Insurer Financial Statements

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Insurer Financial Statements

• Chapter 12

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Who Looks at Insurers Financial Statements?

• Company managers need information to plan,
  monitor and control operations.
• Earn a profit and maximize firm value.
• Assess performance for class of business and/or
  policy type.
• Reports for middle managers, and others to
  evaluate divisions, units, offices.
• Investors need information to assess the
  financial health of an insurer.
• Want satisfactory, competitive return on
  investment.
• Regulators assess insurer solvency to protect
  consumers.
• PHs, producers and risk managers need to know how
  stable insurers are.
• Rating services evaluate insurers ability to pay
  claims, grow, remain solvent.

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Key Financial Statements

• Balance Sheet
• Income Statement
• However, components of these statements are
  different than for other firms.
• SAP statutory accounting principles
• Specific to insurers
• GAAP generally accepted accounting principles

4
Financial Statement Users

• Management to assist in reaching primary goal
  of firm value maximization and secondary goal of
  earning a profit.
• Allows managers to evaluate performance, set new
  goals and objectives, restructure, or reformulate
  policies.
• Also gives specific details about performance of
  particular lines and classes of business
• Competitive prices?
• Cash being distributed effectively to highest
  performing lines?
• How are geographic areas performing?
• Provides specific information regarding the
  performance of departments, divisions, units,
  offices, etc
• Investors desire competitive return on
  investment
• By examining quarterly and annual reports they
  can decide if investment is still the best
  option for them.
• Returns must be competitive with other
  investments of similar risk and liquidity.
• Rating services evaluate financial insurer
  financial strength for investors and
  policyholders. Interested in growth, solvency,
  claims paying ability and return to investors.

5
Financial Statement Users

• Regulators state insurance regulators are
  concerned with insurer solvency and require
  insurers to meet many standards.
• Minimum start up capital and sufficient capital
  to continue after start up.
• Set restrictions on the amount of premiums an
  insurer can write based on its amount of capital.
• Premiums are earned over period of policy and not
  when received.
• Must set adequate reserves for incurred losses to
  pay claims.

6
Financial Statement Users

• NAIC Financial Statement required by every
  state and prepared by insurers under special
  rules (SAP) developed by the NAIC.
• Balance sheet
• Income statement
• Cash flow statement
• Account of changes to surplus
• Many supporting schedules
• Other filings
• SEC for insurers whose stock is publicly
  traded.
• Initial registration, 10K annual statement
  filed within 90 days of end of fiscal year, 10-Q
  filed quarterly and is unaudited.
• For these statements go to www.sec.gov/edgar
• IRS federal income tax return
• Based on SAP with adjustments
• Insurers recognize expenses when incurred and
  premiums when earned.
• Losses are recognized when incurred and reserved
  but PV estimates are used.
• Net income and taxable income is reduced by
  recognizing expenses and losses incurred
  immediately.

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Financial Statement Users

• Policyholders, Producers, and Risk Managers
• Policyholders need to be sure that claims will be
  paid even if filed far after policy expires.
• Producers must be assured of financial strength
  of company since may be liable for EO if they
  should have known of any solvency issues.
• Risk managers are concerned due to high exposure
  of very large losses that may take years to
  develop.
• Must be sure insurer is financially stable now
  and in the future.
• Must also be aware of reinsurers solvency since
  large firms may have high attachment points and
  reinsurers are more vulnerable to rate
  inadequacy.

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Insurer Financial Statements

• Two key statements balance sheet and income
  statement.
• Balance sheet is a listing of assets (property
  that insurer owns) and liabilities (what insurer
  owes others) at a point in time.
• Insurance companies list different elements in
  this report than most other companies.
• Policyholders surplus assets liabilities
• PHS is first to pay claims before insurer can use
  any for growth or investment projects.
• If negative, then insurer owes more than it owns.
• Most likely insolvent.
• If positive, then insurer owns more than it owes.
• Insurer assets most are intangible with bonds
  being the largest class of insurer assets.
• Bonds issued by insurers to raise capital.
  Insurers make regular interest payments to the
  bondholder and then the face amount at maturity.
• Stocks, cash (and equivalents), receivables
  most important being premium balances owed by
  agents, reinsurance recoverables funds due from
  reinsurers or affiliated companies.
• Buildings, equipment, office furnishings.

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Insurer Financial Statements

• Insurer Liabilities
• Two main liabilities (and are specific to
  insurers are loss reserves and unearned premiums.
• Loss reserves losses that have occurred but not
  yet been paid.
• Loss adjustment expense reserves costs to
  handle claim that have occurred but not yet been
  paid.
• These two reserves are estimates, can be
  inaccurate and directly affect PHS because
  balance sheet must always balance.
• If reserves too low then PHS will be stated too
  high. PHS is very important because it directly
  affects the financial strength and solvency of an
  insurer.
• Unearned premium reserve premiums that have
  been received but not yet earned by insurer.
• May receive entire premium (or portion) at
  beginning of policy period but premiums are
  earned proportionately throughout the period.

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Principal Balance Sheet Elements

• Assets
• Bonds
• Stocks
• Cash
• Premium balances
• Reinsurance recov

• Liabilities
• Losses
• Loss Adj Expenses
• Unearned Premiums
• PH Surplus

Policyholder Surplus Assets - Liabilities
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Income Statement

• Financial results over a period of time, one year
  or quarter.
• Reports gains or losses from asset activity.
• Measures profitability of a firm that occurs when
  revenues are greater than expenses.
• Net income revenues - expenses

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Main Elements of Income Statement

• Earned Premium
• - Losses Incurred
• - Loss Adj Exp Incurred
• - Othr UW Expenses
• Net UW Gain(Loss)
• Investment Income
• Net Real Cap Gains(Loss)
• Net Income (B4 divtax)

Earned Premiums Unearned premiums _at_ beg of year
NPW during year unearned premiums at year end.
Incurred losses and LAE losses paid during year
loss reserves _at_ year end loss reserves _at_
beginning of year.
Other UW Exp sales commissions, salaries and
benefits to staff, advertising, rent
Investment Income mainly from interest payments
from bonds and dividend payments from stock.
Capital gains(loss) when asset is sold for
more(less) than its purchase price.
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Statutory Accounting

• Used in the annual statement that is submitted to
  state insurance departments.
• the principles and practices prescribed or
  permitted by an insurers domiciliary state.
• State law prevails though NAIC has developed
  standards for reporting that most states follow.
  
• If insurers statement differs from the NAIC
  standards due to state law then the insurer must
  disclose
• How it differs and its effect on net income and
  surplus.
• Insurers file statements in the state they are
  domiciled and in each state they do business.
• Can file with NAIC to meet each state filing.
• also must file supplements as demanded by each
  state.

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Annual Statement http//www.naic.org/documents
/store_idp_deguide_PropertyAnnual.pdf

• Title page and Jurat
• Assets
• Liabilities, Surplus and Other Funds
• Underwriting and Investment Exhibit
• Statement of Income
• Underwriting Income
• Investment Income
• Other Income
• Capital and Surplus Account
• Cash Flow
• Cash from Operations
• Cash from Investments
• Cash from Financing and Miscellaneous Sources
• Reconciliation of Cash and Short-Term
  Investments
• Underwriting and Investment Exhibit
• Part 1 Premiums Earned, Part 1A
  Recapitulation of All Premiums, Part 2 Losses
  Paid and Incurred, Part 2A Unpaid losses and
  LAE, Part 3 Expenses.
• General Interrogatories
• Five-Year Historical Data
• Schedules

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Balance Sheet

• Various items come from supporting documents.
• Mortgage loans on real estate come from SCH A.
• Cash comes from SCH E.
• Other invested assets from SCH DA
• Reinsurance recoverables from SCH F
• SCH D key invested assets bonds, preferred
  stock, common stock.
• Lists country, quality ratings and maturity.
• SCH F lists insurers reinsurance arrangements
  and can have large impact on insurer financial
  strength.
• Reinsurance recoverables amt owed to insurer
  for losses and LAE from reinsurance contract.
• Unauthorized reinsurance with reinsurers that
  are not licensed or authorized in the primary
  insurers domicile state.

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Income Statement

• Very similar to previous slide on income
  statement.
• Other income gains or losses from charge-offs
  of agents balances, finance charges, other misc
  income.
• Dividends to policyholders and taxes are
  deducted.
• SCH P more than 50 pages in the annual
  statement. Analysis of Losses and Loss Expenses.
  
• Provides info to analyze loss reserve and
  incurred loss development.
• Compares a given years earned premiums with
  incurred losses.

Supplements to annual statement Management
discussion and analysis narrative by manager
reporting operations and material changes in
financial reports, trends, events. Statement of
Actuarial Opinion actuarys opinion of the loss
and LAE reserves of the insurer. Must discuss
actuarial methods, assumptions and data and
render an opinion as to whether reserves meet
state laws, meet accepted loss reserving methods
and can pay all outstanding loss and LAE.
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SAP vs. GAAP

• Chapter 12.30

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SAP vs. GAAP 6 differences

• GAAP rules are made by the Financial Standards
  Accounting Board and used by most businesses.
• Insurer SEC filings must use GAAP
• 1 - Have different objectives
• GAAP is targeted to all users of financial
  statements and measures emerging earnings.
• Focus correctly measuring earnings
• SAP is targeted to regulators and measures the
  ability to pay future claims.
• Focus correctly measuring liquidity. Todays
  assets should be able to meet all claims.
• SAP began with GAAP rules and then made
  appropriate changes to the rules.

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Assets Treatment

• 2 - Main difference between SAP and GAAP is the
  treatment of assets.
• Some assets are given no value in SAP
  nonadmitted assets.
• Cannot be used to pay claims
• Poor liquidity, encumbered, partial ownership by
  third party.
• Charged against surplus when acquired or when
  availability becomes questionable.
• Furniture, fixtures, leasehold improvements,
  office equipment, vehicles, unsecured loans, cash
  advances, prepaid expenses, agents balances and
  premium balances gt 90 days past due and bills
  receivable that are past due
• EDP equipment and software are admitted assets
  but restricted to 3 of capital and surplus.
• Admitted assets those assets that are liquid
  enough to help meet insurer obligations.

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SAP vs GAAP Differences

• 3 policy acquisition costs and commissions are
  immediately written off as expenses when
  incurred.
• In contrast, premiums are earned over the policy
  period.
• Leads to decreases in surplus when writing new
  business and may have to purchase reinsurance to
  replenish surplus.
• 4 valuation of bonds is at amortized amounts so
  that there is even depreciation and at maturity
  bond value face amount. Exhibit 12-14, p.
  12-33.
• GAAP reports bonds at market value.

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SAP vs GAAP Differences

• 5 subsidiaries, controlled or affiliated
  entities (SCAs) must be listed on parents
  balance sheet as admitted assets. Under certain
  circumstances SAP is used to evaluate these SCAs
  for example, if SCA is an insurer or exists to
  hold assets for parent company.
• GAAP requires financial statements of
  majority-owned subsidiaries to be consolidated
  with parents.
• SAP does not allow consolidation
• 6 Pensions SAP considers retirees and fully
  vested employees. GAAP requires provisions for
  all employees, whether they are vested or
  non-vested.
• SAP does not recognize contributions for
  non-vested employees and they are not deductible
  under the income statement. These contributions
  are considered pre-paid expenses but they are
  classified as nonadmitted assets.
• GAAP recognizes expenses for all employees.