Part 3.1 (Odomirok 8-9) (***) Flashcards
(32 cards)
Statements required to calculate Income and Surplus
Income Statement, and the Capital & Surplus Account
Income Statement
Revenue and expense components used to calculate net income
3 Types of Income
- Underwriting Income
- Investment Income
- Other Income
Capital & Surplus Account
Details on the changes in Surplus during the year
Underwriting Income (1st major category of Income in Income Statement)
UW Income = Earned Prem - Incurred LAE - Incurred Other Underwriting Expenses
Expenses (LAE & Other Underwiring Expenses)
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
Subsidies
Happen if allocation is not accurate
Distortion of profitability measures
Inefficient allocation of resources
anti-selection
Net Investment Gain
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)
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
Exhibit of Net Investment Income
- 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)
Exhibit of Capital Gains
Bonds
Stocks
Cash, Cash Equivalents, and Short Term Investments
Derivatives
Bonds (Largest Asset Held by Insurer) and the Net Investment Income Earned
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
Bonds (Largest Asset Held by Insurer) and the Capital Gains
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
Bond Capital Gains Calculation
- 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)
Valuation Rules for Bonds
> 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.
Schedules for Bonds
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
Valuation of Common Stock
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
Common Stock investment gain
Investment income earned
- Dividends received
- Change in accrual for dividends decreased but unpaid
Realized Capital gains
- Amount received - Original Cost including commission and tax
Preferred Stock 2 types
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
Valuation of Preferred Stocks
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)
Cash, Cash Equivalents, & Short Term Investments
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
Derivatives
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
Accounting of a derivative
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
Schedules for Derivatives
Schedule DB, Part 1 - Derivatives owned
Schedule DB, Part 2 - Derivatives written (sold)
Schedule DB, Part 3 - Derivates terminated during the year
Schedule DB
- 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
