Part 3.1 (Odomirok 8-9) (***) Flashcards

1
Q

Statements required to calculate Income and Surplus

A

Income Statement, and the Capital & Surplus Account

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2
Q

Income Statement

A

Revenue and expense components used to calculate net income

3 Types of Income
- Underwriting Income
- Investment Income
- Other Income

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3
Q

Capital & Surplus Account

A

Details on the changes in Surplus during the year

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4
Q

Underwriting Income (1st major category of Income in Income Statement)

A

UW Income = Earned Prem - Incurred LAE - Incurred Other Underwriting Expenses

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5
Q

Expenses (LAE & Other Underwiring Expenses)

A

Allocated in 3 different ways in the annual Statement

NAIC operating expense classifications
- Includes 24 types of expenses
- Rows of U&IE, Part 3

Expense Categories
- Grouped by operational function
- LAE, Other UW Expenses, Investment Expenses

Line of Business
- IEE segments the expenses into the lines of business listed in the U&IE, part 2A

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6
Q

Subsidies

A

Happen if allocation is not accurate

Distortion of profitability measures
Inefficient allocation of resources
anti-selection

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7
Q

Net Investment Gain

A

Shown in the Income Statement and divided into two components

Net Investment Income Earned
- Segments the investment income from the different asset classes
- Lists deductions required to convert gross investment income to net investment income
> Mainly from interest and dividends
> Net of investment expenses
> Gross of taxes
> Recorded on an accrual basis

Net Realized Capital Gains
- Also segments by asset class
- Distinguishes between gain/losses realized on sale of the asset and losses due to impairment and foreign exchange (second column)

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8
Q

Net Investment Income Earned

A
  • Segments the investment income from the different asset classes
  • Lists deductions required to convert gross investment income to net investment income
    > Mainly from interest and dividends
    > Net of investment expenses
    > Gross of taxes
    > Recorded on an accrual basis
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9
Q

Exhibit of Net Investment Income

A
  • Also segments by asset class
  • Distinguishes between gain/losses realized on sale of the asset and losses due to impairment and foreign exchange (second column)
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10
Q

Exhibit of Capital Gains

A

Bonds
Stocks
Cash, Cash Equivalents, and Short Term Investments
Derivatives

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11
Q

Bonds (Largest Asset Held by Insurer) and the Net Investment Income Earned

A

Exhibit of Net Investment Income shows the Net Investment income based on:

> Interest received during the year
- On a cash flow basis, so needs to be added to the change in interest due & accrued in order to calculate income

> Interest due & accrued

> Current year’s amortization/accretion
- When purchase price of bond is different to face value
- Ie when Coupon rate different to the market interest rate at time bond bought
- Amortized cost equal to the face value at maturity since prem or discount is amortized over the life of the bond

> Interest paid for accrued interest on dividends
- Required whenever an insurer purchases a bond between coupon payments
- A portion of the coupon was “earned” by seller so purchaser should reimburse this amount

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12
Q

Bonds (Largest Asset Held by Insurer) and the Capital Gains

A

Total gain shown in Exhibit of Capital Gain by:

> Realized gain on sale/maturity (Col 1)

> Other Realized Adjustments (Col 2)
- Foreign exchange gain on disposal
- Other than temporary impairments

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13
Q

Bond Capital Gains Calculation

A
  1. Find value of bond
    - When bond is purchased, it is recorded at actual cost, which includes brokerage and other fees
    - After purchase, it is valued at adjusted carrying value

Adjusted Carrying Value
> NAIC Class 1-2 (higher grade) = Amortized Cost (updated annually)
> NAIC Class 3-4 (lower grade) = Min(Amortized Cost, Fair Value)

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14
Q

Valuation Rules for Bonds

A

> If adjusted to the fair value, the adjustment is treated as an unrealized loss

> When sold, the realized gain is the difference between the amount received and the adjusted carrying value

> If a bond is valued at amortized cost (higher grade) because held till maturity, no capital gain/loss occurs over the life of the bond

> Foreign currency bonds are impacted by changes in the exchange rates. This impact is included in the adjusted carrying value, but is not realized until the bond is sold.

> “Other than temp Impairments” occur when an insurer won’t collect all the amounts due. Treat the amount of the impairment as a realized capital loss.

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15
Q

Schedules for Bonds

A

Schedule D, Part 1 - Long term bonds owned
Schedule D, Part 2 - Long term bonds sold, redeemed, disposed of
Schedule DA, Part 1 - Bonds with 1 year or less maturity

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16
Q

Valuation of Common Stock

A

When being held valued at fair value.

Changes in fair value are recorded as unrealized valuation changes.
- Fair value obtained from a stock exchange
- If not publicly traded, value is determined by NAIC’s (Security Valuation Office) SVO

17
Q

Common Stock investment gain

A

Investment income earned
- Dividends received
- Change in accrual for dividends decreased but unpaid

Realized Capital gains
- Amount received - Original Cost including commission and tax

18
Q

Preferred Stock 2 types

A

Redeemable
- The issuer has the option to redeem for a preset price at a specified maturity date, or after a specified period of notice

Perpetual
- Cannot be redeemed

19
Q

Valuation of Preferred Stocks

A

Highest two rated redeemable preferred
- Valuation = Amortized Cost

Highest two rated perpetual preferred
- Valuation = Fair Value

Lower rated bonds & Lower rated Preferred stocks
- Valuation = Min(Amortized Cost, Fair Value)

20
Q

Cash, Cash Equivalents, & Short Term Investments

A

Assets immediately convertible to cash & have an original maturity of a year or less

> Any premium or discount when the asset is purchased is amortized over its life
Not receiving premium (impairment) is possible, but not common since short duration

21
Q

Derivatives

A

Contract between two parties where the value depends on the value of a particular asset or variable

Used to hedge exposure to a risk

High profile, can cause failure of insurance group in financial crises

22
Q

Accounting of a derivative

A

Highly effective Hedge
- If it can be demonstrated the derivative has significantly reduced a particular risk exposure
- Derivative receives same accounting treatment as the hedged asset (used to offset asset)

Mark-To-Market
- If not the case above

23
Q

Schedules for Derivatives

A

Schedule DB, Part 1 - Derivatives owned
Schedule DB, Part 2 - Derivatives written (sold)
Schedule DB, Part 3 - Derivates terminated during the year

24
Q

Schedule DB

A
  • lists info about counterparties for all derivatives that are open at year end.
  • number of contracts for each derivative
  • notional amount (number of units of the underlying asset involved)
  • dates of purchase and maturity
  • transaction price
  • current price
  • type of risk being hedged
25
Q

Investment Guidlines

A

Governed by State investment laws

NAIC Model Investment Law

26
Q

NAIC Model Investment Law

A

Two types of guidelines

> Defined Limits - established quantitative limits that the insurer has to follow

> Prudent Person - Principles based approach, enables the insurer to develop its own guidelines
- need to strive for protection of the policyholder
- consider the investment expertise and resources available

27
Q

Measuring Investment Performance

A

Consider, but not solely:
- Size of Investable assets
- Risks
- Taxes

Ratio of income to average invested assets
- Common
- Does not reflect the risk

Investment performance between companies
- Income statement presents the “net realized capital gains” after capital gains tax, so differences may be due to tax rates

28
Q

Other Income (3rd major category of Income in Income Statement)

A

> Net gain from agents or premium balances charged off

> Finance and service charges not included in premiums

> Aggregate write-ins in miscellaneous income
- Input on a new line since uncommon

> Dividends to policyholders in cash (Not actually other)
- That have been paid
- Change in dividends that have been declared but not yet paid

> Federal & Foreign Income Taxes
- Excluders any portion deferred to future years

29
Q

Current Year Surplus

A

Prior Year Surplus + Current Year Net Income + Direct Surplus Changes

30
Q

How to get Net Income

A

Taken from Income Statement

31
Q

How to get Direct Surplus Changes

A

Change in:
- Unrealized Capital Gains
- Net Unrealized Foreign Exchange capital gains
- Net Deferred Income Tax
- Nonadmitted Assets
- Provision for Reinsurance

Cumulative Effect of Changes in Accounting Principles
- e.g. impact from changing recording gross of to net of

Capital Changes & Surplus Adjustments

Dividends to stockholders (paid out as cash)
- only paid from unassigned surplus (not assigned to the par value of stock etc)

32
Q

Capital Changes & Surplus Adjustments

A

Changes in capital due to issuance of stock
- Paid in capital is the amount collected associated with the par value
- Paid in surplus is the excess

Changes due to return of capital

Impact of Stock dividends (do not impact total surplus balance, but reallocation of surplus to capital)
- Paid out as stock