Odomirok Ch. 8 to 9

Question 1

Underwriting Income formula:

Answer 1

Earned Premium - Loss & LAE Incurred - Other Underwriting

Expenses Incurred

Question 2

List some factors that can be used to allocate expenses:

Answer 2

Premium, claim count or headcount

Question 3

List some problems that may arise if expenses are not accurately allocated:

Answer 3

• distorted profitability measures
• inefficient allocation of resources
• anti-selection

Question 4

The Exhibit of Net Investment Income divides the investment income from bonds into:

Answer 4

• Interest received during the year
• Interest due & accrued
• Current year’s amortization/ accretion
• Interest paid for accrued interest on dividends

Question 5

Net investment income earned: Where it comes from and how it’s recorded in income statement

Answer 5

• 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

Question 6

Net realized capital gain: How it’s recorded

Answer 6

-adjusted for amortization of premiums/ accretion of discounts
-realized losses can also be caused by impairment (permanent decrease in
fair value of the asset)

Question 7

Describe interest paid for accrued interest on dividends:

Answer 7

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.

Question 8

Why is amortization or accretion of bonds required:

Answer 8

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

Question 9

How are bonds valued:

- NAIC 1,2,3,4,5,6

Answer 9

NAIC Class 1-2 (higher grade bonds) = amortized cost

NAIC Class 3-6 (lower grade bonds) = Min(amortized cost, fair value)

Question 10

How to value common stocks

Answer 10

fair value

Question 11

How to value preferred stock

Answer 11

• 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)

Question 12

Formula to derive realized gain when bond is sold:

Answer 12

Amount received - adjusted carrying value

Question 13

Define redeemable preferred stock:

Answer 13

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

Question 14

Define perpetual preferred stock:

Answer 14

Preferred stock with no maturity date (i.e., can not be redeemed by the issuer)

Question 15

How can a derivative qualify to be a “highly effective” hedge:

Answer 15

If the insurer can demonstrate that a derivative has significantly reduced a particular risk exposure

Question 16

Describe hedge accounting treatment:

Answer 16

The derivative receives the same accounting treatment as the hedged asset

Question 17

How are derivatives that do not qualify for hedge accounting treated:

Answer 17

Mark-to-market accounting (any changes in fair value are recorded as unrealized gains)

Question 18

2 types of investment guidelines that are permitted by the NAIC Model Investment Law:

Answer 18

• Defined Limits: quantitative limits

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

Question 19

List some components of Other Income:

Answer 19

• 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

Question 20

Equation to derive Current Year’s surplus from prior value:

Answer 20

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

Question 21

Describe accounting treatment when stocks are issued:

Answer 21

• The amount collected associated with the par value is recorded as paid in capital
• The excess is paid-in surplus

Question 22

List of Direct Surplus Changes

Answer 22

• 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

Question 23

How do direct surplus changes flow into Net Income?

Answer 23

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.