Odomirok Ch. 8 to 9 Flashcards
Underwriting Income formula:
Earned Premium - Loss & LAE Incurred - Other Underwriting
Expenses Incurred
List some factors that can be used to allocate expenses:
Premium, claim count or headcount
List some problems that may arise if expenses are not accurately allocated:
- distorted profitability measures
- inefficient allocation of resources
- anti-selection
The Exhibit of Net Investment Income divides the investment income from bonds into:
- Interest received during the year
- Interest due & accrued
- Current year’s amortization/ accretion
- Interest paid for accrued interest on dividends
Net investment income earned: Where it comes from and how it’s recorded in income statement
- mainly from interest & dividends
- recorded net of investment expenses
- recorded gross of federal income taxes (but net of investment taxes)
- recorded on an accrual basis
Net realized capital gain: How it’s recorded
-adjusted for amortization of premiums/ accretion of discounts
-realized losses can also be caused by impairment (permanent decrease in
fair value of the asset)
Describe interest paid for accrued interest on dividends:
Required whenever an insurer purchases a bond between coupon payments. It needs to pay the seller for the coupons that were earned while they owned the bond.
Why is amortization or accretion of bonds required:
The coupon rate is different to the market interest rate at the time the bond is purchased. The amortization produces an amortized cost equal to the face value at maturity
How are bonds valued:
- NAIC 1,2,3,4,5,6
NAIC Class 1-2 (higher grade bonds) = amortized cost
NAIC Class 3-6 (lower grade bonds) = Min(amortized cost, fair value)
How to value common stocks
fair value
How to value preferred stock
- The highest 2 ratings of redeemable preferred stock = original purchase price +
acquisition costs. I - The highest 2 ratings of perpetual preferred stock = fair value
- Lower rated redeemable & perpetual: min (cost, amortized cost, fair value)
Formula to derive realized gain when bond is sold:
Amount received - adjusted carrying value
Define redeemable preferred stock:
Preferred stock that is redeemable at the option of the issuer at a specified maturity date, or after a specified period of notice, for a specified price
Define perpetual preferred stock:
Preferred stock with no maturity date (i.e., can not be redeemed by the issuer)
How can a derivative qualify to be a “highly effective” hedge:
If the insurer can demonstrate that a derivative has significantly reduced a particular risk exposure
Describe hedge accounting treatment:
The derivative receives the same accounting treatment as the hedged asset
How are derivatives that do not qualify for hedge accounting treated:
Mark-to-market accounting (any changes in fair value are recorded as unrealized gains)
2 types of investment guidelines that are permitted by the NAIC Model Investment Law:
- Defined Limits: quantitative limits
- Prudent Person: a principles based approach, which enables the insurer to develop its own guidelines
List some components of Other Income:
- Net Gain from Agents’ or Premium Balances Charged Off
- Finance & Service Charges not included in Premiums
- Aggregate Write-ins for Miscellaneous Income (Gain on sale of equipment, Retroactive Reinsurance gain, Gain on Foreign
Exchange, Corporate Expenses, Fines & penalties) - Dividends to policyholders:
- Federal & Foreign Income Taxes
Equation to derive Current Year’s surplus from prior value:
= Prior Year’s Surplus + Current Year’s Net Income + Other Surplus Changes + Additional Capital Contributions + Stockholder Dividends
Describe accounting treatment when stocks are issued:
- The amount collected associated with the par value is recorded as paid in capital
- The excess is paid-in surplus
List of Direct Surplus Changes
- Change in unrealized Capital Gains
- Change in Net Unrealized Foreign Exchange Capital Gains
- Change in Net Deferred Income Tax
- Change in Nonadmitted Assets
- Change in Provision for Reinsurance
- Cumulative Effect of Changes in Accounting Principles
- Capital Changes and Surplus adjustments: (Change in surplus notes & change in gross paid in surplus)
- Dividends to stockholders
How do direct surplus changes flow into Net Income?
They don’t! Direct surplus changes do not flow into the income statement and must be adjusted for in order to match up with the balance sheet.
