AFE3 Unit 1

Define Individual Categories of Assets: Mortgage Loans

- Amount of money, loaned at interest, for a specified term, secured by real estate and its improvements such as buildings and infrastructure. - SSAP #37 specifies that a mortgage loan is a debt obligation but NOT a security (which is a share represented by an instrument issued by a bearer, type of commonly dealt security exchange/market, or by its terms is divisible into a class/series of shares.) - Always accompanied by a promissory note (promise to pay) and secured by real estate. - Almost always commercial property. Therefore, to recover debts the recovery is typically limited to the value of the real estate unless specific recourse has been expressly negotiated.

Define Assets

- An asset is a property, right, or claim with future measurable value that is owned or effectively controlled. - SSAP #4 (Assets and Nonadmitted Assets): "... has probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events." - Must comply with statutory accounting requirements to satisfy solvency standards.

Define Individual Categories of Assets: Cash and Short Term Investments

- Cash defined by SSAP #2 "medium of exchange that a bank or other similar institution will accept for deposit and allow an immediate credit to depositor's account.". - Other amounts included as cash for balance statement purposes: savings accounts, CDs with maturity of one year or less, cash equivalents (includes short term, highly liquid investments readily converted to cash and/or close to maturing aka original maturity date 3 mos or less at time of purchase). Negative cash is reported as a negative asset. - Short term investments defined in SSAP #2 as "all investments with remaining maturities/repurchase dates of one year or less at time of acquisition (excluding cash equivalents which are 3 mos)." - Examples include bonds, commercial paper, money market instruments, and repurchase agreements. - Short term investments reported in Schedule DA, Schedule E part 1 lists depositories by insurer and balance of each account, Schedule E Part 2 lists cash equivalents, Schedule E-Verification reconciles cash equivalent activity during the reporting period.

Differentiate between Assets and Nonadmitted Assets and their valuation

- In accordance with solvency orientation of statutory accounting, assets are valued according to their availability to pay claims. - Common stocks valued at market. Nonadmitted assets at zero. Bonds generally at amortized cost (presumed they will eventually mature at principal/face value). - Another way of looking at it: If assets are worth less because of increasing interest rates, then the liabilities (reserves) they support would also decrease if similar interest assumptions are used in their calculation.

Define Individual Categories of Assets: Real Estate

- Investing in real estate has been motivated by the expectation of a long term higher return than fixed income investments. Common stocks are another example of this, but with more volatility. - Prescribed accounting practices cause reported earnings on real estate to appear low when compared with other investments due to depreciation of the real estate affecting earnings (but not cash flow), which may be disadvantageous to some life insurance companies.

Define Individual Categories of Assets: Derivatives

- Investment vehicle with complex regulatory restrictions. State laws dictate permissibility and admissibility of derivatives. Defined as swaps, options, forwards, futures, caps, floors, warrants, and collars. - Hedge accounting used. Either derivative is valued at amortized cost if item being hedged is accounted for at amortized cost, or the derivative is reported at market value if accounted for at market value. - Schedule DB of annual statement.

What should be included on Schedule BA - Other Invested Assets?

- Long term invested assets that may not qualify for inclusion in one of the invested asset classifications (bonds and stocks, mortgage loans, real estate, cash and short term investments, contract loans, and derivatives). - Varies from company to company. Some states have limits on types/amounts that can be reported. - Typically P&C don't invest heavily here.

Provide at least ten examples of Schedule BA assets the NAIC annual statement provides reporting instructions for.

- Oil and gas - Transportation Equipment - Mineral Rights - Fixed or Variable Int Rate Investments w/ underlying characteristics of bonds, mortgage loans, or other fixed income instruments - Joint Venture/Partnership/LLC Interests with underlying characteristics of fixed income instruments, common stocks, real estate, mortgage loans - Surplus debentures - Collateral Loans - Non-collateral loans - Capital notes - Guaranteed federal low income housing tax credit - non-guaranteed federal low income housing tax credit - guaranteed state low income housing tax credit - non-guaranteed state low income housing tax credit - all other low income housing tax credit - working capital finance investment

Define Individual Categories of Assets: Contract Loans

- Policy loans are a significant asset of life insurance categories. Subject to guidelines established in SSAP #49. Meet definition of assets as defined in SSAP #4 and are admitted. - Permanent-plan life insurance builds cash value, that value can be used to secure a loan for a policyholder (recommended only for emergencies). Terms for loans fixed at time of plan purchase. - Two basic types of policy loans: conventional (or cash) and automatic premium loans (APLs). Conventional insured makes a request for a loan for cash, insurer specifies amount and conditions. Max amount is frequently cash value of policy plus paid-up additions minus unpaid premiums. Interest annually. APL insured indicates in application that policy can't lapse for nonpayment of premim if cash value is adequate to cover unpaid premium. Can also be created to pay policy interest if not paying in cash. Admitted assets. - Interest income on policy loans reported as investment income. - Premium Notes: debts of policyholders to the company for payment of premiums. Can be on existing or new business. Can be admitted assets to the extent a reserve liability exists. Premium notes in excess of reserves are unsecured and nonadmitted.

Define Nonadmitted Assets

- Same essential characteristics as admitted assets but are specifically identified within AP&P Manual or by jurisdictions (states) as nonadmitted or specifically identified as admitted. - Not allowed to be included in the amount of balance sheet assets used to measure financial solvency. - Cornerstone of SAP model, interjects level of conservatism. - Nonadmitted assets shown on BS as having zero value. Exhibit of nonadmitted assets shows changes in nonadmitted assets between current and prior year.

Define Individual Categories of Assets: Bonds and Stocks

- Vehicle by which various government and corporate entities borrow money from investors. - Bondholders do not have ownership interest in the issuing corporation nor a voice in the management of the company. - Bondholders receive special treatment over common/preferred stockholders if the issuing company were to file bankruptcy. Considered to be senior debt as claims are settled before stockholders. - Common maturity dates of 5-30 years, bondholder is repaid the principal amount. - Common types: Term, serial, balloon.

Three Essential Characteristics of an Asset

1) embodies a probable future benefit which contributes to cash flow. 2) particular entity can obtain this benefit and control others' access. 3) transaction giving rise to entity's right to or control of benefit has already occurred.

Define impairment according to SSAP #5: Liabilities, Contingencies, and Impairments of Assets

Defined as an existing condition, situation, or set of circumstances involving uncertainty as to possible loss to an enterprise that will ultimately be resolved when one or more future event(s) occurs or fails to occur.

Asset Presentation on Balance Sheet

Invested assets are presented as statutory book value adjusted for excess of book over market value (where appropriate), adjusted for any Other Than Temporary Impairments, net of any valuation allowance (where allowed). Other assets presented as statutory general ledger amount, net of any valuation allowance (where allowed).