CPCU 540 Chapter 2

Revenue

An organization generates revenue from sales of its products or services. For a nonprofit organization, revenue might come from dues, memberships, or contributions. Revenue does not include gains from the sale of property, plan or equipment.

Additional information that companies usually provide on annual report

- financial highlights - letter to shareholders - cooperate message - names of the boards of directors and management - corporate information, such as the date of the annual meeting, stock trading information, and contact information for investors relations, media relations, and company news.

Required sections of an annual report

- financial statements and notes - auditor's report - report of management - management's discussion and analysis of results of operations and finanical conditions - selected finanical data

Securities and exchanged commission filings

All publicly traded companies are required to file quarterly and annual finanical information with the SEC. They are also required to file a notice of any potential material events that might affect the company's finanical condition. The filings that the user of financial statements access most often are the annual for 10-K report, the quarterly form 10-Q report, and the form 8-K material event report.

MD&A Transparency

An MD&A should explain the company's operating results and condition. It should also provide insight into the opportunities, challenges, and risk faced by the company as well as the actions the company is taking to address them. The SEC promotes transparency inf financial reporting by requiring that MD*A disclosure include these items - liquidity and capital resources, including off balance sheet arrangements, contractual agreements, and contingent liabilities - Certain trading activities involving non-exchange traded contracts accounted for a fair market value including buying or selling private securities - relationships and transactions with persons or entities that derive benefits from nondependent relationships with the company or the company's related parties.

Deferred policy acquisition costs

Deferred policy acquisition costs represent prepaid expenses relating to premium revenue that has not yet been earned. They are categorized as assets because they were incurred during the current period but will not be recognized as expenses until the associated premium revenue is earned during a subsequent period.

Accumulated other comprehensive income

Comprehensive income includes a corporation's net income front the income statement plus other income that is not required to be reported on the income statement. This other income that is not reported is referred to as other comprehensive income. Accumulated other comprehensive income is the cumulative other comprehensive income from previous periods. Other comprehensive income has three components, change in unrealized appreciation or depreciation of investments (these are the same as unrealized gains and losses), foreign currency translation gains or losses, and changes in minimum pension liability.

Qualitative assets

Financial statements report an organization's quantitative economic data, but typically no value is assigned to the qualitative assets the organization has developed, such as its proprietary customer data, intellectual property, reputation in the marketplace, the loyal customers of its branded products, the strength of its movement team, or its productive workforce. Although these qualitive assets can be as important as quantitively assets when analyzing an organization, it is extremely difficult, if not impossible, to measure these qualitive assets. Therefore such assets are not presented in financial statements. AS more of the stock market value of an organization relies on these intangibles, new measures and way to value them are being considered.

Form 9-K

Form 8-k is the current report that publicly traded companies must file with the SEC. It is used to announce major events that shareholder should know about. These are some of the events that trigger an 8-K filing: - material definitive agreement entered into or terminated that are not in the ordinary course of the company's business, such as definitive agreement to sell a significant operating division to an unrelated company - relapse of nonpublic information about a company's finanical condition - creation of a direct finanical obligation (such as a long term operating lease) under an off balance sheet arrangement that is an arrangement that does not have to be recorded in the finanical statements - Change of independent auditor certifying the finanical statement 0 departure or election of directors and departure or appointment of principal officers The 8-k must be filed with the SEC within four business days of the triggering event to provide shareholder with information about important events in a timely manner so that they do not have to wait for the next 10-Q or 10-K filing

Types of Financial Statements

Individually, each provides valuable information but when analyzed together, they present a more complete portrait of the organization's financial condition, including its resources, liabilities, and investment decisions. To help ensure consistency among organizations, these statements are prepared using standardized accounting concepts and principles.

For 10-Q

Publicly traded companies are also required to file a quarterly report with the SEC on form 10-Q. The 10-Qreport is an abbreviated version of the 10-K report. The information contained in the 10-Q report includes unaudited finanical statements, a Management discussion & analysis (MD&A) for the quarter, and a lit of material events that have occurred with the company during the prior three months. The 10-Q, which provides a continuing view of the company's finanical position, is filed for each of the first three quarters of the fiscal year.

Fair value

The fact that financial statements do not reflect the current fair (market) value of many of the organization's assets and liabilities is partly because of the cost principle of accounting. The cost principle requires assets to be recorded at the price agreed on at the time of exchange, so a balance sheet must reflect a building purchased 30 years ago at the original purchase price less accumulated depreciation, even thought may have a substantially higher current value because of inflation and other market conditions. Similarly, liabilities are recorded at the amount owned rather than the price at which the liability could be transferred to another party. Income statements are also affected by the cost principle because many expenses, such as depreciation and cost of goods sold, reflect historical costs, not replacement costs. The lack of current or fail value in finanical statements is a significant issue that accounting policy-making bodies are working to resolve.

Operating activties

The operating activities section starts with the net income future, which reflects operating cash inflows and operating cash outflows. However, the net income figure also reflects noncash revenue and noncash expenses. Although changes in these amounts either increase or decrease income, they do not reflect the receipt or use of cash. For example, depreciation is deducted as an expense on the income statement, but no cash payment is made by the organization. Therefore, to determine the actual cash generated by operating activities, noncash expenses are added back to the net income figure and noncash revenues are deducted from the net income figure.

Report of Management

The report of management is a report to the users of the finanical statement in which the company's management acknowledges its responsibility for the quality and integrity of the company's finanical statements, as well as for the accuracy and effectiveness of internal controls over finanical reporting. It also attests that an independent account firm has audited managements' assessment of the internal controls. The chair of the board and chief finanical officer sign the report.

Current assets

a balance sheet asset classification that includes cash and other assets that are expected to be converted into cash, sold, or exchanged witting the business's normal operating cycle, usually one year. this includes cash, marketable securities, receivables (accounts and notes), inventories, and prepaid expenses.

Current liabilites

a balance sheet liability classification that includes obligations whose payments are reasonably expected to require the use of cash or the creation of another current liabilities within one year. include accounts payable short term debt and the portion of long term debt due within one year.

Nonprofit net income

a positive difference between revenue and expenses might be called by a different name, such as "contribution to surpluses" or "excess of revenue over expenses" Just as with for profit businesses, nonprofit organizations require an amount of income that will cover expenses in order to continue operating. Income statements for different organizations are similar in format but may not be exactly alike

Balancing the balance sheet

always balances because the accounting equation dictates that assets must equal liabilities plus shareholder's equity. Therefore, shareholders' equity is positive or negative, depending on the size of the organizations assets in relation to its liabilities. An organization with negative shareholder's equity may be close to bankruptcy.

Company Annual Reports

an annual report is a formal report on the company's performance for the stated year. The audience for the annual report is the company's shareholders and other interested parties such as customers, vendors, and investors. Insurance professionals find the annual report a valuable source of information about the company's business purpose and philosophy, its finanical results, and its directions for the future. This information helps provide a general background for making specific underwriting decisions.

invetory

an asset classification that consists of goods available for sale to customers for a manufacturing company also includes raw materials and finished goods.

Receivables

an asset classification that consists of the amounts owed to a company by customers and other outsiders

Marketable securities

an asset classification that includes temporary investments that can easily be converted into cash

Income Statement

an insurer's GAAP income statement retains the same format and general categories as the income statement for any other organization. All of the relevant revenues and expenses incurred by the insurer during the time period covered by the income statement must be included However specific categories of insurer revenues and expenses differ from those of noninsured organizations.

Retained earnigns

an organization may use these for purposes such as funding capital expenditures, research and development, or debt repayment. Dividends are the portion of an organization's profits that is paid to shareholders. Dividends are not deducted as expenses to arrive at net income, therefore, they are deducted form net income to determine the change in retained earnings from one period to the next. One of the purposes of the retained earnings section of the shareholders' equity is to connect the income statement to the balance sheet by indicating how much of the net income of the company is being reinvested for ongoing and future business needs rather than distributed to the owners in the form of dividends.

Noncurrent assets

are assets that will be used over a period greater than one year. they are grouped into tangible assets (land, buildings, and equipment) and intangible assets. Intangible assets include all assets that cannot be seen or touched, such as leaseholds, patents, copyrights, and trademarks, and are often categorized as intellectual property.

Fixed maturity investments

are investments in debt instruments that have a maturity date greater than one year in the future. examples of fixed maturity investments are us treasury bonds or long term bonds issued by large organizations because of regulatory restrictions on investments investment is fixed maturities are usually an insurer's dominant investments and are carried at either amortized cost or fair value.

Short term investments

are investments that will mature in one year or less similar to current assets

Expenses

are measured by assets relinquished or consumed in the process of delivering goods or rendering services to customers. The nature of these expenses depends on the nature of the organization. Every operating expense can be categorized as either a general operating expense or an expense directly related to sales.

Liabilities

are the debts and obligations that represent claims against an organizations assets. AS with assets, liabilities are categorized as current or noncurrent

Equity securities

are usually common or preferred stock investments in publicly traded organizations, represent an ownership interest in that organization and are carried at fair value.

Balance sheets main components

assets liabilities and shareholders' equity

Assets

assets are the resources an organization owns or uses to operate its business. They are grouped into current assets and non current assets

Cost of goods sold corresponds directly to sales

calculating cost of goods sold is an accounting method for appropriately recognizing as expense the cost of purchasing inventory. Inventory is an asset that appears on the balance sheet until it is sold. Directly showing the purchase of inventory as periodic lump sums to represent expenses on the income statement would skew the income statement because the purchase and the resale of inventory are not perfectly timed. Businesses often stock up months before a busy sales season and many not restock as their busy sales season nears an end. The cost of goods sold formula is a method of recognizing the expenses of acquiring goods to sell and coordinating it directly with the sales on the income statement.

Statement of cash flow and statement of changes in shareholder's equity

can help an underwriter or broker determine change in an organization's finanical strength, which could signal the presence of other trends that might affect their decision about whether to do business with it.

Other invested assets

category is a catch all category representing all other invested assets that do not fall into one of the other three categories.

Accruals for loss contingencies

companies record accruals for loss contingencies directly to the balance sheet and income statement when it is probable that ta liability (Loss) has been incurred and the amount can be reasonably estimated. However, companies can also be subject to loss contingencies whose results cannot be reasonably estimated at the time of the preparation of the financial statements. In such cases, the fact that the company is exposed to possible loss and liability must be disclosed in the notes to the financial statement to ensure that the statements will not be misleading. The disclosure should include the nature of the contingency, the potential damages, and a statement of the likelihood that future events will confirm the loss.

What does an income statement do

compares revenue generated with expenses incurred over a defined period. Then it adds any other gains and subtracts any other losses. The results?? a depiction of the organization's profit or loss over that period

Notes to financial statements

contain additional details that are disclosed to explain or amplify the information presented in finanical statements. The information provided is essential to understanding the statements and has long been integral to complying with generally accepted accounting principles (GAAP) Of the information provided in the notes to the finanical statements, a summary of loss contingencies is often the most directly related to risk management and insurance.

General operating expense

is on that is necessary to run the business by bears no direct relationship to the volume of sales, such as a retail store's cost for heating or air conditioning its place of business. whether sales are booming ro nonexistent the cost of heating or air conditioning is incurred each day.

Operating income

general operating expenses are deducted from gross profit to arrive at operating income amount Not all money a business spends is counted as operating expenses. To be recorded as operating expense, expenses must be incurred in the business's ordinary operating's. For this reason, capital expenditures appear on the income statement gradually over time, normally as a depreciation expenses. A depreciation expense spreads out the expenses of a large purchase over time and may be calculated based on the item's life expectancy or more arbitrarily for accounting convenience, according to generally accepted accounting principles GAAP. Depreciation is a common operating expense. As such depreciation also lowers the business's net income for tax purposes.

Net income

if expenses and other losses exceed revenue and other gains for the period, then the organization ahs a net loss and is not operating profitably. Negative net income is known as a net loss. Positive net income for a for-profit business is often called net profit. The ability to earn net income is essential to a business's continuation. Anything that decreases revenue or increases expenses threatens a business's profit and its future.

Comprehensive income

includes an organization's net income from the income statement plus other income that is not required to be reported on the income statement. It can include unrealized gains and losses on securities for sale, foreign currency translation gains or losses and minimum pension liability adjustments

Shareholders' equity insurance

insurers that are organized as stock companies will have outstanding common and sometimes preferred stock shares. Common and preferred stock is carried on the balance sheet at par value. If the stock is originally issued for an amount above par value, the additional amount appears in the shareholders' equity section as additional paid in capital. Retained earnings represent accumulated net income retained in the business. Accumulated other comprehensive income represents other comprehensive income reported on tan accumulated basis.

Depretiation

is an accounting term used to describe allocation of the value of a noncurrent tangible asset over its useful life. There are many methods of depreciating assets, such as straight line depreciation or declining balance depreciation. On the balance sheet, the historical cost of a noncurrent asset is reduced by the depreciation amount, leaving the net value of the asset

Cost of goods sold

is an expense that deserves special note. Although the term applies to any business, the type of business dictates the expenses that are included. In retail operations, the cost of goods sold is usually the business's cost to purchase its merchandise and for shipping. In manufacturing operations, the cost of goods sold includes the cost of the materials to make the product, the labor involved and the overhead ot make the product. In a service operation, such as insurance agency, the cost of good sold is minimal or nonexistent because no physicals product is being sold. The income statement of most services businesses do not include a cost of goods sold category.

Contingency

is defined as an existing condition, situation or set of circumstances involving uncertainty about a gain or loss to a company. This note to the finanical statements summarizes any material loss contingencies to which the company is subject.

Balance sheet

is one of the four types of finanical statements think of the balance sheet as a snapshot of a company's financial position at a particular moment in time, everything the organization owns and owes. The accounting equation ties together the balance sheet's main components

Expense directly related to sales

is one that increases or decreases in direct relationship to sales, such as the cost of goods sold, commissions, or the cost of the materials used to ship goods that have been sold. If there are no sales, these types of expenses are not incurred.

Paid in capital

is the amount of money raised by issuing stock, calculated as the par value of the stock issued plus any additional paid in capital over the par value. Par value is an arbitrary dollar value that a corporation assigns to its shares. Most new stock is issued at very low or no par value and is sold for whatever price the market is willing to pay. A share's par value generally bears no relationship to its market value.

statement of shareholders equity

is the finanical statement that explains any changes that have occurred in the insurers capital accounts over the fiscal period being examined. Any activity affecting the value of shareholders' equity, such as the issuance of common stock, is shown and used to reconcile changes in shareholder's equity between the beginning and the end of the period. Comprehensive income (loss) also appears in the statement and is used to reconcile the differences between beginning and ending accumulated comprehensive income.

Goodwill

is usually classified as an intangible asset and is usually generated as part of an acquisition. Whenever the acquiring organization pays more than the book value for the acquired organization, the difference between the price paid for the organization and the book value can be listed as goodwill on the balance sheet. Goodwill is not amortized over any specific time period, like other intangible assets. If goodwill becomes impaired, it is reduced in value on the balance sheet and is recognized as a loss on the income statement.

Noncurrent

liabilities are those that will be paid or satisfied more than one year after the balance sheet date

Management's discussion and analysis of results

of operations and finanical conditions is essential to understanding a company's financial statements. The SEC has set forth three goals for the MD&A: - provide a narrative explanation that enables users to view the company from management's perspective - improve overall financial disclosure and provide the context within which finanical statements should be analyzed. - Provide information about the quality and potential variability of the company's income and cash flow that addresses the likelihood that past performance indicates future performance.

Financial statemetns

often serve as effective windows into an organizations health by communicating information about its financial activities and the results of those activities.

Income statement

one of the four types of financial statements that together form a portrait of tan organization's health, an income statement reveals profitability over time. This information helps arm risk and insurance professionals with vital knowledge about an organizations coverage needs, amount other things.

statement of cash flows

operating activities include all cash flows associated with marketing, underwriting, and servicing of insurance policies and related services. On the statement of cash flows, the net income, changes in reserves, changes in accounts receivable (premiums receivable, reinsurance recoverable), depreciation, and other activities all appear under the cash flows from operating activities section Activities related to investments appear in the cash flow form investing activities section. These activities include proceeds from sales or maturities of fixed maturity investment or equities. They also include the purchase of securities, fixed maturity investments, other investments, and property and equipment, as well as activities in an other category. Cash flow activity form issuer-issued debt or equity securities appears in the cash flows from financing activities section such activity can include new issues or repayment of long term debt, or new issues or buy backs of stock. at the end of the statement of cash flow, the net cash position over the time period summarized.

Revenues insurance

primary revenue sources generated by property causality insures are premiums earned and income from investments. which come in two forms, investment income and net realized investment gains or losses. Premiums earned include premiums income generated by coverage provided by the insurer on policies in force during the time period covered by the income statement. Investment income includes coupon payments on fixed income securities, dividend payments on equity holdings, and income generated by real estate holdings less the insurer's investment expense. Any investment gains or losses realized on the sale of investments are included in the net realized investment gains (losses) category of revenues. Unrealized gains on investments are recognized in the statement of comprehensive income insurers other income generally listed on the income statement as other income is not usually a major revenue source.

Reinsurance recoverables

represent loss payments that are due to an insurer from a reinsurer for accrued losses that were covered by reinsurance contracts. When a policy holder incurs a loss, the insurer may pay the claim and then be reimbursed by a reinsurer (if the loss is covered by the reinsurance contract) the amount owed by the reinsurer is an asset for the insurer.

Premium receivables

represent the premiums that have been promised by policy holders in exchange for insurance coverage but have yet to be received by the insure. The premium receivables category is similar to the accounts receivable category that appears on a noninsurance balance sheet.

Statement of changes in shareholder's equity

shows changes from the beginning to the end of the period for each major component of the capital accounts that constitute shareholder's equity

Shareholders' equity includes

the capital contributed by owners and the accumulated earnings retained by the organization since its inception. It is shown on the liabilies (right) side of the balance sheet because an organization does not own its net worth. It "owes" its net worth to its owners or members.

Gross profit

the cost of good sold expense, which is shown separately from other expenses, is subtracted from sales on the income statement to arrive at the gross profit. This is sometimes referred to as the trading section of the income statement. Any item deducted form revenue to arrive at gross profit is said to be included in the trading section. Gross profit expressed as a percentage of gross sales is sometimes calls the gross margin. Similarly, the gross profit expressed as a percentage of the cost of goods sold is sometimes called mark up.

Shareholders' equity

the different between assets and liabilities is called shareholders' equity (owners' equity, net worth, or book value)

No sales

the ending inventory is equal to the sum of the beginning inventory plus any additions to it. Notice that under this formula there can be a cost of goods sold only if there has been a sale that lowers the ending inventory from the amount that could have been sold once an item of inventory has been sold, its cost appears as an expense on the income statement by operation of the costs of goods sold formula.

Financing activities

the financing activities section reports the cash inflows and outflows that have occurred as a result of activities such as issuing or repurchasing stock, bonds or mortgages. Financing activities including cash payments for the payment of dividends.

Investing activities

the investing activities section reflects the actual cash inflows and outflows that have occurred as a result of activities such as selling or purchasing of property, plan, or reequipment, acquiring or disposing of marketable securities, and receiving payments on loans made to others.

Net income insurance

the net income calculation for that property casualty insurer is identical to that used by noninsureres. the total revenues minus total expense calculation yields the income before taxes once income tax expense is taken into account, the resulting balance is the net income. As is true for noninsureres, certain categories of income do not appear on the income statement. those categories appear on the statement of comprehensive income.

expenses

the primary expenses of property casualty insurers include tin the income statement are losses and loss adjustment expenses. In addition to these expenses, insurers incur expenses acquiring and underwriting policies (policy acquisition costs and other underwriting expenses) paying interest expenses on any debt they have outstanding interests expenses . The expense categories that are directly related to the policies (loss and loss adjustment expense, policy acquisition costs, and other underwriting expenses are matched to the policies as the premiums are earned.

Statement of cash flows

the purpose of the statement of cash flows is to identify the sources and uses of cash during the year, essentially reconciling any difference in the beginning and the ending balances in the cash account. This statement is sued to determine an organization's ability to generate positive future cash flows, its ability to meet its finanical obligations, and its need to additional financing. It is also used to determine the reasons for any differences between net income and associated cash receipts and disbursements, such as those resulting from loan proceeds or repayments, increases or decreases in accounts receivable, or depreciation expense. The statement of cash flows is divided into three sections, operating activities, investing activities, and financing activities.

statement of comprehensive income insurance

the statement of comprehensive income for insurers may contain significant amounts of income not reported as part of net income on its income statement. Because insurers have a significant percentage of their assets in vestments, the unrealized appreciation or depreciation of those investments may be substantial. unrealized net capital gains or losses on investment may be substantial for insureds.

Shareholders' equity reflects

the values placed on the balance sheet's assets and liabilities. Some assets are valued at the price paid for them (historical cost) rather than their current market value, and the two values can differ significantly. Therefore evaluating an organization's shareholders' equity requires understanding how its assets and liabilities are valued.

Limitations of financial statements

though they may appear to have an air of infallibility, finanical statements are in fact the byproduct of many estimates, assumptions, and compromises. That's why it's important for risk and insurance professionals to look behind the numbers to determine an organization's finanical strength. Financial statements aspire to fairly present the finanical position of the organization and the results of its operations. However, a fair presentation is not necessarily accurate down to the smalless detail. Two significant limitations undermine financial statements'; depiction of an organization's true worth, their inability to measure the economic value of an organizations' qualitative assets and the absence of current fair (market) value of all the organizations' assets and liabilities.

Liabilities insurance

two unique categories unpaid losses and loss adjustments expenses unearned premium reserves represent payments that the insures will like have to make in the future. The unpaid losses and loss adjustment expenses entry on the balance sheet estimates insurer liabilities for various sources - loses and loss adjustment expense that have been incurred but not yet paid - incurred but not reported losses and loss adjustment expenses loss and loss adjustment expenses from claims that may be reopened property casualty insurers are not allowed to set aside reserves for losses that do not occur during the policy period being covered. For example, insurer cannot plan ahead by setting aside reserves for a hurricane that is likely but has not yet occurred. The insurer's other principal lability is the unearned premium reserve. this represents the amount of premiums received from policyholders but not yet earned. Policy holders pay premiums before the period for which they are covered ands ofttimes pay the entire premium before the policy period begins. Although insurers receive cash for the premium at the sort of the policy period, they earn premium proportionately as the policy period transpires for example on a annual policy the insurer earns 1/365th of the annual premium as each day of the policy period passes. At the end of the policy period all premiums received will be earned however in the meantime, insures must recognize as a liability the unearned premium amount they have received from policyholders.

Treasury stock

when a corporation buys back its own stock, those shares become treasury stock. The cost of treasury stock is deducted from shareholders' equity because the company sued an asset to buy back stock that it had previously issued. The company initially received payment for the stock and included it in the paid in capital section of shareholders' equity.

Form 10-K

which publicly traded companies must file annually with the SEC, is similar to the company's own annual report, except that it contains more-detailed information about the company's business, finances, and management. It also includes information not contained in the company's annual report to shareholders, such as the company's bylaws and other legal documents. The SEC recognized three different types of filers with regards to the 10-K