Part 16 (Odomirok 22&23) (***) Flashcards
Who is SAP mainly used by, and what is it mainly focused on
Used by Regulators
Focus on surplus adequacy (insurer’s ability to pay claims)
Who is GAAP mainly used by, and what is it mainly focused on
Used by Investors and Creditors
Focused on measurement of earning emergence
What are the 11 differences that need to be known between SAP & GAAP
- 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
Difference in DAC
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.
Difference in PDR
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
Difference in Nonadmitted Assets
SAP does not include assets in Statutory Surplus Calculation
GAAP does not have a nonadmitted assets category, but instead all assets contribute towards surplus
Brief summary of DTA
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.
Difference in DTA
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.
Difference in Invested Assets
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
Difference in Prospective Reinsurance
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
Difference in Retroactive Reinsurance
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
Structure Settlements and the release of liability
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)
Difference in Structure Settlements if release is signed
If Release of Liability is signed:
SAP & GAAP treatment is the same
- Purchase price of annuity is recorded as paid loss
- Claim is closed
Difference in Structure Settlements if released is NOT signed
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
Difference in Anticipated Salvage and Sub
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
Difference in Reserve discounting
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
SAP
What is Goodwill
What is it capped at
What is it amortized to
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)
SAP
What is negative goodwill recorded as
A contra asset (negative valued asset)
GAP
What is Goodwill
Assets and Liabilities are recorded at fair value
Goodwill is purchase price - fair value of net assets
Not automatically amortized, regularly evaluated for impairment
GAP
How is negative goodwill treated
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
What are the 3 reports SEC required by GAAP
- 10-K
- 10-Q
- 8-K
What are the 4 points included in 10-K
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
What is the 10-Q
An abbreviated version of the 10-K
What is the 8-K filed to disclose
- Change in principal officers or directors
- Change in the company’s certified accountant
- Entering/ terminating a material definitive agreement
The SEC reporting requirements are outlined in what 2 regulations
- Regulation S-X: Form and Content of financial statements
- Regulation S-K: Integrated Disclosure rules
What does Regulation S-X require the insurer to state the following in its Notes to the Financial Statements
- Basis of assumptions (eg. interest rates)
- Deferred acquisition costs amortized during the period
- Statutory stockholders equity
What does Regulation S-X require the insurer to include in the 10-K
- Schedule III: Supplemental insurance info for reach reporting segment
- Schedule IV: Reinsurance
- Schedule VI: Supplemental information
Regulation S-K needs these items to be disclosed
- 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
Tabular analysis disclosure needed for Regulation S-K
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
Fair Value of Loss Reserves is based on 3 peices
- Future cash flow
- Adjustments to reflect time value of money and illiquidity
- Risk adjustment
How is risk adjustment calculated
Using the Cost of capital approach
Cost of Capital approach
- Calculate capital required at each date
- Excess return = captial_required * ( ROC_required - risk_free_rate - illiquidity prem)
- Risk margin = PV of the excess returns (discounted at risk_free_rate + illiquidity premium)
Why is illiquid liability preferred
There is more flexibility to invest money, since there is long time before payments
