **B** - Disclosure items regarding NET reserves in scope ## Footnote Odomirok 16

Answer 55

**S**ize - insurer is small (less than $1m annual GWP and less than $1m gross reserves at year end) **L**OB - certain lines of business are exempt **u** **S**upervision - exempt if insurer is under supervision **H**ardship - if insurer is under financial hardship - if cost of SAO exceeds lesser of 1% of CY capital & surplus from latest quarterly statement or 3% of GWP for year projected from latest quarterly statement ## Footnote Odomirok 16

Answer 56

Regulators Board of Directors Management Investors General Public

Answer 57

Actuary's name/title + WARDIN' **W**who made appointment **A**ffirmation of qualifications **R**elationship to the company **D**ate of appointment **IN**tended purpose/users ## Footnote Odomirok 16

Answer 58

**Must identify**: * Reserve items in opinion * accounting basis for reserves * intercompany pooling * review date * data source ## Footnote Odomirok 16

Answer 59

* [A] & [B]: statements about laws and actuarial standards * [C]: type of opinion: R, I, E, Q, or N * [D]: miscellaneous (other loss reserve items, work of others...) ## Footnote Odomirok 16

Answer 60

* comments and disclosures to aid reader's understanding * items 1 & 2: MAD (materiality standard regarding MAD, risks that may result in MAD) * items 3-8: various ## Footnote Odomirok 16

Answer 61

Recorded amounts for items mentioned in the scope 6+3 items **Loss and LAE Reserves** * Reserve for Unpaid Losses * Reserve for Unpaid Loss Adjustment Expenses * Reserve for Unpaid Losses - Direct and Assumed * Reserve for Unpaid Loss Adjustment Expenses - Direct and Assumed * Page 3 write in item reserve, "Retroactive Reinsurance Reserve Assumed" * Other Loss Reserve Items on which AA is expressing an opinion **Premium Reserves** * Reserve for Direct and Assumed Unearned Premiums for P&C Long Duration Contracts * Reserve for Net Unearned Premiums for P&C Long Duration Contracts * Other Premium Reserve items on which the AA is expressing an opinion ## Footnote Odomirok 16

Answer 62

Disclosure items regarding NET reserves in the scope 14 items ## Footnote Odomirok 16

Answer 63

The date subsequent to the valuation date through which material information known to the actuary is included in forming the reserve opinion ## Footnote Odomirok 16

Answer 64

The actuary either performed or reviewed reconciliation to Schedule P ## Footnote Odomiork 16

Answer 65

**R**easonable - recorded reserves are within the AA's reasonable range of Unpaid Liabilities **I**nadequate - recorded reserves are below the AA's reasonable range of Unpaid Liabilities **E**xcessive - recorded reserves are above the AA's reasonable range of Unpaid Liabilities **Q**ualified - AA in unable to issue an opinion on certain material items **N**o Opinion - AA unable to conclude that reserves are reasonable ## Footnote Odomirok 16

Answer 66

Must disclose the minimum (or maximum) reasonable reserve level ## Footnote Odomiork 16

Answer 67

**SAO** - public, so that investors, policy holders are informed **AOS** - confidential, sent to state regulator, proprietary information to assess solvency risks **Actuarial Report** - confidential, internal management uses ## Footnote Odomirok 16

Answer 68

In my opinion, the amounts carried in Exhibit A on account of the items identified... **A** meet the requirements of the insurance laws in state X **B** are computed in accordance with accepted actuarial standards and practices **C** make reasonable provision for all unpaid loss and loss adjustment expense obligations of the company under the terms of its contracts and agreements **D** (if necessary) make a reasonable provision for the unearned premium reserves for long duration contracts (and possibly other loss reserve items on which the AA is expressing an opinion of the company under the terms of its contracts and agreements) ## Footnote Odomirok 16 / COPFLR

Answer 69

The materiality standard is used to examine risk factors that could lead to MAD **Percentage-Based Standards** * % of loss and LAE reserves (10% is typical and reasonable) * % of surplus (10-20% is typical and reasonable) * % of net income **Regulatory based Standards** * reduction in surplus that would trigger the next RBC action level * amount that would trigger an unusual IRIS ratio **Others from COPLFR** * Reinsurance considerations, such as levels of ceded reserves compared to surplus or concerns about solvency or collectability of reinsurance * The upper limit of a company's reinsurance protection on reserve development, if any ## Footnote Odomirok 16

Answer 70

March 1st 7 years ## Footnote Odomirok 16

Answer 71

Yes, it must be stated ## Footnote Odomiork 16

Answer 72

* Asbestos Claims * Mass Tort Claims * Catastrophic Weather Claims ## Footnote Odomirok 16

Answer 73

Regulators of the domiciliary state (is not filed with NAIC, not a public document because it contains proprietary company information) ## Footnote Odomirok 16

Answer 74

A-D estimates both on Net and Gross of reinsurance basis **A** - Actuary's Reasonable Range of Reserves Lower and Upper bounds (not required if not calculated) **B** - Actuary's Point Estimate **C** - Carried Reserves by company **D** - Difference between C and A/B **E** - Statement regarding whether there has been 1-year adverse development (relative to prior year surplus) greater than 5% in 3 of the last 5 calendar years (if there hasn't been, best practice to state this fact although not required; if there has been, actuary should provide sufficient detail so that the regulator can determine whether additional regulatory review is required) (This is IRIS ratio 11) ## Footnote Odomirok 17

Answer 75

Five-Year Historical Data, line 74 (statutory basis Annual Statement), though the raw data comes from Schedule P, Part 2 - Summary ## Footnote Odomirok 17

Answer 76

* **state** that there has been adverse development and for which years * **summarize** the reason for the adverse development (for example, strengthened loss reserve) * **explain** the reason in more detail (increased exposure...) * **mitigate** the effects of this adverse development (puchased unaffiliated retroactive reinsurance) ## Footnote Odomirok 17

Answer 77

Show how booked reserves compare to actuarial estimates (gross/net) and disclose historical adverse development if necessary ## Footnote Odomirok 17

Answer 78

Provide a more lengthy/detailed report including the items in the SAO and AOS as well as an explanation on Actuary's analysis, data reconciliation to schedule P, etc... Fully Describes the work so another actuary practicing in the field can understand and replicate. ## Footnote Odomirok 17

Answer 79

A Qualified Actuary is a person who: * **meets** the basic education, experience, and continuing education requirements of the Specific Qualifications Standards for Statements of Actuarial Opinion, NAIC Property and Casualty Annual Statement, as set forth in the Qualification Standards for Actuaries Issuing Statements of Actuarial Opinion in the United States, promulgated by the Americna Academy of Actuaries, and * has obtained and maintains an Accepted Actuarial Designation; and * is a member of a professional actuarial association that requires adherence to the same Code of Professional Conduct promulgated by the Academy, requires adherence to the U.S. Qualification Standards, and participates in the Actuarial Board for Counseling and Discipline when its members are practicing in the U.S. ## Footnote COPLFR

Answer 80

**D**ata Sources **R**serve items being opined on **E**valuation of data for reasonableness **A**ccounting basis for reserves **R**eview Date **I**ntercompany pooling (if applicable) **R**evewed reserve setting methods and assumptions **R**econciliation of Data to Schedule P ## Footnote COPLFR

Answer 81

* reconcile the given data on a direct + assumed basis and net of reinsurance basis or explain why omitted reconciliations were not done * reconcile by line of business and accident year * explain any discrepancies * Also, note that reconciliation often include complicated mapping of data used by AA to data in schedule P Use language "I reconciled the data to Schedule P - part 1 of the company's current ANnual Statement. If discrepencies, provide explanation, if not, say so ## Footnote COPLFR

Answer 82

**P**roportion of reserves covered by other person's work **-** **N**ature of coverage **E**ffect of variations in other person's estimates on AA's opinion **C**redentials of other person ## Footnote COPLFR

Answer 83

Actuary - Disclose name, credential, affiliation within Opinion paragraph Non-Actuary - Disclose name, affiliation, type of analysis performed ## Footnote COPLFR

Answer 84

**D**ata (thin data or unexplained changes) **O**perations (qualitative changes in operations) **N**ew products or markets **G**rowth (rapid growth in one or more business segments) **A**dequacy (changes in adequacy of case reserves) **S**everity (changes in frequency and severity) ## Footnote COPLFR

Answer 85

* Asbestos & Environmental losses * Catastrophic weather events * cyber liability * mass torts (asbestos) * construction defects * new legislation * distributional changes in limits / attachment points / deductibles * terms of reinsurance contracts ## Footnote COPLFR

Answer 86

A document from company management assuring a non-employee appointed actuary that they have all the relevant information on which to form an opinion. Could include: * company provided complete and accurate data, information on subsequent events, basis of carried reserves (net/gross of reinsurance, salv/subro, risk margin), changes in reserving methodology ## Footnote COPLFR

Answer 87

Still should comment on potential risk factors ## Footnote COPLFR

Answer 88

Increase in limits on policies sold with decrease in reinsurance Text lists others ## Footnote COPLFR

Answer 89

* Direct: loss and unearned premium reserves, claims patterns and loss trends, collectability of reinsurance and/or premiums, exposure * Indirect: claims handling delays and procedural changes resulting from public health orders ## Footnote COPLFR

Answer 90

* **Worker's Compensation**: Some states have passed regulations whereby an exmployee working outside of their home who tests positive for COVID-19 is presumed to have acquired the disease related to their employement and is eligible for workers' compensation benefits. * **Actuarial Loss Data**: Delays in the court system may have impacted loss payment and reporting * **Exposure Assumptions**: The COVID-19 Impact on the overall economy could bring about changes in exposure assumptions that were established before COVID-19 ## Footnote COPLFR

Answer 91

IF: [1] the AA does not address material adverse deviation [2] .1 x (net L & LAE reserves) > TAC - CAL THEN: The financial analyst should pursue comments from the AA ## Footnote COPLFR

Answer 92

* I believe there are significant risks and uncertainties associated with the company's net loss and loss adjustment expense reserves that could result in material adverse deviation * I have identified those risk factors as ____, _____, and _____ * These risk factors are discussed in more detail here and elsewhere in this opinion * Other risks may arise in the future ## Footnote COPLFR

Answer 93

* Company-Specific Risk Factors * Risk of Material Adverse Deviation and Materiality Standard Must Identify MS * Other Disclosures in Exhibit B * Reinsurance Collectability, retroactive * IRIS Ratios (11, 12, 13) * Methods and Assumptions (State if change has been made) * (COVID-19) ## Footnote COPLFR

Answer 94

8. Anticipated Salvage and Subrogation 9. Discounting (non-tabular and tabular in Schedule P) 10. Voluntary/Involuntary Underwriting Pools and Associations 11. A&E liabilities 12. Extended Reporting Endorsements 13. Accident and Health Long Duration Contracts 14. Other items ## Footnote COPLFR

Answer 95

Refers to contracts, excluding financial guaranty contracts and surety contracts, that fulfill both of the following conditions: 1. The contracted term is greater than or equal to thirteen months 2. The insurer can neither cancel nor increase the premium during the contract term ## Footnote COPLFR

Answer 96

IEE shows statutory profit(loss) both direct & net of reinsurance, by line of business Income Statement shows only aggregate information net of reinsurance ## Footnote Odomirok 18

Answer 97

**Actuary:** * examine premium, loss, expenses by line * benchmark company performance by line **Policyholder:** * examine expenses by line * may affect purchase decision because lower expenses mean lower rates **Investor:** * examine profitability versus premium growth by line * may affect investment decision if growth is in unprofitable lines **Competitor:** * examine profit & expenses by line * may affect market entry decision in lines where profits are high **Regulator:** * examine data/trends by line * Highlights solvency and/or rate concerns by line that the income statment may mask **Rating Agency:** * examinen profit by line * highlights subsidies from strong lines to weak ## Footnote Odomirok 18

Answer 98

**IEE Part 1** * allocates expenses (from Part 3) into 22 different expense groups * doesn't show profit (loss) **IEE Part 2** * shows pre-tax profit (loss) net of reinsurance **IEE Part 3** * shows pre-tax profit (loss) direct of reinsurance * excludes all investment gain **IEE interrogatories** * explanatory notes for Parts 1, 2, 3 (comes before all three) * interrogatory question #4 is very important: provides info on the allocation of profits and expenses to line * if the allocation is done in a standard way then no furthur info is required ## Footnote Odomirok 18

Answer 99

Surplus is shown on an aggregate basis on the balance sheet, IEE allocates surplus to LOB (all averages are of current and prior year) Surplus Ratio = AVG(Surplus) / [AVG(Losses) + AVG(LAE) + AVG(UEP) + Current Net Earned Premium] Surplus LOB Allocation = Surplus Ratio * [AVG(Losses) + AVG(LAE) + AVG(UEP) + Current Net Earned Premium] ## Footnote Odomirok 18

Answer 100

**Advantages** Not distorted by **R**einsurance Uses **2** years of data to smooth results (reduces distortions) Easy to obtain **D**ata (from annual statement) easy to **C**alculate & compare across companies & Lines of business **Disadvantages** Does not reflect **F**uture business or growth (it is retrospective) Does not allow for **A**ctuarial/management input (formulaic) Does not reflect **R**isk characteristics of line of business (ex. short tail vs long tail) Does not recognize **C**atastrophe potential **e** ## Footnote Odomirok 18

Answer 101

* Based on internal model, can incorporate CAT and operation risk * TVaR approach * Use similar method but with RBC, judgmentally allocate additional Surplus ## Footnote Odomirok 18

Answer 102

1. IEE - retrospective; ratemaking - prospective 2. IEE - formulaic; ratemaking - can use different methods 3. IEE - LOB basis; ratemaking - may allocate to more granular or broader levels 4. IEE - allocates all surplus; ratemaking - may not allocate all surplus ## Footnote Odomirok 18

Answer 103

NIGR = NIG / TIA NIG = Net Investment Gain TIA = Total Investable Assets TIA = AVG(L) + AVG(LAE) + AVG(UEP) + AVG(re) + AVG(Surplus) - AVG(AB) re = Ceded Reinsurance Premium Payable AB = Agent's Balances NIG(A) = NIGR X TIA(A) ## Footnote Odomirok 18

Answer 104

1. Investment Gain attributable to Capital And Surplus 2. Investment Gain attributable to Insurance Transactions ## Footnote Odomirok 18

Answer 105

NIGIT(A) = NIGR x FAIT(A) All of the following are for LOB A FAIT(A) = AVG(L) + AVG(LAE) + AVG(UEP) + AVG(re) - AVG(AB) - PPE for UEP PPE for UEP = PPER x AVG(UEP) PPER = Net Acquisition Expense / NWP FAIT = Funds Attributable to Insurance Transactions PPE for UEP = prepaid expenses in UEP PPER = prepaid expense ratio ## Footnote Odomirok 18

Answer 106

**LOB breakout** -IEE shows expenses by LOB, U&IE does not **Reinsurance** - IEE shows direct & net, U&IE shows net only **Display** - IEE in 000's, U&IE to nearest dollar **Other U/W Expenses** IEE separates into: acquisition, filed supervision, collection expenses / General Expenses / Investment Expenses; U&IE does not ## Footnote Odomirok 18

Answer 107

RBC = TAC / ACL TAC = Total Adjusted Capital ACL = Authorized Control Level Capital ## Footnote Odomirok 19

Answer 108

**C**ompany Action Level (CAL) ; 150-200%; Regulator - None; Insurer - Submit action plan within 45 days to meet RBC standards **R**egulatory Action Level (RAL) ; 100-150%; Regulator - has right to issue order specifying corrective action; Insurer - Submit action plan within 45 days to meet RBC standards **A**uthorized Control Level (ACL); 70-100% Regulator - commissioner authorized to take control of company; Insurer - None **M**andatory Control Level (MCL) ; <=70%; Regulator - Commissioner must rehabilitate or liquidate; Insurerer - None ## Footnote Odomirok 19

Answer 109

* Explain how to raise needed capital * Explain how to reduce operations to save money * Explain how to reduce risks to lower RBC charges ## Footnote Odomirok 19

Answer 110

If a company's RBC ratio is in the 200-300% range and also has a Combined Operating Ratio > 120%, then they are subject to the CAL action from the action table ## Footnote Odomirok 19

Answer 111

Sum of: * **L**oss & LAE Ratio = (CY net incurred loss & LAE)/NEP * **E**xpense Ratio = [(other UW expenses) + (agg. write-ins for underwriting deductions)]/NWP * **D**ividend Ratio = (Policyholder Dividends) / NEP Does not include Investment Income ## Footnote Odomirok 19

Answer 112

**S**ubsidiary Insurance Companies and Miscellaneous Other Amounts [R0] **F**ixed Income Risk [R1] **E**quity Risk [R2] **C**redit Risk [R3] **R**eserve Risk [R4] **N**et Written Premium Risk [R5] **C**atastrophe Risk [RCAT] **O**perational Risk ## Footnote Odomirok 19

Answer 113

3% of pre-operational risk RBC total Charge can be furthur reduced by the sum of offset amounts reported by directly owned life insurance company subsidiaries that prepare and file the Life RBC calculation, adjusted for the percentage of ownership in the directly owned life insurance company subsidiaries (but not to produce a charge that is less than zero). ## Footnote Odomirok 19

Answer 114

R0 + sqrt(R1^2+R2^2+R3^2+R4^2+R5^2+RCAT^2) + Opperational Risk ## Footnote Odomiork 19

Answer 115

**L**egal risk **-** **P**ersonnel risk **I**nadequacy or failure of internal systems **P**rocedural Risk (and/or risk of failure of internal controls) **E**xternal risk (due to external events) ## Footnote Odomirok 19

Answer 116

It is unlikely that risks R1 thorugh Rcat would reach their maximum value at the same time (assumed independent). Reduces the required capital (diversification credit) R0 is excluded because it is correlated with other risks, represents charge for a subsidiary company ## Footnote Odomirok 19

Answer 117

ACL Capital required = .5xRBC Capital Required ## Footnote Odomirok 19

Answer 118

R2 - Equity Risk - Risk associated with stocks, etc.. R4 - Reserve Risk - Risk associated with reserves (30%) R5 - NWP Risk - Risk associated with writing policies, unexpired portion, deals with portions remaining less than year while reserves can span multiple years (20%) RCAT - CAT Risk - Hurricane / Earthquake risk (14%) R3 - Credit - Mostly safe, largest portion from reinsurers, offset by smart agreements (2%) R1 - Fixed Income - Very safe. Example Government bond (2%) ## Footnote Odomirok 19

Answer 119

TAC = Policy Holder Surplus - (non-tablular discount) - (tabular discount on medical reserves) ## Footnote Odomirok 19

Answer 120

1. Common stocks in the subsidiary 2. Preferred stocks in the subsidiary 3. Investments in alien insurance company affiliates 4. Off-balance sheet or other items ## Footnote Odomirok 19

Answer 121

R0(common stocks) = min(affiliate RBC x ownership % of common stock, value of common stock as recorded by reporting entity) *equity method* *OR* R0(common stocks) = min(affiliate RBC x ownership % of common stock, statutory surplus of affiliate x ownership % of common stock) *market method* R0(preferred stocks) = min( (affiliate RBC - total common stock value) x ownership% of preferred stock), value of preferred stock as reported by reporting entity) R0(alien insurance affiliate) = 0.5 x (carrying value of company's interest in affiliate) R0(off-balance sheet items) = 1.0% x (value of each off-balance sheet item) Sum of above charges ## Footnote Odomirok 19

Answer 122

* non-controlled assets * guarantees for the benefit of affiliates * contingent liabilities * Deferred Tax Assets ## Footnote Odomiork 19

Answer 123

R1 RBC charge covers interest rate risk and default risk for: * Bonds * Off-balance sheet collateral and Schedule DL, Part 1, Assets * Other long term assets (mortgage laons, low income housing tax credits, working capital finance investments....) * Miscellaneous assets (includes cash, cash equivalents, other short-term investments, nonadmitted collateral loans) * Replication (synthetic asset) transactions and mandatorily convertible securities ## Footnote Odomirok 19

Answer 124

R1 = basic charge + Bond Size Charge (BSC) + Asset Concentration Charge (ACC) Basic Charge = sum(asset values x RBC factor) BSC = BSF x (total R1 charges for bonds subject to BSF) BSF = weighted average - 1 using: First 50: 2.5 Next 50: 1.3 Next 300: 1.0 '> 400: .9 ACC = double count RBC for applicable investments from top 10 companies that contribute towards total ACC (involves both R1 and R2) ## Footnote Odomirok 19

Answer 125

NAIC 01-06 bonds Non government bonds ## Footnote Odomirok 19

Answer 126

**Fixed Income**: Unaffiliated bonds in classes 02 - 05 Collateral Loans Mortgage Loans **Equity** Unaffiliated Preferred Stocks and hybrid securities in classes 02 - 05 Unaffiliated Common Stock Investment in Real Estate Encumbrances on Invested Real Estate Schedule BA Assets (excluding collateral loans) Receiveable for securities Aggregate write-ins for invested assets Derivatives ## Footnote Odomirok 19

Answer 127

ACF = weighted average of RBC factors for assets subject to the concentration charge ## Footnote Odomirok 19

Answer 128

R2 includes the charge for risk associated with equity investments in the following categories: Affiliated investments Unaffiliated stocks Real Estate Schedule BA Assets Miscellaneous assets, including receivables for securities, aggregate write-ins for invested assets and derivatives Replication (synthetic asset) transactions and mandatory convertible securities ## Footnote Odomirok 19

Answer 129

R2 = Basic Charge + ACC ## Footnote Odomirok 19

Answer 130

Assets deemed to be of low risk (like class 01 unaffiliated bonds or preferred stock) Asssets that have already received the maximum charge of .3 (like class 06 unaffiliated bonds) ## Footnote Odomirok 19

Answer 131

For holding companies, multiply RBC factor by the holding company value in excess of the carrying value for indirectly owned insurance affiliates ## Footnote Odomirok 19

Answer 132

Use the split only if unpaid loss & LAE component of R4 > (RBC charge for non-invested assets) + .5 x (RBC charge for reinsurance recoverables) ## Footnote Odomirok 19

Answer 133

**Non-Invested Assets** * Investment income due and accrued (.01) * Amounts Receivable related to uninsured plans (.05) * Federal income tax recoverable (.05) * Guaranty funds receivable or on deposit (.05) * Recoverable (parent/subs/affiliates) (.05) * Aggregate Write-ins for other than Invested Assets (.05) **Reinsurance Recoverable** (.1) **Health Credit Risk** (accounts for 0% of P&C Insurer risk) ## Footnote Odomirok 19

Answer 134

Reinsurance Recoverables (8% of R4 Charge) Unpaid Loss & LAE Reserve (91% of R4 Charge) Excessive Premium Growth RBC (1% of R4 Charge) Health Stabilization RBC (0% of R4 Charge, not discussed) ## Footnote Odomirok 19

Answer 135

[[(C+1)xA]-1] * The Company RBC% (C) is derived from the corresponding Industry RBC% by applying a company specific adjustment. * The adjustment factor = (company Loss & LAE LDF)/(industry Loss & LAE LDF) * The LDFs are calculated as the (current reserve for 9 prior AYs)/(initial reserves for those AYs) <- capped at 400% * A is an adjustment for investment income, A < 1 Loss-Sensitive Discount (LSD) - Subtracted from the basic charge (.3 x % Direct Loss Sensitive + .15 x % Assumed Loss Sensitive) Loss Concentration Factor (LCF) - Multiplicative Adjustment (highest LOB Reserve / Total Reserves) x .3 + .7 (applies to total after LSD) Afterwards, need to add Reinsurance Recoverable RBC and Excessive Growth Charge. Excessive Growth Charge = Excessive Growth X 0.45 X Net Loss & LAE Reserves Excessive Growth = Average Growth over last 3 years - 10% (each year is capped at 40%) ## Footnote Odomirok 19

Answer 136

Written Premium RBC (99% of R5) Excessive Premium Growth RBC (1% of R5) Health Premium RBC (1% of R5, not very important) Health Stabilization RBC (0% of R5, not very important) ## Footnote Odomirok 19

Answer 137

(C x A) + U - 1 * The Company RBC% (C) is derived from the corresponding Industry RBC% by applying a company specific adjustment. * The adjustment factor = (company Loss & LAE Ratio)/(industry Loss & LAE Ratio) * The AVG Ratios are calculated as the AVG(Loss Ratios for 10 prior AYs) <- capped at 300% * A is an adjustment for investment income, A < 1 * C = .5 x Industry Loss & LAE Ratio + .5 x Industry Loss & LAE Ratio * Adjustment Factor [spoken of] Loss-Sensitive Discount (LSD) - Subtracted from the basic charge (.3 x % Direct Loss Sensitive + .15 x % Assumed Loss Sensitive) Premium Concentration Factor (LCF) - Multiplicative Adjustment (highest LOB Reserve / Total Reserves) x .3 + .7 (applies to total after LSD) Afterwards, need to add Reinsurance Recoverable RBC and Excessive Growth Charge Excessive Growth Charge = Excessive Growth X 0.225 X NWP Excessive Growth = Average Growth in **TOTAL GWP** over last 3 years - 10% (each year is capped at 40%) ## Footnote Odomirok 19

Answer 138

RCAT = sqrt((Total Earthquake Charge)^2+(Total Hurricane Risk)^2) Same methodology to calculate each Need to know 1-in-100 year event model losses for Gross and Net of reinsurance Charge = Modeled Net Loss x 1 + (Gross - Net Loss) x .048 ## Footnote Odomirok 19

Answer 139

* Reporting of projected Catastrophe losses: can be done on an Aggregate Exceedance Probability (AEP) basis, or Occurence Exceedance Probability (OEP) basis * Exemptions from filing catastrophe charges: granted when certain conditions are met that indicate a low net catastrophe exposure such as when coverage is less than 10% of policyholder surplus * Credit Risk Charge: losses ceded to U.S. affiliates and mandatory pools (whether authorized, unauthorized, or certified) are not subject to the .048 credit risk charge ## Footnote Odomirok 19

Answer 140

* Less insight into new business, harder to underwrite/price the risk * Major factor that has historically lead to insolvency, indication that the insurer has lax UW standards * Less insight into new business, may lead to poor UW results, hard to estimate Unpaid claims amounts * May indicate that insurer is trying to increase cash flow to pay for current liabilities, short term solution that may lead to solvency issues ## Footnote Odomirok 19

Answer 141

**Similarities** * Both serve as early warning against insureres that may become insolvent * Both are quantitative metrics * Both lay out numeric thresholds for regulators to follow as guidelines for financial trouble warnings * Both attempt to measure financial solidity of an insurer **Differences** * RBC is used to calculate a minimum amount of capital that an insurer should carry, IRIS does not * RBC framework has authority to regulate/intervene businesses by its RBC model act, IRIS framework does not * RBC penalizes an insurer for low grade bonds; IRIS does not ## Footnote Odomirok 19

Answer 142

* Identify Insurers that are in financial trouble and that need regulatory attention / early warning wign * Requirments attempt to individualize minimum capital requirements for each insurer * RBC allows/mandates a regulator to take action when an company reaches a certain RBC level ## Footnote Odomirok 19

Answer 143

* Balance sheet strength - are assets sufficient to cover liabilities? * Earning Potential - is the company going to generate a profit going forward? ## Footnote Odomirok 21

Answer 144

* 5-year historical exhibit * Schedule P (main source) * Schedule F (shows reserves net of reinsurance) * Notes to the financial statements (miscellaneous items that may or may not provide furthur details on reserve adequacy ## Footnote Odomirok 21

Answer 145

Poor **Go**vernance **N**ew entrant to market (inexperienced management, lower capital) **G**rowth too rapid (get premiums up front, but the trouble starts when the losses start) **S**ize too small (can't absortb unexpected losses) **U**nder-pricing **D**eficient Reserves **C**atastrophe **R**einsurer Insolvency **A**sbestos **P**oor investment results ## Footnote Odomirok 21

Answer 146

**B**alance sheet presentation of reinsurance **A**nticipated Salvage and Subrogation **S**tructured Settlements **I**nvested assets **C**eded reinsurance **D**efferred Tax Asset **D**eferred Acquisition Expense **D**iscounting Loss Reserves **N**on-admitted assets **G**oodwill **P**remium Deficiency Reserve ## Footnote Odomirok 22

Answer 147

**General Comment**: SAP - used only by insurance companies, evolved from GAAP; GAAP - used by all U.S. public companies **Objective**: SAP - measures ability to pay claims (focus on severity); GAAP - measure earnings **Intended User**: SAP - regulators; GAAP - general audience, policyholders, investors, public **Oversight**: SAP - individual states with assistance from NAIC; GAAP - SEC (but SEC has delegated responsibiltiy to FASB) ## Footnote Odomirok 22

Answer 148

**Under SAP**: record annuity cost as paid loss, disclose in Notes to Financial Statements **Under GAAP**: record annuity cost as reinsurance, retain loss reserves & book payments as recoverables ## Footnote Odomirok 22

Answer 149

**Under SAP**: tabular discount rate - few state regulations; non-tabular discount rate - formula based and capped **Under GAAP**: options, use SAP rate or reasonable alternative ## Footnote Odomirok 22

Answer 150

**Under SAP**: record undiscounted ceded reserves as negative write-in liability, Schedule P is unchanged (shows gross of reinsurance), gain (negative write-in liability - cost of reinsurance) is recorded as write-in gain and goes into other income, no change to regular surplus because change goes into special surplus **Under GAAP**: record ceded reserves as reinsurance asset, gain is deferred (amortized over time), no immediate impact on income or surplus ## Footnote Odomirok 22

Answer 151

**Under SAP**: recorded net of reinsurance; Recoverable on paid loss is the same; Loss reserve is taken down by amount of recoverable on unpaid loss; UEP is taken down by prepaid reinsurance premiums **Under GAAP**: Gross of reinsurance ## Footnote Odomirok 22

Answer 152

**Under SAP**: DTAs subject to strict admissability test **Under GAAP**: DTAs fully recognized ## Footnote Odomirok 22

Answer 153

**Under SAP**: Not recognized **Under GAAP**: Recognized, may offset PDR ## Footnote Odomirok 22

Answer 154

**Under SAP**: Lots of new designations. Basic chart is as follows: * Fair Value: Common stocks, non-redeemable preferred stocks, SVO-Identified Investments * Amortized Cost: Investment-grade bonds (NAIC 1,2) long & short term * min(Amortized Cost, Fair Value): non-investment grade bonds (NAIC 3-6) long & short term **Under GAAP**: HTM - Amortized Cost; AFS, HFT - Fair Value ## Footnote Odomirok 22

Answer 155

**Under SAP**: Can choose to show Schedule P reserves gross or net of salv/subro **Under GAAP**: Reserves must be net of salv/subro ## Footnote Odomirok 22

Answer 156

**Under SAP**: Premium Deficiency is either included in the UPR balance or reported as a write-in liability item. Commissions and other acquisition costs should not be included if those amounts have been expensed rather than established as an asset (difference with Deferred Acquisition Cost); UPR - PV(loss) + Inv. Income. If negative, PDR **Under GAAP**:DAC is established as an asset and is presented net of ceded DAC; if a PDF is calculated, it first lowers the recorded DAC asset; once exhausted, a separate PDF liability is established ; UPR - PV(loss) + Inv. Income - DAC. If negative, PDR ## Footnote Odomirok 22

Answer 157

**Under SAP**: Goodwill = min(P - Surplus Acquired Company, 10% of Surplus Acquiring Company) Record as a contra-asset and amortize to unrealized capital gains over 10 years (at most) **Under GAAP**: Goodwill = Price - (net Assets) = Price - (Assets Fair Value - Liabilities Fair Value) ## Footnote Odomirok 22

Answer 158

GAAP Surplus = SAP Surplus + Provision for Reinsurance + DAC ## Footnote Odomirok 22

Answer 159

Fair Value is the price at which an orderly transaction to sell the asset (or to transfer the liability) would take place between market participants at the measurement date under current market conditions. ## Footnote Odomirok 23

Answer 160

**Component 1 / Nominal Future Cash Flows of Liabilities** - Calculate using LDFs **Component 2 / Discounted 1st Component + Load for Illiquid Nature of Liabilities** - Calculate using risk-free rate **Component 3 / Risk Margin to compensate for uncertainty of Liabilities** - Calculate using cost-of-capital approach ## Footnote Odomirok 23

Answer 161

Risk Margin = (R - i) x sum(avg(Ct, Ct+1)/(1+i)^(t+1)) t = time (sum across t = 0, 1, 2...) R = pre-tax cost-of-capital i = risk-free rate that includes illiquidity premium Ct = Capital carried at time t to support liability ## Footnote Odomirok 23

Answer 162

**International Financial Reporting Standards** are global reporting standards from the **International Accounting Standards Board** ## Footnote Odomirok 24

Answer 163

Financial Accounting Standards Board (FASB, U.S.) develops and issues GAAP standards International Accounting Standards Board (IASB) develops and issues IFRS standards FASB and IASB are cooperating to create to create financial reporting standards to: * increase transparency and consistency among insurers operating in different countries * align standards with company economics (versus regulatory prudence) ## Footnote Odomirok 24

Answer 164

A contract under which one party (the insurer) accepts significant insurance risk from another party (the policyholder) by agreeing to compensate the policyholder if a specified uncertain future event (the insured event) adversely affects the policyholder ## Footnote Odomirok 24

Answer 165

Establishes the principles for the recognition, measurement, presentation and disclosure of insurance contracts ## Footnote Odomirok 24

Answer 166

* An insurer can aggregate its portfolio of insurance contracts into different groups * there are 3 broad levels of aggregation used for defining groups and these levels are based on the concept of "onerous contracts" * the term "onerous contracts" is a key concept in IFRS but it is not defined in Odomirok (for this reason, it would not be a good exam question) After the insurer aggregates their contracts into groups, the next step is to measure the liabilities associated with these groups ## Footnote Odomirok 24

Answer 167

Default approach in IFRS Balance sheet Liability = Fulfillment Cash Flow + Contractual Service Margin FCF = Present Value of (Premium - Losses - Benefits - Expenses) + Adjustment for timing and risk of these cash flows CSM = Expected profit for providing future insurance coverage Calculating discount rate used in PV calc is complex topic, as general rule use current discount rates Variable Fee Approach is based on General Model, but with additional features to account for contracts with direct participating features ## Footnote Odomirok 24

Answer 168

Simplified version of the General Model, but one of the following eligibility requirements assessed at contract inception must be met: * can be used for short-term contracts (policy term <= 1 year) * can be used for longer-duration contracts IF PAA is a reasonable approximation to GMA over the life of the contract * applies only to LRC component of insurance contract liabilities Liability for Incurred Claims (LIC) insurer's obligation to pay claims for events that have already occurred Liability for Remaining Coverage (LRC) - insurer's obligation to provide insurance coverage for events that have not yet occurred (basically just the premium liabilities) Under IFRS, insurance contract liability = LRC + LIC, where CSM is part of LRC ## Footnote Odomirok 24

Answer 169

The Financial Sector Assessment Program (FSAP) is a period peer review of financial regulation for G20 countries * It is benchmarked against International Association of Insurance Supervisers (IAIS) Insurance Core Principles (ICPs) * The U.S. did well historically but may not do well going forward because SAP doesn't reflect the time value of money ## Footnote Odomirok 30

Answer 170

CommFrame is being deveoped by the International Association of Insurance Supervisers to supervise international insurance groups. * needs a standard method for valuing assets and liabilities * ComFrame proposes IFRS to meet this need * The U.S. method is different from IFRS (problem, U.S. insurers may need to create 2 sets of financial statements) ## Footnote Odomirok 30

Answer 171

FIO was created by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 * studies and collects information on the Insurance Industry and State Insurance Regulatory Systems * drafts federal regulation for the insurance industry ## Footnote Odomirok 30

Answer 172

Solvency II is a principles-based insurance regulatory system for capital levels of insurance companies in the European Union ## Footnote Odomirok 25

Answer 173

**Q**uantitative: Sets Solvency Capital Requirement (SCR) and Minimum Capital Requirement * Uses a total balance sheet approach * SCR corresponds to 99.5% VaR (Value at Risk) meaning that the probability of ruin is < 0.5% **G**overnance: supervisory activities - requires adequate governance for: * internal audit (should report failure to follow company policies and/or deficiencies in internal controls) * actuarial (ensure reasonability of DAM when calculating technical provisions - Data, Assumptions, Methods) * risk management (perform ORSA to identify unique risks of company) * compliance (report failure to comply with regulations to board of directors) **T**ransparency: supervisory reporting & public disclosure * information from pillars 1 & 2 are given to the supervisor & financial markets * purpose is to increase market discipline because companies know their decisions are public * this should reduce intervention by regulators ## Footnote Odomirok 25

Answer 174

* Free Surplus (if any) * Solvency Capital Requirement (in addition to MCR, SCR includes MCR) * Minimum Capital Requirement * Risk Margin * Best Est of Liabilities Total Technical Provisions is the sum of the last 2 groups ## Footnote Odomirok 25

Answer 175

SCR assets required ≤ IFRS assets available → no action MCR assets required ≤ IFRS assets available < SCR assets required → regulator will intervene IFRS assets available < MCR assets required → company is no longer permitted to operate ## Footnote Odomirok 25

Answer 176

**Solvency Capital Requirement (SCR)**: This is the amount of capital that an insurance company must hold to ensure it can withstand significant unforeseen shocks. It's calculated based on various risk modules, including market risk, credit risk, underwriting risk, and operational risk. The SCR is a critical regulatory threshold, and insurers are required to manage their capital to ensure they stay above this level. **Solvency Capital Requirement Assets Required**: This refers to the actual assets that an insurance company must have on hand to meet the SCR. It includes the mix of bonds, stocks, real estate, and other investments that the insurer uses to back its SCR. The type and quality of these assets are usually subject to regulatory guidelines to ensure they can be readily converted into cash if needed. ## Footnote Odomirok 25

Answer 177

Mutliply R-i (Cost of capital - risk free/illiquidity) by capital required each year, bring it back to present value using the risk free/illiquidity rate ## Footnote Odomirok 25

Answer 178

Set using a total balance sheet approach with either standard/regulator model or approved internal model. Corresponds to the 99.5% percentile on loss distribution for both models * Model is used in running the business * Model has been validated by an independent third party * Model is documented appropriately ## Footnote Odomirok 25

Answer 179

ORSA pertains to all short-term & long-term risks: - identify, assess, monitor, manage, and report these risks (including capital requirements) - includes all risks considered considered in Solvency 2 + unique company risks - should explain any inconsistencies with MCR or SCR - helps management understand how risk relates to capital (and to make good business decisions)

Answer 180

Fitness & Propriety, Outsourcing, Internal Countrol Compliance, Actuarial, Risk Management, Internal Audit ## Footnote Odomirok 25

Answer 181

Tax-basis income is SAP or statutory income with a few adjustments: ==> EP is adjusted with a revenue-offset ==> losses (or reserves) are discounted ## Footnote Odomirok 26

Answer 182

* in SAP, acquisition costs are not deferred so the insurer would incur a loss * the insurer would then be entitled to a future tax refund on this loss * but the IRS wanted to simplify the process: instead of a refund, the IRS reduces UEP liability by 20% for all insurers (assumes the acquisition cost ratio is 20% for all lines for all insurers) ## Footnote Odomirok 26

Answer 183

* Pricing * Valuation * Constructing Capital Models * Tax Return Preparation ## Footnote Odomirok 26

Answer 184

TBI = TBEP +InvInc - TBIL TBEP = EP + 20%xchg(UEP) = WP - 80%xchg(UEP) TBIL = PL + chg(L D) = IL - chg(D) TBEP = Tax-Basis Earned Premium InvInc = Investment Income (taxable portion) TBIL = Tax-Basis Incurred Loss PL = Paid Loss during year IL = Incurred Loss during year L D = Loss Reserves after Discounting D = Discount Amount (= Difference between undiscounted and discounted loss reserves) ## Footnote Odomirok 26

Answer 185

Multiply by .25 BTW corporate tax rate is .21 ## Footnote Odomirok 26

Answer 186

BEAT is a new tax under the Tax Cuts and Jobs Act of 2017. It limits the ability of multinational corporations to shift profits from the United States Beat works as follows: * the corporation calculates its regular tax (as a percentage of taxable income, currently 21%) * The corporation calculates its alternative tax (as a percentage of gross income, currently 10%) * If alternative tax is higher than regular tax, than the corporation must pay the difference (BEAT = this difference) ## Footnote Odomirok 26

Answer 187

* insurer is part of a U.S. group of companies with average gross receipts in the past three years ≥ $500M * insurer makes base erosion payments ≥ 3% of the total deductions taken by the U.S. group on its current tax return. Note however that if the foreign company to which tax-deductible payments have been made has elected to be taxed as a U.S. taxpayer then the U.S. corporation or insurer is not subject to BEAT. That seems like a little trick they might throw at you on the exam. So pay attention! (Maybe they'll give you information on 2 companies that made foreign payments but where only 1 of them is subject to BEAT because the other doesn't satisfy the conditions described above.) ## Footnote Odomirok 26

Answer 188

* Even though reserves are reported at their nominal value on the balance sheet, every company is primarily interested in the economic impact of their assets & liabilities (versus the purely statutory impact). Obviously the company wants to ensure that its assets are sufficient to support its liabilities, but if you know you have $1,000 of liabilities due in 1 year, you don't need to set aside $1,000 of assets at the beginning of the year. If you think your assets will earn 10%, then you only need to set aside $1,000/1.1 = $909. This is an economic calculation. * Calculation is different for taxes ## Footnote Odomirok 26

Answer 189

undiscounted loss reserves: - Schedule P, Part 1 - note that Part 1 is net of tabular discount, but gross of nontabular discount (means that any tabular discount must first be eliminated to get the true undiscounted reserves) discount rate: (shout-out to BC!) - NEW: based on the corporate bond yield curve (determined by the U.S. Treasury for each accident year) - (no longer valid: 60-month moving average of Federal midterm rates for each AY) payment pattern: - use Schedule P, Part 1 from industry data (IRS does the calcs for you. Thanks IRS!) - (no longer valid: using Schedule P, Part 1 from company data) ## Footnote Odomirok 26

Answer 190

* Part 3 may be skewed because it doesn't include adjusting/other expenses * Part 3 is not audited (Part 1 is audited) * Part 1 requires no judgment for the IRS method ## Footnote Odomirok 26

Answer 191

 Yields for stocks are typically higher than yields for bonds  Stocks are more volatile than bonds, and management dislikes erratic income  Taxes are minimized when stocks and bonds are allocated such that the regular income tax equals the alternative minimum income tax  Stocks, like loss reserves, are inflation sensitive. Bonds are typically not inflation sensitive.  State mandated limits on investment holdings may dictate permissible allocations of stocks versus bonds  Stocks have a higher RBC charge than most bonds  Should reduce investment risk through diversification by having a proper mix of stocks and bonds  Stocks are more liquid than municipal bonds  Should allocate stocks and bonds such that the duration of assets equals the duration of liabilities ## Footnote Odomirok 26

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