Part 16 (Odomirok 22&23) (***)

Question 1

Who is SAP mainly used by, and what is it mainly focused on

Answer 1

Used by Regulators

Focus on surplus adequacy (insurer’s ability to pay claims)

Question 2

Who is GAAP mainly used by, and what is it mainly focused on

Answer 2

Used by Investors and Creditors

Focused on measurement of earning emergence

Question 3

What are the 11 differences that need to be known between SAP & GAAP

Answer 3

• Deferred acquisition costs (DAC)
• Premium deficiency reserves (PDR)
• Nonadmitted assets
• Deferred Tax Assets (DTAs)
• Invested assets
• Balance sheet presentation of reinsurance
• Ceded reinsurance (prospective and retroactive)
• Structured Settlements
• Anticipated Salvage and Subrogation
• Discounting of loss reserves
• Goodwill under purchase accounting

Question 4

Difference in DAC

Answer 4

Deferred Acquisition Costs

GAAP, insurers can create DAC asset to defer recognition of acquisition expenses to match the recognition of earned premium

SAP does not allow deferring of expenses, all costs expensed as incurred. Immediate hit to surplus when policy written

SAP also requires a liability to be created to reflect ceding commission that exceeds the acquisition costs for reinsurance agreement.

Question 5

Difference in PDR

Answer 5

Premium Deficiency Reserves

Under SAP, commissions and acquisition costs are typically expensed at inception and do not need to be factored into the UEPR calculation.

Difference in presentation:
GAAP: PDR exists, first net from DAC, if Completely eliminates DAC, excess recognized as PDR liability
SAP: PDR recognized as write in liability or in UEPR balance

Question 6

Difference in Nonadmitted Assets

Answer 6

SAP does not include assets in Statutory Surplus Calculation
GAAP does not have a nonadmitted assets category, but instead all assets contribute towards surplus

Question 7

Brief summary of DTA

Answer 7

Tax accounting requires that reserves be discounted, which is not usually permitted under statutory accounting. This discount eventually reduces to 0, which will increase the future incurred losses (reducing the future taxable income).

The deferred tax asset recognizes this future reduction in taxable income.

Question 8

Difference in DTA

Answer 8

GAAP: Fully Recognizes the DTA, but creates valuation allowance if it is more likely than not that the DTAs will not be recognized

SAP: Strict test to allow recognizing of DTA, in addition to valuation allowance. Admitted portion is capped.

Question 9

Difference in Invested Assets

Answer 9

SAP:
Type of Asset | Valuation
Investment grade bond & Higher rated redeemable preferred stocks
Amortized Cost

Lower Rated Bonds & Lower Rated Preferred Stocks
Min( Amortized Cost, Fair Value)

Common Stocks and Higher rated non redeemable preferred stocks
Fair value

GAAP:
Available for Sale Fair Value
Held to Maturity Amortized Cost
Held for Trading Fair Value

Classification is made when Invesment is acquired

Question 10

Difference in Prospective Reinsurance

Answer 10

Differ in treatment in anticipated reinsurance recoveries on Losses unpaid by the ceding company

SAP: Records the reserves net of anticipated reinsurance recoveries

GAAP: Establishes Asset to recognize the ceding reinsurance recoverable
since usually does not allow offsetting of assets and liabilities

Question 11

Difference in Retroactive Reinsurance

Answer 11

SAP:
- Undiscounted ceded reserves are recorded as negative write in liabilities
- A gain may be generated if the consideration paid is less than the negative write in liability
- Gain treated as write-in gain as part of other income
- Gain has surplus benefit, treated as special surplus until paid reinsurance recovery exceeds consideration paid

GAAP:
- Ceded Reserves are treated as a reinsurance recoverable asset
- Gain is deferred

Question 12

Structure Settlements and the release of liability

Answer 12

An insurer uses this by buying an annuity from a life insurer
Claimant then sign’s a release of liability (but doesn’t have to)

Question 13

Difference in Structure Settlements if release is signed

Answer 13

If Release of Liability is signed:
SAP & GAAP treatment is the same
- Purchase price of annuity is recorded as paid loss
- Claim is closed

Question 14

Difference in Structure Settlements if released is NOT signed

Answer 14

SAP: Treatment is the same as the case where there is a release
- But insurer must also disclose the contingent liability in the Notes to the Financial Statements

GAAP: Reinsurance recoverable asset must be created

Question 15

Difference in Anticipated Salvage and Sub

Answer 15

SAP: Insurer can choose whether to record to the Schedule P reserves gross or net of anticipated salvage and sub

GAAP: Insurer must subtract the anticipated balances

Question 16

Difference in Reserve discounting

Answer 16

SAP: Rarely allows discounting apart from Tab/Non Tab discounting
- Does not specify discount rate, although typically 3.5% is used

GAAP: Allows the SAP discount to be used
- Also gives option to use reasonable alternative discount rate

Question 17

SAP
What is Goodwill
What is it capped at
What is it amortized to

Answer 17

Difference between the purchase price and net book value

Capped at 10% of acquiring firm’s capital and surplus from most recent annual statement

Amortized to unrealized capital gains and losses over the period in which the acquiring firm benefits economically (up to 10 years)

Question 18

SAP
What is negative goodwill recorded as

Answer 18

A contra asset (negative valued asset)

Question 19

GAP
What is Goodwill

Answer 19

Assets and Liabilities are recorded at fair value
Goodwill is purchase price - fair value of net assets
Not automatically amortized, regularly evaluated for impairment

Question 20

GAP
How is negative goodwill treated

Answer 20

First used to offset the book value of the acquired non-current assets

Residual is recorded as a bargain purchase gain in the income statement

Question 21

What are the 3 reports SEC required by GAAP

Answer 21

• 10-K
• 10-Q
• 8-K

Question 22

What are the 4 points included in 10-K

Answer 22

Part 1: Business description/Risk Factors/Unresolved Comments from the SEC matters subject to vote by shareholders

Part 2: Financial Statements/ Supplementary data/ Management’s discussion and analysis of results/ controls and procedures

Part 3: Directors and officers/ executive compensation/ securities ownership by certain beneficial owners and management/ fees of principle accountant

Part 4: Reports, Exhibits and Schedules from any 8-K filed

Question 23

What is the 10-Q

Answer 23

An abbreviated version of the 10-K

Question 24

What is the 8-K filed to disclose

Answer 24

• Change in principal officers or directors
• Change in the company’s certified accountant
• Entering/ terminating a material definitive agreement

Question 25

The SEC reporting requirements are outlined in what 2 regulations

Answer 25

• Regulation S-X: Form and Content of financial statements
• Regulation S-K: Integrated Disclosure rules

Question 26

What does Regulation S-X require the insurer to state the following in its Notes to the Financial Statements

Answer 26

• Basis of assumptions (eg. interest rates)
• Deferred acquisition costs amortized during the period
• Statutory stockholders equity

Question 27

What does Regulation S-X require the insurer to include in the 10-K

Answer 27

• Schedule III: Supplemental insurance info for reach reporting segment
• Schedule IV: Reinsurance
• Schedule VI: Supplemental information

Question 28

Regulation S-K needs these items to be disclosed

Answer 28

• Tabular analysis of the changes in aggregate reserves for unpaid claims and claim adjustment expenses for each of the latest 3 one year periods. (including: beginning reserve, reserve development during CY, Paid losses and ending reserve)
• Method to estimate the effects of inflation
• Reconciliation between SAP and GAAP reserves for unpaid claims and claim adjustment expenses, including an explanation of the key differences
• Amount of discount of the GAAP loss reserves

Question 29

Tabular analysis disclosure needed for Regulation S-K

Answer 29

Tabular analysis of the

• changes in aggregate reserves for unpaid claims and claim adjustment expenses
• for each of the latest 3 one year periods.
• includes: beginning reserve, reserve development during CY, Paid losses and ending reserve

Question 30

Fair Value of Loss Reserves is based on 3 peices

Answer 30

• Future cash flow
• Adjustments to reflect time value of money and illiquidity
• Risk adjustment

Question 31

How is risk adjustment calculated

Answer 31

Using the Cost of capital approach

Question 32

Cost of Capital approach

Answer 32

1. Calculate capital required at each date
2. Excess return = captial_required * ( ROC_required - risk_free_rate - illiquidity prem)
3. Risk margin = PV of the excess returns (discounted at risk_free_rate + illiquidity premium)

Question 33

Why is illiquid liability preferred

Answer 33

There is more flexibility to invest money, since there is long time before payments