Transcript Section I Slides - Bryant University

Statutory Accounting
1. NAIC Annual Statement Blank
2. Differences between Statutory Accounting
and GAAP
• admitted and non-admitted assets
• valuation of assets (stocks, bonds)
• matching of revenues and expenses
8-1
Terminology
Policyholders’ Surplus
• excess of assets over liabilities
• for capital stock insurers, capital and
surplus
• for mutual insurers, surplus
Reserves
• synonymous with liability in insurance
company accounting
8-2
NAIC Codification Project
1. Statutory accounting system has come under
criticism by public accountants (AICPA).
2. In 1993, the AICPA announced it would not
issue unqualified opinions on statutory
accounting statements after 1994.
3. AICPA argues that statutory accounting
principles are not clearly articulated: they are
not generally codified by state laws and
differences exist across states.
4. NAIC responded with a project to more clearly
define principles of statutory accounting and
seek state codification of these principles.
8-3
Property and Liability Insurers
1. Earned premiums
2. Unearned premium reserve
3. Incurred losses/loss reserves
4. Incurred expenses
5. Summary of operations
6. Investment results
7. The combined ratio
8-4
Property and Liability Insurer Surplus Drain
Premiums Written
Premiums Earned
Expenses Incurred
Incurred Losses
Net Operating Loss
$100,000
50,000
-40,000
-25,000
-15,000
Statutory operating loss is an illusion that
stems from mis-matching revenues and
expenses.
8-5
Property and Liability Insurer Surplus Drain
1.
Incurred expenses must be charged before
income is earned.
2.
Premiums earned on existing policies could
offset the statutory underwriting loss.
3.
When premiums are increasing, statutory
profit is understated.
4.
When premiums are decreasing, statutory
profit is overstated.
8-6
Life Insurers
1.
Life insurer assets
2.
Life insurers liabilities
3.
Life insurers policyholders surplus
4.
Life insurer summary of operations
5.
Surplus drain in life insurance
8-7
Reinsurance
1.
Nature of reinsurance
2.
General approaches
• facultative
• treaty
3.
Types of treaties
• facultative
• automatic
8-8
Reinsurance in Property & Liability Insurance
1.
2.
Proportional reinsurance
•
quota share
•
surplus line
Excess loss reinsurance
8-9
Reinsurance in Life Insurance
1.
Term insurance approach
2.
Coinsurance approach (quota share)
8-10
Functions of Reinsurance
1.
Spreading of risk
2.
Financing function - surplus relief
8-11
Risk Financing Alternatives to Reinsurance
Insurance Derivatives - Securitization of
Insurance Risk
• Derivatives are financial instruments that
embody futures or options in a security,
commodity, and financial markets.
• Price is derived from the value of commodity
prices, interest rates, stock market prices, and
now insurance indexes.
• Like reinsurance, insurance derivatives are
designed to transfer a part of an insurer’s
underwriting risk to another party.
8-12
Risk Financing Alternatives to Reinsurance
Derivatives differ from reinsurance in risk
financing by securitizing insurance risk--that is,
linking it to securities.
• Instead of transferring specific risks, insurer
makes a side bet with a speculator.
• Side-bets have been manifest in two ways:
» CBOT catastrophe insurance futures
options
» catastrophe bonds (act of God bonds).
8-13
Catastrophe Futures and Options
A futures contract is a binding contract
providing for the delivery of a specified
quantity of some commodity or financial
instrument at some future specified date
An option contract is a contract in which one of
the parties pays for the right to purchase a
commodity at a specified price (called the
exercise price or strike price) at some time
during a specified option period.
8-14
Catastrophe Futures and Options
In 1995, CBOT began trading catastrophe
insurance futures options, based on a benchmark
of catastrophe estimates, provided by Property
Claim Services, known as PCS options.
• For PCS options, the “commodity” is an
amount of dollars indicated by an index of
catastrophe losses.
• By acquiring call options—the right to buy
futures contracts whose price is pegged to
disaster losses—an insurer can earn a profit
and arrange a future source of funds to pay
claims for catastrophe losses.
8-15
Catastrophe Bonds
(also called cat bonds of act of God bonds)
Issued by an insurer with the repayment terms
linked to company's losses from disasters.
• Loss exceeding a certain size automatically
produces changes in the bonds' structure
designed to protect insurer's capital base.
• Some or all of the principal is forgiven or
subject to deferred payment in the event the
issuing insurer suffers a catastrophe loss.
• For stock insurers, the bonds may also provide
for automatic conversion of the cat bonds into
stock in the insurer.
8-16
Future of Insurance Derivatives
Future of insurance derivatives remains to be seen.
• Initially, the industry has been indifferent.
• Some reluctance is a philosophic predisposition.
• Some uncertainty regarding regulatory response.
• Illinois, New York, and California approved use of
futures but most states have not addressed
issue.
• Reinsurance is well understood, while insurance
derivatives are new and untested.
• Transactions thus far do not offer any economies
over traditional reinsurance.
8-17
Taxation of Insurance Companies
1. State premium taxes
• sales tax on all premiums sold in state
• varies from 2% to 4%
• some states tax domestic insurers at a
lower rate
8-18
Taxation of Insurance Companies
2.
Federal income taxes
•
same tax rates as other corporations
•
computation of taxable income is
different to reflect effect of reserves
and prepaid expenses
8-19
Taxation of Life Insurers
Special I.R.C. provisions for life insurers
1.
Small Company deduction - 60% of first $3
million in life insurance company taxable
income (LICTI)
2.
Mutual insurers’ deduction for
policyholders dividends is reduced by a
“differential earnings” amount (an imputed
return on equity)
3.
Policy acquisition expense must be
capitalized and amortized.
8-20
Taxation of Property & Liability Insurers
Tax Reform Act of 1986
1.
Only 80% of increase in unearned premium
reserve is deductible.
2.
Loss reserves are subject to statutory
discounting.
3.
15% of tax exempt interest and dividends is
disallowed.
8-21