CAS Exam 6

Intro III. Jurat

First page of Annual Statement. Provides basic information on reporting entity.

CH6/7. Coupon Bond

Instrument that makes interest payments during the term, returns principal at maturity.

CH 6/7. Premium over 90 days overdue

Nonadmitted and treated as a bad debt (impairment)

CH6/7. Non-invested Assets

Relatively illiquid assets and are largely not allowed (nonadmitted) on the BS.

CH6/7. Cash & Invested Assets

Relatively liquid assets and are largely allowed (admitted) on the BS.

CH 6/7. Premium Deficiency Reserve (PDR)

This is included in BS as a separate liability when premium is insufficient to cover losses and expenses.

CH2. SAP/GAAP Loss Reserves and Reinsurance

SAP - recorded net of reinsurance GAAP - recorded gross of reinsurance

CH1. US Business Taxable Income and SAP

SAP income used for insurance companies as starting point for Federal income tax.

CH 8/9. Details about held bonds

Schedule D, Part 1 (long term bonds owned) Schedule D, Part 4 (long term bonds sold, redeemed or disposed of) Schedule DA, Part 1 (bonds with mat 1 yr or less)

CH1. IFRS 4

Standards for recognition and measurement of insurance contracts. IFRS 4 says insurance company can report under local accounting rules. Mod ex: establish PDR.

CH 8/9. Problems with Bad Expense Allocation

Subsidies may arise and cause problems: 1) Can distort profitability measures 2) Inefficient allocation of resources 3) Adverse selection

CH 8/9. Unassigned Surplus

Surplus not assigned to par value of stock, special surplus funds, surplus notes, or treasury stock.

Intro III. The Blank

Template that insurance companies use to report under SAP, for all states.

CH 8/9. NAIC Model Investment Law - Investment Guideline Options

1) Defined Limits - NAIC stipulates the types and amounts of assets an insurance company can invest in 5% limit of admitted assets with any single issuer (exceptions for government bonds) • 1% limit of admitted assets with any single issuer with rating of NAIC 3 • 0.5% limit of admitted assets with any single issuer with rating of NAIC 4 or lower • 20% limit of admitted assets in all securities rated NAIC 3 or lower • 10% limit of admitted assets in all securities rated NAIC 4 or lower • 5% limit of admitted assets in all securities rated NAIC 5 or lower • 1% limit of admitted assets in all securities rated NAIC 6 • 25% limit of admitted assets or 100% of surplus in all common stocks 2) Prudent Person - Investments are evaluated based on the guidelines and standards of the company: a) Insurer should protect the policyholder b) Consider investment expertise and resources available

Ch 8/9. For currency bond valuation

1) Exchange rate differences present in adjusted carrying value 2) Impact of these differences unrealized until bond is sold

CH 8/9. Bond valuation rules

1) Fair value published by NAIC Valuation of Securities Manual 2) Schedule D, Part 1 has NAIC designation, actual cost, fair value, par value, book/adjusted carrying value. 3) If valuation is adjusted to fair value, then adjustment is an unrealized loss 4) When bond is sold, realized gain = amount received - adjusted carrying value

CH 8/9. Calculate preferred stock capital gains (Unaffiliated)

1) Initial carrying value (when purchased) 2) If 2 highest rating: a) redeemable preferred: orig purchase price + acq costs (or use amortized cost if given) b) perpetual preferred: fair value 3) if lower rated: min (book value, fair value) Redeemable - Must be redeemed by issuer, but holder as an option to redeem Perpetual - Issuer has a redeem option, or no option exists at all.

CH 6/7. Nonadmitted Assets (Approx 3% of industry assets)

1) Investment in bonds, stocks, mortgage loans/real estate in xs of specific limits set by state 2) Investments in electronic data processing equipment & software exceeding set limits 3) Furniture, equipment & supplies 4) Balances due from an agent from sale of a security, overdue by over 15 days from settlement 5) Funds held by ceding company that exceed the associated liabilities. 6) 10% of deductibles recoverable in excess of collateral 7) Premiums > 90 days overdue 8) DTAs that fail the admissibility test 9) Permanent excess of book over market for real estate 10) Interest due and accrued > 90 days overdue 11) 10% of accrued retrospective premium

CH 8/9. Stock Investment Income

1) Investment income earned: a) dividends received b) change in accrual for dividends declared but unpaid 2) realized capital gains

CH 8/9. Causes for Change in Surplus

1) Unrealized Cap gains - Inc 2) Unrealized Foreign Exchange Cap Gains - Inc 3) Net Deferred Income Tax - Inc 4) Nonadmitted asset - Dec 5) Provision for Reinsurance - Dec 6) Changes in Accounting Principles - Only impacts beginning surplus 7) Capital Changes/Surplus Adjustments a) Issuance of stock (paid in capital/paid in surplus) - Inc b) Return of capital - Dec c) Transfer from surplus to capital (no change) 8) Dividends to stockholders - Dec (paid from unassigned surplus)

F Surplus. Accounting Non-Admin Assets

1) Write off NMA as expense in IS 2) Classify asset as "nonadmitted" and charge surplus directly

Intro III. Annual Statement contents

1. Jurat 2. Statutory financial statements 3. General interrogatories 4. 5year historical data 5. Schedules A, B, BA, D, DA, F, P, T, and Y.

Ch 6/7. Underwriting & Investment Exhibit, Part 3 Expense categories

Col1: LAE Col2: Other underwriting expenses Col3: Investment expenses Insurer must allocate expenses to above groups. Can impact BS because of impacts reserves.

CH 8/9. Compare investment between companies

Consider 1) Size of investable assets 2) Level of risk in the investment portfolio 3) Taxes Note: investment income / premium and size of investment income do not accurately reflect performance because they do not consider invested asset base. ***Can use ratio of income to average invested assets. Does not reflect risk.

CH 8/9. Exhibit of Capital Gains

Contains details of net realized capital gains by asset class. Separates losses due to impairment.

CH 8/9. Derivative

Contract between two parties where the value depends on the value of a particular asset. Schedule DB, 1: Derivatives owned Schedule DB, 2: Derivatives sold Schedule DB, 3: Derivatives terminated during year Schedule E: Has derivative counterparty exposure open at year-end

CH5. Fair value vs historical cost

Fair value - value the asset could be bought or sold for in the open market. Historical cost is original purchase price less depreciation. Historical cost is more reliable; fair value is more accurate.

CH1. FASB/GASB

Federal Accounting Standards Board which has authoritative accounting guidance for nongovernmental entities./Governmental Accounting Standards Board is over govermental entities.

CH 6/7. Net Deferred Tax Assets

Future tax benefits that arise due to temporary differences in income recognition between tax and statutory accounting. This may be due to the accelerated recognition of income under tax accounting. Usually book a DTA net of DTL.

CH 8/9. Schedule E Contents

Information about counterparties for all derivatives open at year end.

Ch 6/7. Stocks

Instruments that represent an ownership share in a company. Provide voting rights, and possible dividends. Preferred stocks do not offer voting rights, but do guarantee dividends. These stock owners hold priority on investment returns over common stock owners during liquidation

CH4. Liquidity issues

Insurance companies collect premiums at policy inception, and therefore are less burdened by illiquid assets.

F Surplus. Adv/Disadv of NMA Methods

Method 1: Insurer must keep separate set of books for GAAP & Statutory accounting Method 2: GAAP books only and derive SAP by subtracting out the nonadmitted column.

CH1. NAIC?

National Association of Insurance Commissioners is an org. of state regulators that coordinates governance in the US, but does not impose law (states do).

F Surplus. Nonequivalence of BS and IS

Nonadmitted assets will reduce the surplus according to BS definition, but no change to IS Surplus.

CH 6/7. Receivables from Parent, Subsidiary & Affiliates

Not as liquid as other asset classes.

CH 8/9. Impairments

Occur when insurer believes it won't collect all amount due. Treated as realized capital loss.

CH 8/9. Bond Amortization/Accretion

Occurs when purchase price of bond differs from face value. Treated as investment income. Can happen when coupon rate differs from market interest rate when bond is purchased. The premium or discount is amortized over the life of the bond. Thus the maturity amortized cost = Face value. Overall effective yield in each period equals market rate

CH5. Liquidation vs going concern

Perspective of viewing a company as either an ongoing business, or a collection of assets being sold or traded. GAAP - presents results that closely measure financial performance during reporting period SAP - presents results that measure asset value during runoff.

CH 6/7. Ceded reinsurance premiums payable

Premiums owed to reinsurers for ceded business. Record these net of any commission

CH4. Balance Sheet

Presents A and L as of a specific date.

CH4. Cash Flow Statement

Presents all operational payments or receipts strictly from a cash perspective. The timing is not related to when assets or liabilities are recognized.

CH4. Income Statement

Presents net income (net loss) during a specific time period (usually using revenue and expenses).

CH1. Statutory Accounting Principles

Princ/Pract prescribed or permitted by insurer's domiciliary state regulators.

CH5. Principle-based vs rule-based

Principle describes a general approach that must be interpreted. Rule describes specifically what must be done.

CH4. Definition of a Liability

Probable sacrifices of economic benefit arising from present obligations of a company to transfer assets or provide services to other entities in the future, as a result of past events.

CH1. SEC Mission

Protect investors, maintain fair, orderly and efficient markets, and facilitate capital formation.

CH1. Codification of SAP

Provides common set of principles that ind. states can follow to ease regulatory burden on companies/promote consistency. Probably published in the NAIC Accounting Practices and Procedures Manual.

CH 8/9. Exhibit of Net Investment Income

Provides details by asset class. a) Differentiates between income earned (accrual) and income collected ($ flow). b) Deductions for investment expenses and other costs

CH 8/9 stock impairment

Recognize a permanent reduction in value as impairment.

CH4. Capital and Surplus Statement

Reconciles ending surplus with beginning surplus for a reporting period.

CH1. Acceleration of Income for Tax Purposes

Reduction of unearned premiums and discounting of loss reserves.

CH2. Tabular Discounted Reserves/What's not Included?

Reserves discounted for things like mortality, remarriage, inflation. Does not include medical loss reserves or LAE reserves.

CH4. Definition of Asset

Resources obtained or controlled by a company as a result of past events that have a probable future economic benefit to the company

CH5. Adv of principle-based and rule-based accounting

Rule: Easy to understand and audit Principle: More adaptable to changing business environments.

CH1. GAAP DAC

SAP expenses are not deferred, but GAAP expenses are deferred in effort to match expenses with earnings over time.

CH1. SAP Conservatism

SAP has conservative rules which provide early warnings of solvency problems. They also lower the surplus measure relative to other accounting systems.

CH 6/7. Real Estate and Schedule A

Schedule A has details of real estate transactions and holdings 1) Properties occupied by company (50% or more of property): Orig Cost - Dep - Encum. 2) Properties held for production of income: Orig Cost - Dep - Encum 3) Properties helf for sale: Min(Dep Cost, Fair value)

CH 8/9. Allocating Expenses

Should be based on pertinent factors (premium, claim count, or headcount)

CH 8/9. Investment Income from Bonds

a) Interest received during year (must modify to accrual basis in order to calc net income) b) Interest due & accrued c) Current year's amortization/accretion d) Interest paid for accrued interest on dividends (insurer pays seller for time seller held bond between coupon dates)

CH 8/9. Schedule DB details

1) # of contracts for derivative 2) Notional amount 3) Original trade and mat/exp dates 4) Transaction price 5) Current price 6) Information about item hedged

CH4. Primary financial statements

1) Balance Sheet 2) Income Statement 3) Statement of capital and surplus 4) Statement of cash flow

CH 6/7. Surplus Common Components

1) Common capital stock - par value on stock issued outstanding. 2) Gross paid in & contributed surplus -excess of sale price over par value when insurer issues stock 3) Unassigned funds - contribution of retained earnings to surplus. Note mutual insurers surplus consists primarily from unassigned funds.

CH 6/7. Unearned premiums, Part 1 in U&IE

1) Daily pro rata method: based on # days expired (more common) 2) Monthly pro rata method: assumes premiums are written evenly each month. Uses middle of the month rule.

CH 8/9. Calculate common stock capital gains (Unaffiliated)

1) Initial carrying value = actual cost + comm and taxes 2) After initial purchase, carried at fair value. Changes in fair value recorded as unrealized valuation changes. 3) If stock is not publicly traded, refer to NAIC Security Valuation Office

F Surplus. Examples of NMA

1) Interest due & accrued 90 days overdue 2) Accrued retrospective premium (10% NMA) 3) Real Estate - (permanent) excess of book value over market value

Ch 6/7. Loss Liabilities

1) Loss and LAE Note: Booked at Management's best estimate. Midpoint is booked in cases where management has only a range of estimates. 2) Reinsurance payable on L & LAE 2) Other expenses incurred but not paid. Taxes, Licenses, Fees not included.

CH 6/7. Two common sources of DTA

1) Loss reserves discounted in tax accounting, but undiscounted in SAP accounting. 2) Carry forward net operating loss from prior years

CH 8/9. Other Income Accounts

1) Net Gain from Agents' or Premium Balances Charged Off - used as a write-off when insurer doesn't think it will receive money. 2) Finance & Service Charges (includes premium installment fees) 3) Aggregate Write-ins for Misc. Income a) Gain on sale of equipment b) Retroactive Reinsurance c) Gain on Foreign Exchange d) Corporate Expenses e) Fines & penalties of regulatory authorities 4) Dividends to policyholders (paid or declared but unpaid) 5) Federal & Foreign Income Taxes (excludes portion deferred to future years)

CH 8/9. 2 Components of Investment Income

1) Net Investment Income Earned: a) mainly interest and dividends b) recorded net of investment expenses c) recorded gross of taxes d) accrual bases (reflected in year earned, not in year cash transferred) 2) Net realized capital gain a) adjusted for amortization of bond premium/accretion of bond discounts b) realized losses can be caused by impairment

F Surplus. Statutory Liabilities

1) Provision for Reinsurance - Affects BS, but not IS. Direct charge to surplus. 2) PDR - Direct charge to surplus

CH 8/9. Bond realized capital gain (loss)

1) Realized gain on sale/maturity 2) Other adjustments (?) a) Foreign exchange gain on disposal b) Other than temporary impairments

CH 8/9. Calculating capital gain

1) Record bond purchase at actual cost (includes brokerage and fees) 2) After purchase, value at amortized cost (for NAIC 1&2), or at min(amortized cost, fair value) (for NAIC 3-6).

CH 6/7. Schedule D Bond Info

1) Type of issuer (federal, state, corporate), 2) Maturity, 3) NAIC Class

CH2. 7 ways actuary work areas impacted by accounting convention

1) Working with regulators to monitor financial health of an insurer 2) Pricing/product development (profit margins) 3) Determining capital requirements 4) Evaluating risk transfer of reinsurance contracts 5) Reserve adequacy for non-insurance entities (e.g. self insurer) 6) Preparing tax returns 7) Appraising/valuing companies in merger/acqs

CH1. Stakeholders of an insurance company?

1. Policyholders, 2. Claimants, 3. Investors, 4. Directors of the board, 5. Company management, 6. IRS, 7. Employees

CH 8/9. Underwriting and Investment Expenses - Overview

24 types in 3 groups. On Part 3 of U&IE. Grouped by operational function: 1) LAE, 2) Other Underwriting Expenses, and 3) Investment Expenses Organized by LoB in Part 2A.

CH 8/9. Current Year Surplus

= PY Surplus + CY NI + Other Surplus Changes + Addt'l Cap Cont's + Stockholder Divs

CH4. Net Worth (Equity)

A - L; measures a company's ability to use A to satisfy L. For insurance company reporting under SAP, Net Worth = Statutory Surplus (Policyholder Surplus)

CH6. Permitted Practices

Accounting practices permitted by the state that differ from NAIC SAP.

F Surplus. Debit v Credit

Accounts increased with a debit 1) Dividends 2) Expenses 3) Assets Accounts increased with a credit 1) Gains 2) Income 3) Revenues 4) Liabilities 5) Stockholder's Equity 6) Surplus

CH 6/7. BS Item - Amounts recoverable from reinsurers (Schedule F)

Balances due on paid losses. Balances on unpaid losses are not included. The unpaid loss liability has already been reduced to net recovery.

CH6/7. Primary Asset for Insurers

Bonds

CH 8/9. Investment Bond Asset Classes

Bonds - largest asset class for insurers a) US gov bonds b) Bonds exempt from US tax c) Other bonds (unaffiliated) d) Bonds of affiliates

CH1. Purpose of financial report?

CH1. Enable stakeholders and regulators to 1) track financial performance, 2) make comparisons, 3) make in formed financial decisions.

CH 8/9. Opportunity for Investment Income

Can invest the initially collected premiums until the losses are paid out at a later date.

F Surplus. Nonadmitted Assets Exhibit - Change for Year

Change for year = prior value - current value (this is only for nonadmitted assets).

CH 8/9. Hedge Accounting

* If a risk exposure is significantly reduced by derivative ("highly effective" hedge), then the derivative receives same accounting treatment as hedged asset E.g. interest rate swap to effectively hedge bond portfolio. Can record the swap on amortized basis and offset the bond portfolio value changes.

F Surplus. Reconciling BS and IS Surplus

Credits/Charges to surplus in IS are applied for each transaction that does not flow through the IS.

CH 6/7. Cash and Short Term Investments

E-P1 - cash details E-P2 - cash equivalent (maturity under 3 months) DA - short term investments (maturity under 1 year)

CH 8/9. UW Income

EP - IL - UWExp

CH6/7. EBUB

Earned But UnBilled - Premiums estimated to be earned once the policy ends and an audit is performed. EBUB premiums must be reliably estimable in the aggregate.

F Surplus. PDR Example

PDR = Unreported + DPAC - UEPR

CH 8/9. Schedule DB Parts

Part 1: Derivatives owned Part 2: Derivatives sold (written) Part 3: Derivatives terminated during the year

F Surplus. Equivalence of BS and IS

The balance sheet and income statement are equal as long as all transactions flow through both exhibits.

CH4. What is unique to the insurance company's BS?

The larger than typical uncertainty inherent in the estimation of the liability of unpaid claims and claim adjustment expenses.

CH 6/7. UEPR Components

UEPR = Amount Unearned (1yr or less + 1yr or more) + Earned but unbilled (EBUB) + Reserves for rate credits & retrospective adjustments

CH1. Pressure for US GAAP -> IFRS

US will not likely convert directly. FASB may slowly convert by endorsing IASB standards.

CH 6/7. Uncollected/Deferred Premium & Agents' Balances

Uncollected:Premium due before the financial statement date Deferred: Premium due after the financial statement date

Ch 6/7. Funds held under reinsurance treaties

When insurer holds funds from a reinsurer as collateral