Odomirok 8-9

Question 1

Income Statement contains

Answer 1

revenue, expenses & net income

Question 2

There are 3 types of income

Answer 2

Underwriting income 

Investment income 

Other income

Question 3

Capital & Surplus Account

Answer 3

provides details on the changes in surplus during the year

Question 4

Underwriting Income

Answer 4

Earned Premium – Loss & LAE Incurred – Other Underwriting Expenses Incurred

Question 5

Expenses (LAE & Other Underwriting Expenses) are allocated in 3 different ways in the Annual Statement

Answer 5

NAIC operating expense classifications: includes 24 types of expenses, listed in the rows of U&IE, Part 3 

Expense categories: grouped by operational function: LAE/ Other Underwriting Expenses/ Investment Expenses. These are listed in the columns of the U&IE, Part 3 

Line of business: The IEE (discussed later) uses the lines of business listed in the U&IE, Part 2A

Question 6

Each expense will need to be allocated to

Answer 6

expense classification, expense category & line of business

Question 7

 If the allocation is not accurate, subsidies may arise that may cause problems, including:

Answer 7

• distortion of the profitability measures
• inefficient allocation of resources
• anti-selection

Question 8

Insurers have an opportunity to earn investment income because

Answer 8

there is a delay between the time that the premium is collected and when the losses are paid out

Question 9

2 components of investment income in the income statement

Answer 9

Net investment income earned: -mainly from interest & dividends -recorded net of investment expenses -recorded gross of taxes -accrual basis 

Net realized capital gain: -adjusted for amortization of premiums/ accretion of discounts -realized losses can also be caused by impairment

Question 10

Exhibit of Net Investment Income

Answer 10

contains details by asset class. In addition, it: 

Differentiates between income earned & income collected 

Contains the deductions for investment expenses & other costs

Question 11

Exhibit of Capital Gains

Answer 11

contains details of net realized capital gain by asset class. It distinguishes between the gains/ losses realized on sale of the asset; and losses due to impairment.

Question 12

major investment asset classes

Answer 12

Bonds, Stocks

Cash

Cash Equivalents & Short Term Investments

Derivatives

Question 13

Bonds

Answer 13

largest asset held by insurers

they are divided into 4 categories:  US government bonds  Bonds exempt from US tax  Other bonds (unaffiliated)  Bonds of affiliates

Question 14

Exhibit of Net Investment Income shows net investment income earned from bonds, which is based on

Answer 14

Interest received during the year

Interest due & accrued

Current year’s amortization/ accretion

Interest paid for accrued interest on dividends:

Question 15

Amortization or accretion

Answer 15

arises when the purchase price of the bond is different to the face value. This difference arises because the coupon rate is different to the market interest rate at the time the bond is purchased. This premium or discount is amortized over the life of the bond. This will produce an amortized cost equal to the face value at maturity

Question 16

also earn realized capital gains (or losses) from bonds. The total gain

Answer 16

is derived in the Exhibit of Capital Gains.

It consists of: 

Realized gain on sale/ maturity (Col 1) 

Other Realized Adjustments (Col 2)

Question 17

To calculate the capital gains, the value of the bond first needs to be derived

Answer 17

When the bond is purchased, it is recorded at actual cost. This includes the brokerage and other fees

After purchase, it is valued at adjusted carrying value

Question 18

adjusted carrying value of bonds

Answer 18

• NAIC Class 1 & 2 (higher grade bonds): amortized cost: updated annually to reflect amortization/ accretion of premium/ discount
• NAIC Class 3-6 (lower grade bonds): min (amortized cost, fair value)

Question 19

Impairments occur

Answer 19

when the insurer believes that it won’t collect all the amounts due. In this case, the insurer has to treat the amount of the impairment as a realized capital loss (even if it is still holding the bond)

Question 20

investment income from common stocks consists of

Answer 20

investment income earned (dividends received; change in accrual for dividends declared but unpaid)

realized capital gains

Question 21

To calculate the capital gains, the value of common stocks needs to be derived

Answer 21

When common stocks are purchased, they are valued at the initial carrying value: actual cost plus commissions and taxes. 

After purchase, they are valued at fair value. Changes in fair value are recorded as unrealized valuation changes.

Question 22

value of preferred stocks

Answer 22

valued at the initial carrying value when purchased

Value after purchase depends on whether they are redeemable (the issuer has the option to redeem for a preset price at a specified maturity date or after a specified period of notice) or perpetual (cannot be redeemed)

Question 23

preferred stocks value after purchase

Answer 23

The highest 2 ratings of redeemable preferred stock: original purchase price + acquisition costs

The highest 2 ratings of perpetual preferred stock: fair value 

Lower rated redeemable & perpetual: min (book value, fair value)

Question 24

When a stock is sold, the difference between the amount received & the original cost is recorded as

Answer 24

realized gain/ loss

Question 25

Cash, Cash Equivalents & Short Term Investments valuation

Answer 25

Any premium or discount when the asset is purchased is amortized over its life.  Impairment is also possible, but is not common given the short duration

Question 26

If the insurer can demonstrate that a derivative has significantly reduced a particular risk exposure, it may qualify for hedge accounting

valuation using this accounting

Answer 26

the derivative receives the same accounting treatment as the hedged asset 

this allows changes in the value of the hedged asset to be offset by changes in the value of the derivative

Question 27

If the derivative does not/ no longer qualifies for hedge accounting

Answer 27

mark-to-market accounting should be used in which case any changes in fair value are recorded as unrealized gains.

Question 28

NAIC Model Investment Law allows the insurer to adopt either of the following 2 types of investment guidelines:

Answer 28

Defined Limits: quantitative limits 

Prudent Person: a principles based approach, which enables the insurer to develop its own guidelines. The insurer should:

• strive for the protection of the policyholder
• consider the investment expertise and resources available

Question 29

It is often difficult to measure investment performance, including making comparisons between companies. Analysts need to consider:

Answer 29

Size of investable assets 

Risk

Taxes

Question 30

common metric used to compare companies for investment performance and problem

Answer 30

ratio of income to average invested assets. The problem with this metric is that this does not reflect the risk

Question 31

OTHER INCOME: common elements

Answer 31

Net Gain from Agents’ or Premium Balances Charged Off: If the insurer believes that the balances won’t be collected, it needs to recognize them as a loss. This particular component includes any balances that had previously been written off and later collected. 

Finance & Service Charges not included in Premiums: This includes the service charges that the insurer adds to the premium that is paid in installments. 

Aggregate Write-ins for Miscellaneous Income: including gain on sale of equipment, retroactive reinsurance, gain on foreign exchange, corporate expenses, etc

Question 32

what are not part of Other Income, but do impact the overall income

Answer 32

Dividends to policyholders: this includes: -dividends that have been paid -change in dividends that have been declared but not yet paid 

Federal & Foreign Income Taxes: This excludes any portion deferred to future years

Question 33

Current Year’s surplus

Answer 33

= Prior Year’s Surplus + Current Year’s Net Income + Other Surplus Changes + Additional Capital Contributions – Stockholder Dividends

Net income taken from income statement

Other surplus changes: change in unrealized capital gains, nonadmitted assets, provision for reinsurance