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CAS Exam 9 > Robbin - IRR > Flashcards

Robbin - IRR Flashcards

1
Q

Measures of return (3)

Robbin - IRR

A
  1. IRR on equity flows
  2. Growth ROE model
  3. PVI/PVE
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2
Q

Indicated premium

Robbin - IRR

A

premium where expected return = target return

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3
Q

Appropriateness of fixed vs. variable premium-to-surplus (P/S) ratio

(Robbin - IRR)

A

required surplus should vary with unpaid loss estimates

> > fixed P/S ratio is not appropriate, but used for simplicity

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4
Q

UW income

Robbin - IRR

A

UW income(j) = EP(j) - incurred loss(j) - GAAP incurred expense(j)

incurred expense includes fixed & variable expenses

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5
Q

Difference in GAAP equity and statutory (SAP) equity at time 0

(Robbin - IRR)

A

deferred acquisition costs (DAC)

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6
Q

Expenses in GAAP vs. statutory (SAP) accounting

Robbin - IRR

A

GAAP - expenses are incurred as premium is earned

SAP - expenses are incurred according to a fixed pattern

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7
Q

Deferred acquisition costs (DAC)

Robbin - IRR

A

DAC = statutory incurred expenses(0) - GAAP incurred expenses(0)

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8
Q

Relationship between GAAP equity and statutory (SAP) equity at each point in time

(Robbin - IRR)

A

time 0: GAAP equity = statutory equity + DAC

all other times: GAAP equity = statutory equity

time n: GAAP equity = statutory equity = 0

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9
Q

Total assets

Robbin - IRR

A

assets(j) = UEPR(j) + loss reserve(j) + statutory expense reserve(j) + statutory equity(j)

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10
Q

Unearned premium reserve (UEPR)

Robbin - IRR

A

UEPR = premium - EP to date

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11
Q

Loss reserve (LRSV)

Robbin - IRR

A

loss reserve = incurred losses to date - paid losses to date

initial loss reserve = 0

loss reserve may need to be discounted

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12
Q

Statutory expense reserve (XRSV)

Robbin - IRR

A

statutory expense reserve = statutory incurred expenses to date - paid expenses to date

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13
Q

Invested assets (IA)

Robbin - IRR

A

invested assets(j) = assets(j) - amounts receivable(j)

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14
Q

Amounts receivable (RECV)

Robbin - IRR

A

amounts receivable = premium - premium paid to date

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15
Q

Investment income (II)

Robbin - IRR

A

investment income(j) = investment rate * invested assets(j - 1)

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16
Q

Pre-tax income (INCPTX)

Robbin - IRR

A

pre-tax income(j) = UW income(j) + investment income(j)

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17
Q

Tax amount (TAX)

Robbin - IRR

A

tax(j) = UW tax rate * UW income + II tax rate * investment income

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18
Q

After-tax income (I)

Robbin - IRR

A

after-tax income(j) = pre-tax income(j) - tax(j)

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19
Q

More realistic tax assumptions (3)

Robbin - IRR

A
  1. utilize carry-forwards & carry-backs
  2. apply reserve discounting & unearned premium disallowance
  3. deferred tax balance to reflect differences b/w tax basis & accounting basis income
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20
Q

Equity flows (definition) & signage

Robbin - IRR

A

flows of money b/w equity investor and company

negative CF = investor > company
positive CF = company > investor

21
Q

Sources of equity flows (3)

Robbin - IRR

A
  1. purchase of stock
  2. payment of dividends
  3. repurchase of stock
22
Q

Equity flow formula

Robbin - IRR

A

equity flow = income - change in GAAP equity

initial equity flow = - initial equity (b/c initial income = 0)

23
Q

Reasons that the initial equity flow is always negative (2)

Robbin - IRR

A
  1. initial commitment of equity is needed to fund initial surplus
  2. commitment of equity associated with DAC
24
Q

IRR on equity flows

Robbin - IRR

A

rate (IRR or y) that makes the PV(equity flows) = 0

25
Q

Assumption of the IRR on equity flow method

Robbin - IRR

A

assumes any capital shortfall will be corrected by equity capital

26
Q

Objections to IRR analyses (2)

Robbin - IRR

A
  1. may be multiple solutions to the IRR equation

2. implicit assumption that proceeds can be reinvested at the IRR (which may not be true)

27
Q

Situations when there will be multiple solutions to the IRR on equity flows (2)

(Robbin - IRR)

A

multiple equity flow sign changes, such as with:

  1. earning of investment income
  2. release of surplus
28
Q

PVI / PVE measure of return

Robbin - IRR

A

measure of single policy ROE

29
Q

Present value of income (PVI)

Robbin - IRR

A

PVI = (1 + income interest rate) * PV(income discounted at income interest rate)

**discounted to time 1

30
Q

Present value of equity (PVE)

Robbin - IRR

A

PV(GAAP equity discounted at the equity discount rate)

** discounted to time 0

31
Q

Appropriate interest rate for discounting income & equity in the PVI / PVE measure of return & justification

(Robbin - IRR)

A

cost of capital

justification: rate the company is able to borrow at

32
Q

Condition when PVI / PVE = IRR on equity flows return measure

(Robbin - IRR)

A

when the discount rate used = IRR

33
Q

Interpretation of IRR when PVI / PVE = IRR

Robbin - IRR

A

IRR is a PVI / PVE measure where the discount rate changes with profitability

(inconsistent with PVI / PVE method, which assumes a fixed discount rate)

34
Q

Growth ROE/book of business growth model

Robbin - IRR

A

models a book of single policy business where:

  1. new policy is written at the start of each accounting period
  2. each subsequent policy = scaled version of the prior policy (scaling = growth rate)
35
Q

ROE for the growth ROE/book of business growth model and trend over time

(Robbin - IRR)

A

ROE = EOY income / BOY GAAP equity

eventually stabilize at the equilibrium growth ROE

36
Q

Point in time when ROEs stabilize for the growth ROE/book of business growth model

(Robbin - IRR)

A

reached after all losses are paid for the single policy

37
Q

Condition when growth ROE = IRR on equity flows return measure & IRR interpretation

(Robbin - IRR)

A

g = IRR on equity flows

IRR interpretation: maximum self-sustaining growth rate

38
Q

Premium-to-surplus (P / S) ratios for the growth ROE/book of business growth model

(Robbin - IRR)

A

eventually stabilize when final single policy loss is paid

39
Q

Relationship between discounted reserves & ROEs

Robbin - IRR

A

lower reserves increase income, which increases ROE

40
Q

Relationship between growth rates and ROEs

Robbin - IRR

A

high growth rates lead to decreased ROE

41
Q

Methods to account for quarterly equity flows in the PVI / PVE method (2)

(Robbin - IRR)

A
  1. calculate PVI / PVE at a quarterly level (quarterly effective returns)
  2. annualize return by dividing equity by 4
42
Q

Indicated premium and profit provision

Robbin - IRR

A

solve for the indicated premium that yields selected return, then solve for the indicated profit provision using indicated premium

43
Q

Sensitivity of profit provision to surplus

Robbin - IRR

A

higher surplus loading factors lead to higher profit provisions

44
Q

Sensitivity of profit provision to interest rates

Robbin - IRR

A

higher interest rates/investment yields lead to lower profit provisions (b/c less UW income is needed)

45
Q

Sensitivity of profit provision to loss payment patterns/duration

(Robbin - IRR)

A

higher duration loss payment patterns lead to lower profit provisions

46
Q

Differences between the risk-adjusted discounted CF method (RA DCF) for determining the UW profit provision and the return measures in the IRR paper (4)

(Robbin - IRR)

A
  1. RA DCF finds fair premium directly rather than requiring target return on surplus
  2. RA DCF has no underlying corporate or accounting structure
  3. surplus does not play a major role in RA DCF
  4. different reflection of risk
47
Q

Differences in reflection of risk in the risk-adjusted discounted CF method (RA DCF) for determining the UW profit provision and the return measures in the IRR paper

(Robbin - IRR)

A

RA DCF reflects risk through beta in the risk-adjusted rate (systematic risk only)

return measure methods reflect risk through required surplus and spread b/w target return & after-tax investment yields

48
Q

Pricing perspectives of the risk-adjusted discounted CF method (RA DCF) vs. return measures in the IRR paper

(Robbin - IRR)

A

management & equity investors are more interested in determining indicated premium than fair premium

PH & regulators are more interested in determining fair premium than indicated premium

CAS Exam 9 (26 decks)

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