LOMA 308 Module 3

Present value

In simple terms, the present value of an investment is the principal—the original amount invested before it's affected by interest. Present value = Principal

capital

In the context of minimum capital standards, the excess of an insurer's assets over its liabilities.

Some of the financial reports insurers prepare are unique to the insurance buisness. Other reports are common to all businesses. The reports that are common to all businesses include (choose all that apply) Cash flow statement Statement of owners' equity Annual report Annual Statement

all but annual statement - Companies in most industries prepare cash flow statements, statements of owners' equity, and annual reports to provide information to stakeholders about the company's financial status. The Annual Statement is unique to the insurance industry.

Annuity due

payment made or received at the beginning of each annuity period. ex- A series of rent payments made at the beginning of each month A series of premiums for a life insurance policy paid at the beginning of each year

ordinary annuity

payment made or received at the end of each annuity period. A series of paychecks an employee receives at the end of each month A series of interest payments on a bond

Calculating the Present Value of a Single Amount for One Period

- FV = PV × (1 + i ) - PV = FV ÷ (1 + i ) or PV = FV × [1 ÷ (1 + i )]

Which characteristics describe an insurance company's Annual Statement? (Choose all that apply.) Designed to provide information about company profitability Designed to provide information about company solvency Used primarily by investors and the public Used primarily by regulators Reported on a going concern basis Required for all U.S. insurance companies Required by the Securities and Exchange Commission (SEC) for publicly traded companies and companies that offer variable products

- designed to provide information about company solvency - used primarily by regulators - required for all U.S. insurance companies

Elegant Financial invested $300,000 for one year at 5 percent interest. How much did Elegant have at the end of the year? ___________ = PV × (1 + i ) $1,500,000 $450,000 $315,000

315,000

Future Value Interest Factors for an Annuity (FVIFAs)

Analysts have developed future value interest factors for annuities to simplify calculations, particularly for annuities with large numbers of payments and compounding periods.These compound interest factors, which are combined into tables, are called future value interest factors for an annuity (FVIFAs). We can use FVIFAs to calculate the future value of an annuity due or ordinary annuity the same way we used FVIFs to calculate the future value of a sum of money.

Suppose that Jensen Financial invests $2,000,000 per year at an annual rate of 5 percent.If Jensen makes payments on the first day of the year instead of the last day, how much money will Jensen have in 20 years? $66,132,000 $69,438,600 $71,438,600

Because Jensen makes its investment at the beginning of each payment period, its account is an annuity due. To find the future value of an annuity due, we multiply the amount of each payment by the FVIFA factor for (20 + 1) periods and 5 percent interest and subtract the amount of one payment.FV of Jensen's annuity due = $2,000,000 × 35.7193 = $71,438,600 - $2,000,000 = $69,438,600

Identify the terms that would appear on an insurance company's income statement under Expenses. (Choose all that apply.) Investment income Benefits and claims Premiums Utilities Sales commissions Investment expenses Fee income

Benefits and claims, utilities, sales commission, investment expenses

Because the nominal interest rate includes the effects of compounding, it's usually greater than the effective interest rate. True False

False- Because the effective interest rate includes the effects of compounding, it's usually greater than the nominal interest rate. And it increases even more if interest is compounded more than once each year.

Cash Receipts (Cash Inflows)

Individual life insurance premiums Payments into individual annuity contracts Group life insurance premiums Investment income

Friendly Fraternal Life Insurance, Melody Mutual Life Insurance, and Stellar Life Insurance all operate within the United States. Friendly Fraternal sells term and whole life insurance products and fixed immediate annuities. Melody Mutual sells term and whole life insurance products and variable annuity products. Stellar is a publicly traded stock insurer that sells term and whole life insurance products. Companies that are required by the Securities and Exchange Commission to publish an annual report include

Melody Mutual must publish an annual report because it sells variable products. Although Stellar doesn't sell variable products, it must publish an annual report because it's a publicly traded company. Although Friendly may choose to publish an annual report, it isn't required to do so because it doesn't issue stock or sell variable products.

calculating the present value of a single amount for multiple periods

PV = FV × [1 ÷ (1 + i )2]

Present value of an annuity due Periodic payment × PVIFA Periodic payment × PVIFA for one fewer period + one periodic payment Periodic payment × PVIFA for one greater period - one periodic payment

Periodic payment × PVIFA for one fewer period + one periodic payment For an annuity due, the valuation date is the beginning of the first period, which is also the date on which the first payment is made. The present value of an annuity due, therefore, is equal to the present value of an ordinary annuity of one fewer period plus the amount of one periodic payment.

Identify the terms that would appear on an insurance company's income statement under Revenues. (Choose all that apply.) Investment income Benefits and claims Premiums Utilities Sales commissions Investment expenses Fee income

Premiums, Fee income, Investment income

Calculating Interest Earned

Principal (regular amount) × Interest rate = Interest earned

The Annual Statement

The Annual Statement is unique to insurance companies and is designed to provide state insurance regulators with the information they need to assess an insurer's solvency.The NAIC developed a general format for the Annual Statement that includes a variety of exhibits, schedules, and supplemental reports that support the information in the company's financial statements. However, each state's insurance commissioner can specify the content of the report, so Annual Statements often vary from state to state.Life insurers in the U.S. must file Quarterly Statements and Annual Statements with the NAIC and regulators in all states in which they conduct business. Insurers in other countries report similar information to regulators.

The Annual Report

The annual report is a broad evaluation of a company's financial performance designed to help users assess the company's profitability and financial strength. Insurers also view the annual report as a way to promote themselves to potential investors and customers.An annual report directed to shareholders includes four key financial statements: An income statement A balance sheet A cash flow statement A statement of owners' equity

Present Value of an Annuity Due and an Ordinary Annuity

The present value of an annuity, like the future value of an annuity, can be calculated for both an ordinary annuity and an annuity due. Remember that the payment for an ordinary annuity is made or received at the end of each annuity period, and that the payment for an annuity due is made or received at the beginning of each annuity period. The following time line represents the present value of an ordinary annuity of $100 per year for three years. Note that, for an ordinary annuity, the valuation date for the present value occurs at the beginning of the first period, which is one period before the first payment is made.

Budgets

Unlike the financial reports we've discussed so far that are prepared for external users and describe a company's past and current performance, budgets are generally Reserved for internal company use Designed to estimate or project a company's future revenues and expenses

An insurer's balance sheet is based on the basic accounting equation, which states that the company's Net income = Revenues - Expenses Assets = Liabilities + Capital and surplus Owners' equity = Liability - Capital and surplus Surplus = Assets + Liabilities

assets = liabilities + capital and surplus The basic accounting equation, which forms the foundation of a company's balance sheet, states that a company's assets equal the sum of its liabilities and its capital and surplus. Net income is a component of a company's income statement. Owners' equity is another name for the capital and surplus component of the basic accounting equation. Surplus is equal to assets minus liabilities.

Exeter Insurance Company is considering buying a new office building. Before finalizing the transaction, senior management created a budget to determine the project's long-term benefits. Capital budget Revenue budget Cash budget Master budget

capital budget

Warwick Financial deposits $1,000,000 in an investment account on the first day of each year. If Warwick contributes to the account for 6 years and the account earns 4 percent interest annually, what will be the value of the account? What would we need to find to answer this question? The future value of an ordinary annuity The future value of an annuity due The present value of an ordinary annuity The present value of an annuity due

future value of annuity due- We want to determine the value of Warwick's money in the future, and because Warwick contributes to the account at the beginning of the payment period, we need to find the future value of an annuity due.

If interest rates decrease, present values will ( decrease / increase ). decrease increase

increase hat's correct! Future values change in the same direction as interest rates. Present values change in the opposite direction. If interest rates decrease, present values will increase because more principal is needed to accumulate a specified future amount when rates are low.

The Glendale Insurance Company combines individual budgets from each department into a single budget that shows the company's overall operating and financing plans for the next accounting period. Capital budget Revenue budget Cash budget Master budget

master budget

Top-down budgeting

senior management uses the company's current budget as a starting point and then makes adjustments to accommodate projections of company-wide revenues and expenses for the coming year. Management then divides available resources among operational areas according to company goals. Operational managers then create budgets for their areas using allocated resources to cover their projected expenses.

Because ( simple / compound ) interest is applied to the same amount of principal each year, the amount of interest earned each year is the same, found by multiplying the principal amount by the interest rate. simple compound

simple- Because simple interest is applied to the same amount of principal each year, the amount of interest earned each year is the same, found by multiplying the principal amount by the interest rate.

Characteristics of Project Scheduling

- have a beginning and a end - include a set of activites and events - follow a series of steps - require time to complete - generally require the efforts of more than one person

Interest on investments, 3 factors affect their growth

1. Interest rate 2. The type of interest 3. The time period during which the invested principal earns interest

Insurers and financial services companies like ours make extensive use of numbers. Which of the following statements about how we use numbers is true? (Choose all that apply.) a. Managers and other insurance company employees generally don't have trouble finding the data they need. b. Most company-specific data are stored in the company's records and databases, and users can generally find noncompany data in external databases and reports. c. It's easy for insurers to find a way to arrange, sort, and condense large amounts of data into a form that makes sense.

A & B - It is true that managers and other insurance company employees generally don't have trouble finding the data they need. And most company-specific data are stored in the company's records and databases, and users can generally find noncompany data in external databases and reports. However, the problem is in finding a way to arrange, sort, and condense large amounts of data into a form that makes sense. How to do that is what this lesson is about! Submit

Flow Chart

A flow chart includes an arrangement of events or activities in their actual or desired order. Most flow charts consist of a series of ovals, boxes, and diamonds. In general, Ovals represent starting and stopping points. Boxes represent important activities. Diamonds indicate yes/no decision points.

Pictograph

A graph showing growth in revenues for a particular insurance product could use stacks of coins instead of bars to show sales amounts like the pictograph on the right. This pictograph also contains a line diagram, something you'll learn more about shortly!

baselines

A marketing manager who knows the most common amount of coverage the company's life insurance policies provide or the most common age at which people apply for life insurance coverage can focus the department's marketing efforts on the types of products and customers that are most likely to generate new business.

Ratio Calculations

A ratio can be expressed as a fraction or as a percentage.A fraction is a part of a whole. It's what you have when a meeting lasts for half an hour or the gas tank in your car is three quarters full. Ratios turn those verbal descriptions into numbers. For example, your meeting would last for 1/2 hour or your gas tank would be 3/4 full.Doing the math turns fractions into decimal form. For example, 1/2 equals 0.5(1 ÷ 2) and 3/4 equals 0.75 (3 ÷ 4).Multiplying the result by 100 gives you the answer as a percent—in this case, 50% (0.5 × 100) of an hour or a gas tank that's 75% (0.75 × 100) full.

Ratio Basics

A ratio is a comparison of two numerical values: A numerator that represents the value being studied A denominator, or base value, used for comparison Ratios are structured as fractions with the numerator as the top number and the denominator as the bottom number.

Activity Ratios

Activity ratios compare a company's revenues, which appear on the company's income statement, to its assets, which appear on the balance sheet. Total asset turnover ratio = total revenues/total assets

Schedules help ensure that a manager handles projects efficiently by giving her information about (choose all that apply) The activities involved in a project When to perform project activities Where to allocate project resources

All 3 - Schedules help ensure that a manager handles projects efficiently by giving her information about the activities involved in a project, when to perform those activities, and where to allocate resources. Schedules also give managers a way to monitor progress on a project and identify places to take corrective action. That's what we'll talk about next!

For each age of a given group of people, a mortality table shows the Number of people surviving Number of people dying Remaining life expectancy Specific people to die

All except specific people to die- A mortality table shows for each age of a given group of people, the number of people surviving, the number of people dying, and remaining life expectancy. Mortality tables do not indicate when a given individual in the group is expected to die

Insurance companies only use dashboards to evaluate their sales staff performance. True False

Although dashboards commonly focus on sales, they can be used for other applications, including recruiting, human resources, company operations, project management, and customer relationship management.

Component Bar Chart

As an alternative to comparing data sets side by side, companies can combine data into a component bar chart. Each of the bars in this chart represents 100 percent of sales in each product category, and the colored segments show the percentage of total sales that come from each of the two field offices. This component bar chart is an example of ungrouped data because it shows individual values rather than ranges of values.

Measures the rate at which a company's assets are converted into cash Debt-to-equity ratio Total asset turnover ratio Net profit margin Return on assets (ROA) ratio

Asset turnover ratio

Managers use (dashboards / balanced scorecards) to assign target outcomes to a small number of financial or nonfinancial activities and then monitor the actual performance of those activities to see how closely current performance meets expectations. Dashboards Balanced scorecards

Balance scorecards - Managers use balanced scorecards to assign target outcomes to a small number of financial or nonfinancial activities and then monitor the actual performance of those activities to see how closely current performance meets expectations.

Bar chart

Bar charts display the relative size or quantity of various units of data as vertical or horizontal bars along a specified scale. In addition, the bars can be plain solid lines, three-dimensional bars, or even symbols that represent the items being described. The terms below the bars indicate the specific items or units being measured.

How Managers Use Dashboard

Because dashboards capture and report specific data from various departments within a company, they allow management to Monitor the contributions of various departments Measure operating efficiencies and inefficiencies Make informed decisions based on collected business intelligence Align company strategies with the company's business goals Eliminate the need for multiple runs to produce data

Inaccurate assumptions about the timing or sequence of events in the schedule can negate the value of the information on The Gantt chart only The PERT network only Both the Gantt chart and the PERT network

Both - PERT networks and other scheduling tools like Gantt charts can be misleading if the numbers used to create them are inaccurate. Inaccurate assumptions about the timing or sequence of events in the schedule can negate the value of the information on the schedule. In addition, managers must evaluate PERT networks and other project scheduling models and periodically update them to ensure that they reflect any changes that may have occurred in the project.

Changing Ratio Values

Changing either the numerator or the denominator—but not both—changes the value of the ratio. When only the numerator changes, the value of the ratio changes in the SAME direction. If only the numerator increases, then the value of the ratio increases. If only the numerator decreases, then the value of the ratio decreases. When only the denominator changes, the value of the ratio changes in the OPPOSITE direction. If only the denominator increases, then the value of the ratio decreases. If only the denominator decreases, then the value of the ratio increases.

(Tables / Charts) allow users not only to compare data, but also to see the relationships graphically. Tables Charts

Charts- Although tables are a valuable tool for condensing and ordering data, they aren't very effective for showing relationships among the data. Charts allow users not only to compare data, but also to see the relationships graphically.

The Barksdale Insurance Company gathered information about four of its operational areas during the past month and found that the standard deviation from the mean number of Applications underwritten was 4.3 Claims processed was 6.2 Whole life insurance policies sold was 5.7 Customer service errors was 2.4 This information indicates that the area in which individual values were farthest from the mean was the company's Underwriting Claims Whole life insurance policies sold Customer service

Claims - The standard deviation of a data set indicates how dispersed individual values in the set are from the mean. The standard deviation for claims (6.2) is higher than the standard deviation for any of the other categories, so individual claims are dispersed the most widely from the mean.

Gnatt Charts

Companies use Gantt Charts for all types of organizational activities.Because activities are shown graphically, managers can see immediately which activities they have completed and which they have yet to complete. Managers can also track the progress of activities and determine whether corrective action is necessary.Like flow charts, however, Gantt charts can become cumbersome when projects are very complex.

Fran Wells decided to use a chart that combined the values from sales figures for term life and group life policy sales into a single set and indicated the percentage of the total attributable to each set in each of her company's four regions. She used images of policies to symbolize the number of policies on her chart. What type of chart did Fran create? (Choose all that apply.)

Component bar chart, pictograph - Fran's chart is a component bar chart because she combined the component values from two or more data sets into a single set of bars and indicated the percentage of the total attributable to each set. It is also a pictograph because she used images of policies to symbolize the number of policies on her chart. Fran's chart is not an example of a pie chart or line chart.

Insurance companies use numbers to

Create financial statements that describe company performance Predict gross sales revenue for each of the company's products Show how many policies a company and its producers have sold in a specified period Evaluate the risks and costs of developing a new product Calculate the average earnings per share of the company's outstanding common stock Make investment decisions Track the time it takes company employees to process claims and answer customer questions Determine the policy reserves needed to support product liabilities Calculate the mortality rates for certain groups of people Develop project schedules and track progress on those projects Describe company goals and objectives Track changes in interest rates and other economic factors Determine the premium rate to charge for a life insurance policy Analyze customer satisfaction with the company's products and services

The graph above is an example of a Dashboard Scorecard

Dashboard - A performance dashboard puts all the information managers need to evaluate the performance of the company or of individual business units in one place. Scorecards often are simple tables broken down into major sections with specific objectives, performance measures, trends, and initiatives for each section.

When evaluating net profit margins, insurers generally don't take risk into account. True False

False - Although company owners like to see high net profit margins, insurers need to ensure that the risks they take to generate high margins aren't great enough to jeopardize the company's solvency.

In general, when an insurer's leverage increases, the company's exposure to risk decreases. True False

False - Leverage is a measure of the amount of debt a company uses to support its operations. In general, when an insurer's leverage increases, the company's exposure to risk of loss also increases because its debt is larger, or increasing more quickly, than its capital and surplus.

The return on invested assets (ROIA) ratio shows the relationship between net income and average invested assets. An insurer's average invested assets include cash, property, and equipment. True False

False- An insurer's invested assets include assets in the company's investment portfolio and exclude cash, property, equipment, and other noninvested assets.

Data only consists of numbers used to represent specific quantities. True False

False- When numbers are used to represent specific quantities, they're called data. It's important to note that not all data are numbers. For example, characteristics such as gender (male or female) and address (city and state) are also data.

Budgeting

Financial reports look back at our past financial activity, but budgets focus on future financial activities. Most people have at least tried to go through the budgeting process to help them decide how they're going to spend their money. For example, a couple planning for a vacation might use a budget to determine how much money they'll need to set aside each week to cover travel and lodging expenses.

A graphic representation of a sequence of activities and decisions. Flow chart Gantt chart PERT network

Flow chart

A graphical scheduling tool that separates projects into critical activities and plots starting and ending dates for each activity. Flow chart Gantt chart PERT network

Gantt chart

grouped data

Grouped data divide values into classes, or categories, and then show the number of times the observed data fall within the range for each class. A table that displays the number of times observed grouped data fall within specified classes is called a grouped frequency distribution.

Bar charts showing grouped data are known as (component bar charts / histograms). component bar charts histograms

Histograms - When grouped data are displayed in a bar chart, the bars represent the number of times observed data fall within specified ranges. Bar charts showing grouped data are known as histograms.

Regulators in the U.S. use a set of 12 standardized financial ratios to evaluate insurance company solvency and profitability and to identify companies that are most likely to experience financial difficulty. This set of ratios are part of the Financial Analysis and Solvency Tracking (FAST) system Insurance Regulatory Information System (IRIS) Early-warning financial ratio test

IRIS- IRIS applies 12 standardized ratios based on information from insurance companies' Annual Statements to identify companies that have weak financial positions. The FAST system evaluates companies' most recent financial statements and a five-year history of specific aspects of financial statements. Canadian regulators use early-warning financial ratio tests, which are similar to the ratio tests in IRIS.

The Denton Insurance Company wants to survey customers to determine how satisfied they are with the company's products and services. When conducting the survey, Denton can use the law of large numbers to Improve the accuracy of the information gathered in the survey Reduce the number of customers they need to survey

Improve - Denton can use the law of large numbers to improve the accuracy of information it gathers by ensuring that enough customers are included in the survey. In most cases, this involves increasing rather than decreasing the number of customers in the sample. The law of large numbers doesn't eliminate sampling bias.

Cash Disbursements (Cash Outflows)

Insurance claims Payments into individual annuity contracts Commission payments Investment purchases

Measures the amount of debt a company uses to support its resources and operations (choose all that apply) Net profit margin Insurance leverage ratio Debt-to-equity ratio Capital and surplus ratio

Insurance leverage ratio, debt to equity ratio

Mortality table

Insurers use mortality tables to determine the number and timing of future benefit payments. Mortality tables do not indicate when a given individual in the group is expected to die. Instead, they show the mortality rate, number of people surviving, number of people dying, and remaining life expectancy for a given group of people. Actuaries use mortality information to establish the premium rates for life insurance and annuity products during product design and to calculate the amount of the reserve needed to support a product. take mortality rate and divide it by the orginal number of people

Profitability Ratios

Insurers use these four ratios to measure profitability. Click or touch each example box below to learn more about the types of ratios. Net profit margin shows how much after-tax profit the company has. net profit margin = net income / total revenues

Charts that are used to show changes in data over time are known as Pie charts Histograms Line diagrams

Line diagrams - Line diagrams, also known as line charts or line graphs, are used to show changes in data over time. Pie charts present data in the shape of a circle (the "pie") that has been cut into pieces. Each piece of the pie represents a different class, or group, into which values are grouped. Histograms are bar charts showing grouped data.

Line Diagrams

Line diagrams, also known as line charts or line graphs, show changes in data over time. For example, companies can use line diagrams to show trends in data, such as a rise or fall in sales volume. Line diagrams can show changes for a single category—such as sales of a single product, total sales of a single field office, or sales for a single year—or for multiple categories, such as sales of multiple products, total sales for multiple field offices, or sales for multiple years. Companies can create simple line diagrams or three-dimensional line diagrams.

Insurers can reduce the chance of introducing sampling bias by

Making sure that surveys don't include questions that lead to specific answers Varying the order of questions Sending reminders or additional surveys to non-responders Expanding the hours during which survey calls are made Following up on missed calls

Balanced Scorecards

Managers use balanced scorecards to assign target outcomes to a small number of financial or nonfinancial activities and then monitor their actual performance to see how closely current performance meets expectations. To create a scorecard, management generally Translates the company's mission statement into specific operational goals Links the identified goals to individual areas of performance Sets target performance levels or indexes for each area Compares actual performance against targeted performance Scorecards allow managers to identify potential problem areas and take action where necessary, also allowing managers to feed results back into the planning process to adjust strategies. Scorecards often are simple tables broken down into major sections with specific objectives, performance measures, trends, and initiatives for each section. general performance categories: - financial - customer - internal business - growth and innovation

Moody's

Moody's ranks the credit-worthiness of debt securities such as government and corporate bonds, money-market funds, fixed income funds, and hedge funds and of issuers of those securities. Ratings range from Aaa (high) to C (low) based on expected losses in the event of default.

Net Income

Most companies refer to the difference between revenues and expenses as net profit. It's what senior managers mean when they talk about the company's "bottom line", or whether the company is ''in the red'' or ''in the black.'' An insurer's income statement doesn't use the term profit. Instead, the difference between revenues and operating expenses is called pre-tax net income, and the amount left after subtracting income taxes is called net income.

The Edgemont Insurance Company surveyed a sample of customers to evaluate the potential success of a proposed new insurance product. Edgemont used nonprobability sampling to gather information from individuals aged 18 to 25. Nonprobability sampling helped Edgemont ensure that All members of the population had an equal chance of being included in the sample The answers they received were representative of the entire population They received information from ''typical'' customers for the product They included a proportional number of customers in the sample

Nonprobability sampling is often used when researchers believe that a few clearly defined members of a population can identify a ''typical'' member. It does not give every member of the population an equal or even predetermined probability of being included and doesn't ensure that a proportional number of customers are included. Answers obtained from a nonprobability sample aren't necessarily representative of the entire population.

A project scheduling tool that helps shorten the length of time needed to complete large, complex projects. Flow chart Gantt chart PERT network

PERT network

Pie Charts

Pie charts show data in the shape of a circle (the "pie") cut into pieces. Each piece of the pie represents a different class, or group, into which we group values. Pie charts are even more effective than compound bar charts for showing relative proportions or percentages because they allow users to highlight specific groups, as well as show the relationship of a group to the whole. We can construct pie charts using calculated percentages or numerical values for each segment. Most computer software applications convert raw data into proportions automatically

Rating agencies are independent, private organizations that provide information about insurance companies' financial strength in the form of credit ratings. These ratings are designed for use by Potential customers of and investors in insurance companies Current insurance company customers and regulators Potential investors and regulators Insurance companies and regulators

Potential customers- Rating agencies provide information to potential investors in insurance companies about the companies' ability to repay their financial debts and meet their obligations to policyowners.

Project Scheduling

Project scheduling is a critical part of an insurance company's planning process, especially when later steps in a project depend on the successful completion of earlier steps.Schedules help ensure that managers handle projects efficiently by showing the activities involved, when to perform them, and where to allocate resources.Schedules also give managers a way to monitor progress on a project and identify places where managers may need to take corrective action.

Fitch

Provides credit ratings and reports on financial and operational strength of companies in 150 countries. Ratings are based on public information and non-public information provided by issuers. Ratings range from AAA (investment grade) to D (speculative grade)

Standard and Poors

Provides market intelligence to potential investors in the form of credit ratings, indices (e.g., S&P 500), investment research, and risk evaluation. Credit ratings, which describe a company's relative level of credit risk, range from AAA (extremely strong capacity to meet financial obligations) to D (payment default).

A.M. Best

Provides ratings of over 10,000 insurers in 95 countries. Ratings of financial strength are based on balance sheet strength, operating performance, and business (risk) profile. Ratings range from A++ (exceptional) to F (extremely speculative).

The Fenway Insurance Company sent a survey to customers that included the following questions. Which of these questions do you think is/are likely to create response bias? A. How many times have you called the company's home office in the last six months? B. Don't you agree that providing quality service to customers is important? Both Question A and Question B Question A only Question B only Neither Question A nor Question B

Question B

Which company sold more policies, Rainwater or Snowfall? Rainwater Snowfall Rainwater and Snowfall sold the same number of policiesfeedback for question 3

Rainwater and Snowfall sold the same number of policies. Graph A uses a scale of 0 to 4.5 and Graph B uses a scale of 0 to 45. The actual sales figures are the same in both graphs, but the impression they give is very different. Because Graph B uses a scale 10 times larger than Graph A, sales appear much flatter in Graph B than in Graph A, making it appear that Rainwater sold more policies.

Median

Researchers often use the median to describe economic characteristics such as family income, household size, or education levels. Finding the median requires two simple steps: Arranging the values in the population in numerical order Determining the number of values in the population

When Aspen conducted an employee satisfaction survey, it polled a proportional number of employees from each of the company's regional offices. Stratified random sampling Simple random sampling Systematic random sampling

Stratified random sampling

Mean adv/dis

Strengths: Easy to calculate Considers all values weaknesses: Accuracy affected by outliers and distribution of values within the population

Median adv/dis

Strengths: Identifies the center of the population weaknesses: Considers only middle values Accuracy limited if data do not cluster around the mid-point of the population

Histogram

Suppose our insurer wants to see how the amounts of whole life coverage sold by the Southern field office are distributed. A histogram like this one would provide this information.

The manager of Aspen's call center analyzed the center's first-call resolution rate for the past month by looking at every 10th call report in their file. Stratified random sampling Simple random sampling Systematic random sampling

Systematic random sampling

Data Set Bar chart

The insurer in our example could show data from the Southern field office and the Eastern field office in the same chart. In this chart, policy sales for the two field offices are shown side by side for each category. The manager can tell at a glance the best (and worst) selling products for the two offices.In addition, the manager can see that, in all but two categories—variable life and universal life—sales from the Southern office were higher than those from the Eastern office.

Ratios compare two numeric values. The numerator in a ratio is the Value being studied, and it appears in the bottom part of the ratio Value being studied, and it appears in the top part of the ratio Value used for comparison, and it appears in the bottom part of the ratio Value used for comparison, and it appears in the top part of the ratio

The numerator in a ratio is the value being studied, and it appears in the top part of the ratio. The denominator is the value used for comparison, and it appears in the bottom part of the ratio.

Return on assets

The return on assets (ROA) ratio compares net income from the company's income statement and total assets from the balance sheet.The ROA ratio is widely used to rank companies within the same industry. The average ROA for the insurance industry is generally between 0.5 percent and 1.0 percent. ROA = net income / total assets

Return on invested assets

The return on invested assets (ROIA) ratio shows the relationship between net income—from the income statement—and average invested assets—from the balance sheet. Invested assets don't include the company's cash, property, equipment, and other noninvested assets. ROIA = net income/average invested assets

Interpreting Standard Deviations

The standard deviation is an accurate measure of dispersion only if the data are normally distributed, which means that half of the numbers are above the mean and half are below the mean. 68.2% of the data (34.1 × 2) fall between ± 1 standard deviation from the mean 95.4% of the data [(34.1 + 13.6) × 2] fall between ± 2 standard deviations from the mean 99.6% of the data [(34.1 + 13.6 + 2.1) × 2] fall between ± 3 standard deviations from the mean

statistical analysis

The use of mathematical techniques to collect, organize, describe, analyze, and interpret large amounts of numerical data in order to help people make decisions.

Changing the numerator and/or the denominator in a ratio changes the value of the ratio. In general, the value of a ratio will increase if Both the numerator and denominator increase by the same percentage The numerator increases by a larger percentage than the denominator The denominator increases by a larger percentage than the numerator Either the numerator or the denominator, but not both, increase

The value of a ratio will increase if the percentage change in the numerator is greater than the percentage change in the denominator. If both the numerator and denominator increase by the same percentage, the value of the ratio stays the same. If the denominator increases by a larger percentage than the numerator, or if only the denominator increases, the value of the ratio will decrease.

Results after Decreases If the percentage change in the numerator is ... Greater than the percentage change in the denominator Less than the percentage change in the denominator

The value of the ratio will ... Decrease Increase

If the percentage change in the numerator is ... Greater than the percentage change in the denominator Less than the percentage change in the denominator

The value of the ratio will ... Increase Decrease

Which of the following are characteristics of flow charts? (Choose all that apply.) They encourage critical thinking. They indicate the total amount of time necessary to complete a project. They are very practical for complex projects in which multiple activities take place at the same time. They have limited value as scheduling tools.

They encourage critical thinking, they have limited value as scheduling tools- Flow charts are valuable tools because they encourage critical thinking. However, one disadvantage of flow charts is they don't indicate the total amount of time necessary to complete a project or the different amounts of time to complete individual activities. In addition, flow charts are not always practical for complex projects in which multiple activities take place at the same time. So flow charts have limited value as scheduling tools.

Vertical Bar Chart

This is an example of a simple bar chart displaying the number of different types of life insurance policies sold by an insurance company's sales office during a specified time period.In this example, the scale on the side shows a range of 0 to 90 policies sold.

Simple Line Diagram

This is an example of a simple line diagram showing the quarterly sales of whole life insurance policies for our sample company's two field offices.

Three dimensional line diagram

This is an example of a three-dimensional line diagram showing the quarterly sales of whole life insurance policies for our sample company's two field offices.

Pie Chart Example

This shows how a pie chart of our insurance company's Southern field office sales data would look. Note that we've converted the numbers for each policy type to percentages in this example of a two-dimensional pie chart.We calculate percentages by dividing the number of policies in each category by the total number of policies sold. For example, if 84 of the 198 policies sold by the field office are whole life policies, that equals 42 percent (84 ÷ 198 = 0.42).

top down adv/dis

Top-Down Advantages Least time-consuming and least costly Management has greatest control over budgeting Most likely to reflect upper management intentions Top-Down Disadvantages Involves fewest number of employees Can result in a lack of commitment from lower-level employees Least likely to reflect the realities of day-to-day operations

Insurers use weighted values when they calculate capital and surplus ratios for shareholders and regulators. True False

True- Because basic capital and surplus ratios don't generally take risk into account, insurers usually use weighted values in ratios they report to shareholders and regulators.

Putting data into a table is one of the easiest ways to condense large amounts of data and to arrange the data so that they provide meaningful information. True False

True- In addition, order is one of the primary benefits of using tables to present data.

Managers can use computer software to generate scheduling tools such as Gantt charts and PERT networks. True False

True- Managers can hand draw or use applications included in most project management software programs to automatically generate Gantt charts and PERT networks.

Scheduling Tools

Two of the most effective tools for scheduling insurance projects are Gantt charts and program evaluation and review technique (PERT) networks.

ungrouped data

Ungrouped data generally provide greater precision and accuracy than grouped data, because ungrouped data allow users to see individual values. However, grouped data are often a more effective way to show trends and may be the only way to manage extremely large sets of data.

( Ungrouped / Grouped ) data generally provide greater precision and accuracy. ( Ungrouped / Grouped ) data are often a more effective way to show trends and may be the only way to manage extremely large sets of data. Ungrouped / Grouped Ungrouped / Ungrouped Grouped / Ungrouped Grouped / Grouped

Ungrouped/grouped- Ungrouped data generally provide greater precision and accuracy than grouped data, because ungrouped data allow users to see individual values. However, grouped data are often a more effective way to show trends and may be the only way to manage extremely large sets of data.

Dashboards

When you look at the dashboard in your car, you can see—at a glance—how your car is performing. For example, your car dashboard probably includes a variety of dials and gauges showing you how much gas you've used, how many miles you've driven, what your current speed is, and how many RPMs your car's engine is producing. You can even see the current time and temperature. In some cases, you can get more detailed information, too, such as average miles per gallon or average speed. A performance dashboard shows the same kind of information about a company's performance. Like a car dashboard, a performance dashboard puts all the information managers need to evaluate the performance of the company or of individual business units in one place. - pie chart - heat map - guage - bar graph - line graph

Although projects vary widely in terms of complexity and length, all projects (choose all that apply) Have a beginning and an end Include a set of activities and events Follow a series of steps Require time to complete Generally can be done by one person

all but generally can be done by one person - All projects have a beginning and an end, include a set of activities and events, follow a series of steps, and require time to complete. However, projects generally require the efforts of more than one person.

Flanders Insurance's accounting department prepared a budget that showed receipts (inflows) and payments (outflows). The budget gave management an estimate of the timing and amount of possible cash shortages that would require borrowing and excesses that the company could use for investments. Capital budget Revenue budget Cash budget Master budget

cash budget

Measures whether a company has enough assets to cover its long-term or short-term financial obligations (choose all that apply) Debt-to-equity ratio Insurance leverage ratio Current ratio Return on equity (ROE) ratio Capital and surplus ratio

current ratio, capital and surplus ratio

Measures of Central Tendency

describe values in the middle of a population or a sample. Probably the most familiar measure of central tendency is the mean or ''average'' value. Expressed as a formula, the Mean = Sum of values ÷ Number of values

financial leverage

describes the impact that a company's operating and financing costs have on its risks and returns.

Calculating expected times for pert activates

expected time = a +4m+b/6 a = optimistic time m = most probable time b= pessimistic time

Insurers use visual presentations only to order, condense, and display numbers. True False

false: Visual presentations don't just give insurers a way to order, condense, and display numbers. They also offer companies a way to plan, organize, and control activities.

Mode

in a data set doesn't require listing values in a particular order. It can be found just by looking at the numbers in the set. In our example, the mode value is 350 because it appears more often than any other number.

Insurance leverage ratio

indicates a company's ability to cover contractual obligations with existing resources. Because contractual reserves make up a large portion of insurance company liabilities, most insurers have high insurance leverage ratios. However, insurers try to keep ratio values between 4.0 and 6.5. contractual reserves / capital and surplus = insurance leverage ratio

current ratio

measures a company's short-term solvency. A ratio of 100 percent or better usually means the company has adequate liquidity. A ratio lower than 100 percent is often a sign that a company may need to borrow funds or sell long-term investments. A very high ratio can also be a problem because current assets generally produce low returns, and low returns can damage profits. The goal for most insurers, therefore, is to maintain a moderate level of liquidity. current ratio = current assets / current liabilities

capital and surplus ratio

measures long-term solvency. In general, the higher the ratio, the better. However, if a company's ratio is too high, the company may have trouble building equity. If it's too low, the company may be at risk of becoming insolvent. Because capital and surplus ratios don't take risk into account, insurers often use weighted valuesto calculate capital and surplus ratios they report to company owners. Regulators and rating agencies often require insurers to use weighted values in their financial report capital and surplus ratio = capital and surplus/total liabilities

range

measures the difference between the highest and lowest values in the population.

variance

measures the distance between individual values in the population and the mean. Calculate the mean Find the distance between each value in the data set and the mean—subtract the mean from each value Square each distance—that is, multiply each distance by itself Add all the squared values Divide the total by the number of values in the population

NEt profit margin equals

net income/total revenue x 100

Provides an insurer with a relative measure of its overall success by comparing the company's gains from operations to the resources used to generate those gains (choose all that apply) Current ratio Net profit margin Capital and surplus ratio Return on assets (ROA) ratio Return on equity (ROE) ratio

net profit margin, return on assets (ROA) ratio, Return on equity (ROE) ratio

Program Evaluation and Review Technique (PERT) Networks

networks include four important elements - Events - Activities - Time - Critical Path

descriptive statistics

provide information about a population by analyzing all of the data in the data set.

Measures of Dispersion

provide information about the arrangement of individual items in a data set.

Inferential statistics

provide predictions about a population based on a sample of the data in the data set

debt-to-equity ratio

provides information about a company's financial position. In general, the lower the value of the ratio, the stronger the insurer's financial position. High results also indicate relatively high risks, so most companies aim for as low a debt-to-equity ratio as possible. longterm debt/ owners equity = debt to equity ratio

avoiding sampling bias

response bias: The way a question is asked distorts the answer. For example, questions such as ''Don't you agree that telephone calls should be answered within three rings?'' or ''Wouldn't you prefer that applications be processed within three working days?'' encourage survey participants to acknowledge a preference that may not be real. The order in which choices are presented implies that some options are more important than others. For example, because people often associate order with importance or ranking, survey participants are more likely to select the first choice in a list than the last choice in the list. The purpose of the question is unclear. For example, a question such as ''How would you rate Company X's customer service?'' doesn't identify what aspect of service is being evaluated and doesn't provide a rating scale. As a result, survey participants are forced to base their answers on personal criteria. Nonresponse Bias: Nonresponse bias occurs when certain members of a sample are more likely to provide information than other members. For example, customer service surveys tend to generate more responses from customers who have had extremely positive or extremely negative experiences than from customers who have had more neutral experiences. In addition, studies show that middle-income people are more likely to respond to mail surveys than are upper- or lower-income people. As a result, responses to a mail survey tend to over-represent the middle-income population, even though the sample included all income levels. Selection Bias: Selection bias occurs when the way data are collected systematically excludes certain members of the sample. For example, a survey of customers conducted by calling customers at home between 9:00 am and 5:00 pm would systematically exclude customers who work outside the home during regular business hours. In this case, information from certain sample members is excluded because the sample members weren't contacted, and not because they were contacted and chose not to respond.

Standard deviation

reverses the process used to calculate the variance and puts results back in the same numerical scale as the raw data.

simple random sample adv/dis

sample selected: Mechanically, using a random number table or random number generator Strengths: All population members have an equal probability of selection Weakness: Not useful for varied or segmented populations Sampling process often time-consuming

systematic random sampling adv/dis

sample selected: At predetermined time, order, or space intervals strengths: Doesn't require user to assign numbers to elements Ensures sample participants are drawn from the entire population Weakness: Interval size and order of elements important in small samples

stratified random sampling adv/dis

sample selected: Proportionally from individual segments according to ratio of sample to population; individual elements in each segment selected at randomUseful for varied or clearly segmented populationsRequires additional calculations strengths: Useful for varied or clearly segmented populations weakness: Requires additional calculations

To evaluate its new business processes, Aspen's new business manager assigned a number to each application in the file and put those numbers into a random number generator that produced a list of 100 numbers. The manager studied the applications whose numbers matched the list. Stratified random sampling Simple random sampling Systematic random sampling

simple random sampling

Mode adv/dis

strength: Can provide insight about common practices weaknesses: Considers only the most common value A population may have more than one mode or no mode at all

The Financial Analysis and Solvency Tracking (FAST)

system uses 22 individual ratios divided into four groups: profitability, leverage, asset and liquidity, and miscellaneous. Companies whose results on a particular ratio are within normal ranges receive no score. Companies whose results are outside normal ranges are assigned a score between 1 and 175. The higher the score, the higher the risk. High overall FAST scores indicate the need for additional regulatory attention

The Insurance Regulatory Information System (IRIS)

uses 12 standardized financial ratios to evaluate information in an insurer's Annual Statement. Ratios are grouped into four areas: overall ratios, profitability ratios, liquidity ratios, and reserve ratios. If a company's results on four or more of these ratios fall outside established ranges, the company must undergo additional analysis. Canadian regulators use a similar ratio system, known as early-warning ratio tests, to analyze information in the Annual Return filed by all Canadian insurers.

nonprobability sampling

uses criteria such as age, gender, geographic location, type of business, or number of products owned. As a result, Population members don't have an equal or even predetermined probability of being selected because specific selection criteria exclude some members of the population. Predicting the characteristics of a population based on characteristics of a sample isn't always reliable. Even with its limitations, nonprobability sampling is often preferable when a researcher believes that examining only a few clearly defined members of a population can identify a "typical" member.

Durham Financial invested $100,000 at 4 percent interest compounded quarterly. Using the FVIF Table above, what will be the value of Durham's investment in one year? $104,000 $104,060 101,000 That's correct!

$104,060 To calculate the future value, multiply the number of years by the number of compounding periods per year (1 × 4 = 4) to get the number of periods. Then divide the interest rate by the number of compounding periods per year to get the interest rate (4% ÷ 4 = 1). Then find the FVIF in our table for 4 periods at 1 percent interest (1.0406) and multiply that by the amount Durham invested ($100,000 x 1.0406) to give the correct answer of $104,060

Which characteristics describe an insurance company's annual report? (Choose all that apply.) Designed to provide information about company profitability Designed to provide information about company solvency Used primarily by investors and the public Used primarily by regulators Reported on a going concern basis Required for all U.S. insurance companies Required by the Securities and Exchange Commission (SEC) for publicly traded companies and companies that offer variable products

- designed to provide information about company profitability - used primarily by investors and the public - reported on a goin concern basis - required by the SEC for public traded companies that offer variable products

The Balance Sheet

A balance sheet shows a company's assets (what the company owns), its liabilities (what it owes), and its capital and surplus, or owners' equity (what it's worth) as of a specific date—usually the last day of the company's accounting period, such as March 31, June 30, September 30, or December 31.An insurer's balance sheet takes its form from the basic accounting equation and its name from the fact that the two sides of the equation always balance. An equation which states that a company's assets equal the sum of its liabilities and its capital and surplus.

master budget

A budget that shows the overall operating and financial plans for a company during a specified accounting period; formed by combining all of the individual budgets for each department. Also known as a comprehensive budget, a corporate budget, or a performance plan.

cash budgets

A cash budget is similar to the cash flow statement we described earlier. However, unlike the cash flow statement, which presents a company's past cash flows, the cash budget illustrates future cash flows.To create a cash budget, an insurer combines information from two sources: the cash receipts budget showing cash coming into the company and the cash disbursement budget showing cash going out.

figure

A figure illustrating what insurers can do to increase net income which includes an arrow pointing up for increasing revenues and arrow pointing down for decreasing expenses.

Law of large numbers

A mathematical concept which states that, under normal circumstances, the more times a particular event is observed, the more likely it is that the observations will approximate the "true" probability that the event will occur.

Statement of Owners' Equity

A statement of owners' equity describes changes in company owners' investment in the company. Stock companies call this a statement of stockholders' equity. Mutual and fraternal companies, which don't issue stock, often call it a statement of policyowners' equity. Insurers use this report to illustrate the value of investors' and owners' investments in the company. Like the income statement, the cash flow statement and the statement of owners' equity are considered dynamic reports because they document changes in and movement of funds during a specified period of time.

Operational Budgets

All operational budgets begin with a forecast of sales revenue and investment income. Although these budgets vary widely in terms of format and content, they usually include two key elements: a revenue budget and an expense budget. A revenue budget describes the revenue a company expects to generate from sales, investments, and fees. Insurers use it to determine the limits of other company budgets, so they usually prepare it first Insurers generally use expense budgets to control expenses, measure management performance, and assign responsibility for company expenses.

sample data

Although analyzing data about an entire population of customers, life insurance applications, underwriting decisions, or telephone calls to a company's contact center is likely to provide insurers with accurate information, it's not always practical in terms of time, effort, and cost. Studying a sample is easier, faster, and more economical. However, basing decisions on sample data can be risky. That's because conclusions drawn from sample values are inferences rather than facts. And inferences can be right... or wrong. Let's look at an example.

Annuities

An annuity can refer to any series of payments that are equal in amount and paid at regular intervals. An annuity does not refer to a series of unequal payments or payments made at irregular intervals. An annuity can refer to payments received or payments made. An annuity is not the same as an annuity contract, which is a specific type of financial product that can be structured to provide monthly income benefits. As a result, the formulas used to calculate the values of an annuity are valid without any reference to an actual annuity contract.

Financial Reporting

An income statement records company revenues and expenses over a specific period. It's considered a dynamic report because it shows the movement or flow of company finances over time. A balance sheet records company assets, liabilities, and capital and surplus as of a specific date. It's considered a static report because it provides a snapshot of a company's finances at a specific moment.

Annual Statement

An insurer's Annual Statement includes information about the company's operations and financial performance. It's used primarily to show regulators that an insurer is solvent and can meet its obligations to customers even if it stops doing business.All insurers operating in the U.S. must file an Annual Statement with the National Association of Insurance Commissioners (NAIC) and the department of insurance in each state in which they do business. They must also file a Quarterly Statement with the NAIC each quarter. Insurers are required to use statutory accounting practices to prepare the Annual Statements and other reports submitted to insurance regulators.

Annual Report

An insurer's annual report provides stockholders, investors, and/or company owners with information about the company's financial performance during the preceding year. The Securities and Exchange Commission (SEC) requires all publicly traded stock insurers and all insurers that issue variable products, such as variable universal life insurance and variable annuities, to publish an annual report for stockholders and other interested parties. Insurers use generally accepted accounting principles (GAAP) to prepare annual reports because they focus on showing a company's financial stability and profitability.

FV for single amount

Analysts typically substitute present value (PV) for principal because, like principal, present value represents a sum of money before it is affected by interest. So, the formula for calculating the future value (FV) of a single amount for one period is FV = PV + Interest earned

Suppose that Jensen Financial invests $2,000,000 per year at an annual rate of 5 percent. If Jenson makes each deposit on December 31, how much money will Jensen have in 20 years? $66,132,000 $69,438,600 $64,132,000

Because Jensen makes payments at the end of each payment period, its account is an ordinary annuity. To find the future value of an ordinary annuity, we multiply the FVIFA factor for 20 periods at 5 percent interest by the amount of each payment.FV of Jensen's ordinary annuity = $2,000,000 × 33.0660 = $66,132,000

Principal Sum

Because a principal sum invested at interest grows over time, the principal's- Present value < its future value- Future value > its present value

Interest Rate

Because an interest rate is a rate of growth, for money earning a stated rate of interest for a specified period, an increase in the interest rate will result in- A decrease in the present value of a future sum- An increase in the future value of a present sumConversely, a decrease in the interest rate will result in- An increase in the present value of a future sum- A decrease in the future value of a present sum

Number of Periods

Because compound interest is paid periodically, for money earning a stated rate of interest for a specified period, an increase in the number of periods will result in- A decrease in the present value of a future sum- An increase in the future value of a present sumOn the other hand, a decrease in the number of specified periods will result in- An increase in the present value of a future sum- A decrease in the future value of a present sum

Certain elements of an insurance company's current income statement are linked directly to changes in the company's balance sheet from one period to the next. In general, the net income amount from the income statement is linked to values in the company's current balance sheet for Both assets and capital and surplus Assets only Capital and surplus only Neither assets nor capital and surplus

Both - A company's current balance sheet reflects the link between the net income amount from the income statement and both the asset amount and the capital and surplus amount from the previous balance sheet

Bottom-up Adv/dis

Bottom-Up Advantages Most likely to reflect the realities of day-to-day operations Has the greatest support among employees Expresses the objectives of operational areas Bottom-Up Disadvantages Requires input from large numbers of employees Relatively time-consuming Must adhere to overall corporate objectives

FV for one year investment

For a one-year period, the amount of interest earned equals the present value multiplied by the interest rate, i. Because compounding only occurs when money is held for more than one period, we don't specify a value for the number of interest periods, n. We can express the formula for the interest earned on a one-year investment as follows: Interest earned = PV × i

One true statement about a future value interest factor (FVIF) table is that: For any given period of time and any given interest rate, the FVIF is always greater than 1. For any given period of time, FVIF values increase as the interest rate decreases. For any given interest rate, FVIF values decrease as the investment period increases. To find the future value of a sum greater than $1 at a given rate of interest for a stated number of periods, we mutiply the FVIF value by the number of periods.

For any given period of time and any given interest rate, the FVIF is always greater than 1. For any given period of time, FVIF values increase as the interest rate increases.For any given interest rate, FVIF values increase as the investment period increases. To find the future value of a sum greater than $1, multiply the FVIF value by the sum.

If Jonas Fund puts $1,000,000 in an investment each year on December 31, how much will Jonas have at the end of 5 years? Assume the account earns 7 percent interest. What would we need to find to answer this question? The future value of an ordinary annuity The future value of an annuity due The present value of an ordinary annuity The present value of an annuity due

Future value of an ordinary annuity- In this situation, we are trying to find the future value of an ordinary annuity. We know this because we need to determine the amount Jonas will have in the future, and Jonas makes the investment on the last day of each year.

The following statement(s) can correctly be made about present value and future value: A. Generally, a sum of money invested today has a present value that is less than its future value because of interest. B. A sum of money invested today for 10 years will grow to a larger sum than the same amount of money invested for 5 years. Both A and B A only B only Neither A nor B

In the next part of the lesson, we'll take a closer look at future values.

Budgeting advantages and disadvantages

In the process of budgeting, companies systematically project the anticipated revenues and expenses of their departments, divisions, or lines of business during a specified time period. They also create a documented plan for Allocating scarce resources effectively Controlling expenses Monitoring and evaluating ongoing operations Evaluating managerial performance Communicating financial information throughout the company Motivating employees Although budgeting can be a useful tool, the budgeting process may be subject to certain pitfalls if it's not managed appropriately. For example, the process can potentially Consume time that employees could otherwise spend performing their primary job duties Encourage departments or divisions to spend all available funds, even when unnecessary Encourage departments to overestimate costs so that they won't be blamed if they overspend Discourage companies from using innovative solutions when market conditions change Discourage flexibility when responding to internal shifts in goals and priorities

Reports for Stakeholders and Regulators

Insurance companies also prepare a variety of reports for use by regulators, rating agencies, and the general public. Two of the most important of these reports are the annual report and the Annual Statement. Click or touch the right arrow below to learn more about the reports.

TVOM

Insurers rely on the concept of the time value of money (TVOM) to explain the relationships among payment amounts, interest rates, and time.According to this concept, a sum of money has both a present value (PV) and a future value (FV).

Important Insurer Applications of Present Values

Insurers use PVIFs and PVIFAs to determine the prices of one of their most important investments—bonds. Remember that a bond pays periodic interest payments along with the payment of the bond's par value upon maturity. So, to determine the price to pay for a bond, an insurer must calculate two present values: The present value of the bond's coupon payments, which represents the present value of an ordinary annuity The present value of the bond's par value, which is the present value of a single payment Future value of an ordinary annuity = periodic payment × FVIFA Future value of an annuity due = periodic payment × FVIFA for one additional period - one periodic payment Present value of an ordinary annuity = periodic payment × PVIFA Present value of an annuity due = periodic payment × PVIFA for one fewer period + one periodic payment

Interest rate

Interest rate = Interest amount ÷ Principal

The Rule of 72

Investors can use a simple rule of thumb known as the Rule of 72 to estimate how fast a principal sum doubles at a specified compound interest rate. The Rule of 72 states that, for a known interest rate, under annual compounding, the approximate number of years for a principal sum to double is 72 divided by the interest rate. Years to double = 72 ÷ Interest rate

Net Income

Most companies refer to the difference between revenues and expenses as net profit. It's what senior managers mean when they talk about the company's "bottom line", or whether the company is ''in the red'' or ''in the black.'' An insurer's income statement doesn't use the term profit. Instead, the difference between revenues and operating expenses is called pre-tax net income, and the amount left after subtracting income taxes is called net income. Revenues - Expenses = Pre-tax net incomePre-tax net income - Income taxes = Net income

Steadfast Insurance can calculate the interest amount it earned on an initial sum of money invested for one year at a specified interest rate by ( multiplying / dividing ) the principal by the interest rate. multiplying dividing

Multiplying- An investor can calculate the interest amount earned on an initial sum of money invested for one year at a specified interest rate by multiplying the principal by the interest rate.

Interest rates

Remember that interest is a fee that individuals and financial institutions pay (or charge) for the use of borrowed money. And the amount of interest earnings depends on the interest rate that's applied to the principal. Interest rates are usually stated in decimal form, so a 5 percent interest rate appears as 0.05 and a 2.5 percent rate appears as 0.025. Interest earned = $1,000 × 0.025 = $25

Statutory Accounting Practices (SAP)

Required to prepare the Annual Statement and other financial reports for use by state insurance regulators Designed to provide a single, comprehensive set of accounting practices Based on rules that apply uniformly to all companies Focus on company solvency Done on a ''liquidation'' basis to assess whether a company has enough assets to meet obligations if it ceases operations Oversight provided by the National Association of Insurance Commissioners (NAIC)

Stratified random sampling

Simple random sampling and systematic random sampling are usually most effective when the elements of a population are similar. Insurance applications, customer contacts, and underwriting procedures are good examples. If populations are varied or divided into distinct segments, stratified random sampling is a better approach. To determine how many items from each stratum to include in the sample, users need to Determine the percentage of the population that will be included in the sample. For example, a sample of 200 of 1,000 items would be 20% (200 ÷ 1,000 = 0.20). Multiply the number of items in each stratum by the percentage.

Simple Random Sampling

Simple random sampling is just that—simple. Individual elements are pulled from the population at random until the appropriate number of elements is assembled. If a population is well defined and the number of elements needed for a sample is relatively small, researchers can usually select a sample by hand. It's a little like drawing numbers from a hat. For larger populations, researchers usually select a sample using an automated random number generator or a table of random numbers.

Systematic Random Sampling

Systematic random sampling allows users to specify the interval used for selecting sample items. Most often, intervals are measured by time, order, or space. Time interval. A call center manager evaluates the performance of customer service representatives by monitoring one call every 15 minutes. Order interval. A claim manager evaluates the accuracy of claim processing by dividing claims into groups according to the face amount of the policy and then examines a specified number of claims from each group. Space interval. A new business manager checks every 10th application processed for accuracy. advantages: It doesn't require a random number generator. Researchers can use any size interval and can start sampling at any point in the population. If the sample size is large enough in relation to the population, it ensures that all members of the population have an equal chance of being selected, regardless of where sample selection begins. disadvantages: - lack of balance

Steadfast Insurance can use the Rule of 72 to A. Estimate how fast a principal sum doubles at a specified compound interest rate B. Determine the rate of interest a principal sum must earn to double in a certain number of years. Both A and B A only B only Neither A nor B

The Rule of 72 states that, for a known interest rate, under annual compounding, the approximate number of years for a principal sum to double is 72 divided by the interest rate.The Rule of 72 can also help determine the rate of interest a principal sum must earn to double in a certain number of years.

Cash Flow Statement

The cash flow statement shows cash inflows, or receipts—such as policy premiums, investment income, and fee income—and cash outflows, or disbursements—such as policy benefits, investment expenses, and business expenses—during a specified time period. Insurers use this report to show how well it manages its cash over time. By linking it to the balance sheet, insurers can also see how the company's cash changes from one period to the next and how those changes affect its capital and surplus accounts.

surplus

The cumulative amount of money-calculated as an insurance company's assets minus its liabilities and capital-that remains in the company over time.

Future value

The future value is the invested principal plus the interest generated by the investment over time. Future value = Principal + Interest earned

Fv of a single amount for mutiple periods

The general formula for finding the future value of an investment earning compound interest, i, for n periods, can be written as: FV = PV × (1 + i )n So, if we deposited $100,000 into an account that earns 5 percent interest, compounded annually, for five years, the future value of this investment calculated using the formula would be: FV = $100,000 × (1.05)5 FV = $100,000 × (1.05)(1.05)(1.05)(1.05)(1.05) FV = $127,628

The Income Statement

The income statement measures how successfully a company manages Revenues generated by its business operations. For insurers, revenues come primarily from premiums paid by contract owners. They also include investment earnings—such as interest income on bonds and dividends on stocks—and fee income for providing services such as asset management and administration. Expenses incurred as a result of doing business. The biggest expenses for insurers are contractual benefit payments to policyowners and beneficiaries and operating expenses such as commissions on sales, employee salaries and benefits, and product development costs. Insurers typically account for income taxes separately.

So far, you've seen how factors such as interest rates, types of interest, and time affect investment values. How do you think insurers use this information? (Choose all that apply.)

The time value of money (TVOM) concept explains the effects of interest rates, types of interest, and time on investment values. Insurers use TVOM to determine the future value of an investment and the amount they need to invest today to earn a given amount in the future. TVOM doesn't help with investment choices.

Effective Interest Rate

The type of interest rate that includes the effects of compounding.

sampling data

The way a company samples a population depends on the situation. If an insurer needs to know that the answers it collects from a sample of customers are representative of all customers, or to demonstrate that the company is consistently following required procedures, probability sampling, or random sampling, is usually the best choice. Probability sampling can take one of three basic forms: - simple random sampling: ensures that every member of a population has an equal chance of being selected. - systematic random sampling : ensures that, if the sample size is sufficiently large, the entire population will be sampled, regardless of where the sample selection begins. - Stratified Random Sampling : ensures that, if a population is clearly segmented, a proportional number of members from each segment is included in the sample.

Using PVIFAs: An Annuity Due

To calculate how much you need to invest to provide payments of $1,000 at the beginning of each year for the next three years, you use the PVIFA for 2 payments at 5 percent interest, which is 1.859 and one payment of $1,000. So the amount you will need to invest today equals ($1,000 × 1.859) + $1,000 = $1,859 + $1,000 = $2,859.00

Using PVIFAs: An Ordinary Annuity

To calculate how much you need to invest to provide payments of $1,000 at the end of each year for the next three years, you use the PVIFA for 3 payments at 5 percent interest, which is 2.723. So the amount you will need to invest today equals $1,000 × 2.723 = $2,723.00

Which statement correctly describes the use of present value interest factors (PVIFs)? To find the present value of a sum, you must divide the future value by the PVIF. For any given time period, as interest rates increase, PVIFs increase. For any given time period and any given interest rate, PVIFs are always greater than 1. For any given interest rate, as time increases, PVIF values decrease.

To find the present value, multiply the PVIF by a given future value. For any given time period, as interest rates increase, PVIFs decrease. For any given time period and any given interest rate, PVIFs are always less than 1.

Generally Accepted Accounting Principles (GAAP)

Used to prepare the annual report and other financial reports for use by investors, policyowners, and federal regulators Required for all publicly traded stock companies and companies that sell variable products Based on rules that apply uniformly to all companies Focus on company stability and profitability Based on the going-concern concept that assumes a company will be in business going forward Oversight provided by the Financial Accounting Standards Board (FASB)

Linking the Income Statement and Balance Sheet

When an insurer's income statement shows a net gain, that gain increases the company's capital and surplus and is reflected in the company's balance sheet for the next period. Because assets = liabilities + capital and surplus, the company's net income also changes the amount for assets on the balance sheet—from $16,408,000 to $16,600,000 ($16,408,000 + $192,000 = $16,600,000).

Compound interest

When interest is compounded, the interest earned each investment period is added to the original principal amount, and that total is used as the beginning balance when calculating interest earnings for the next period. In this case, the effective interest rate is greater than the nominal interest rate. Compound Interest: At a constant annual rate of 5% compound interest, after 100 years the $10 investment would have earned $1,305.01 in interest and the total value of the investment would be $1,315.01.

zero-based adv/dis

Zero-Based Advantages Relates all expenses to strategic and operational goals Involves extensive employee participation and input Produces broad-based, high-quality financial information Zero-Based Disadvantages Most time-consuming and costly Requires collecting and analyzing data to justify each budget item Applies only to expense budgets

The Crandall Insurance Company's operational areas create budgets each month to outline their expected revenues and expenses. These budgets, which are based on the previous period's results, are then sent to senior management for approval. The budgeting approach Crandall uses is called Top-down budgeting Bottom-up budgeting Zero-based budgeting External budgeting

bottom-up budgeting:: Budgeting that begins at the operational level and moves up to senior management is called bottom-up budgeting. Top-down budgeting moves downward from senior management to operational areas. Zero-based budgeting starts over each period and doesn't use the previous budget as a starting point. All of these budgets are for internal use.

A decrease in investment time will result in a(n) ( decrease / increase ) in future value. decrease increase

decrease Future values change in the same direction as changes in time. Present values change in the opposite direction as changes in time.

An increase in investment time will result in a(n) ( decrease / increase ) in the present value. decrease increase

decrease- Future values change in the same direction as changes in time. Present values change in the opposite direction as changes in time.

Bottom-up budgeting

division managers use current divisional budgets, input from employees, and information about divisional goals to project the division's expenses and determine the resources needed to cover those expenses. Completed budgets are submitted to senior management for approval.

zero-based budgeting (ZBB)

doesn't consider past or even current spending. Instead, it Treats every activity or function as a new project. Requires planners to justify continued company support. In most cases, planners can add resources only if and when they can show that a particular expense satisfies the company's strategic and operational goals.

Insurers use budgets to inform customers and regulators about the company's past performance. True False

false- Unlike a company's income statement and balance sheet, which focus on a company's past performance, budgets are a way for insurers to plan the company's future activities.

Montague Funds invested $100,000 at 3 percent interest compounded semi-annually. Montague wants to know what its investment will be worth in two years. When finding the future value of its investment, what value should Montague use for the number of periods and the interest rate? number of periods = 2, interest rate = 3 number of periods = 2, interest rate = 1.5 number of periods = 4, interest rate = 1.5 number of periods = 4, interest rate = 3

nUMBER OF PERIODS = 4, INTEREST RATE = 1.5 - When interest is compounded more often than annually, you find the number of compounding periods by multiplying the number of years a sum is invested by the number of compounding periods in a year (2 years x 2 compounding periods per year = 4 periods). You then adjust the interest rate by dividing the stated interest rate by the number of compounding periods each year (3 ÷ 2 = 1.5).

Future value of an ordinary annuity Periodic payment × FVIFA Periodic payment × FVIFA for one fewer period + one periodic payment Periodic payment × FVIFA for one greater period - one periodic payment

periodic payment x FVIF: For an ordinary annuity, the future value is found by multiplying the periodic payment by the FVIFA. For an annuity due, the future value is found by multiplying the periodic payment by the FVIFA for one additional period and subtracting one periodic payment.

Edgewood Financial created a budget that showed the amount of income the company expected to earn from policy sales, investments, and fees for the next quarter. Capital budget Revenue budget Cash budget Master budget

revenue budget

An insurance company's income statement illustrates the relationship between company revenues, expenses, and net income. A company's net income is equal to Revenues + Expenses Revenues x Expenses Revenues - Expenses Revenues ÷ Expenses

revenues - expenses A company's net income is the difference between the company's revenues for a given period and the company's expenses for the period.

simple interest

the amount of interest earned for one year is equal to the principal multiplied by the interest rate. As a result, when an investment earns simple interest, the nominal interest rate and the effective interest rate are the same. The total amount of simple interest earned is equal to the interest for one year multiplied by the number of years in the investment period. At a constant annual rate of 5% simple interest, after 100 years the $10 account would have earned $50 in interest (100 x $0.50), and the total value of the investment would be $60.00.

Capital budgeting

to analyze and make decisions about proposed long-term, high-cost projects and describe the company's plans for managing those projects. In most cases, the projects analyzed during the capital budgeting process include New investments in equipment or real estate Major changes to existing projects Acquisitions of other companies or lines of business Government-mandated safety and environmental improvements Expense reduction projects Purchases of new computer systems and equipment All of the projects considered during the capital budgeting process are expected to produce income or other benefits for more than one year.