Download - 12 Insurer Financial Statements

Insurer Financial Statements

Chapter 12

Myhr and Markham, Insurer Operations, Regulation and Statutory Accounting, 2nd Edition, 2004, AICPCU

Who Looks at Insurer’s 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 insurer’s ability to pay claims, grow,

remain solvent.


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


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.


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.


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.


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 E&O 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 reinsurer’s solvency since large firms

may have high attachment points and reinsurers are more vulnerable to rate inadequacy.


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.


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.


Principal Balance Sheet ElementsAssets Bonds Stocks Cash Premium balances Reinsurance recov

Liabilities Losses Loss Adj Expenses Unearned Premiums

PH Surplus

Policyholder Surplus = Assets - Liabilities


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


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 div&tax)

Earned Premiums = Unearned premiums @ beg of year + NPW during year – unearned premiums at year end.

Incurred losses and LAE = losses paid during year + loss reserves @ year end – loss reserves @ 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.


Statutory Accounting Used in the annual statement that is submitted to

state insurance departments. “the principles and practices prescribed or permitted by an

insurer’s domiciliary state.” State law prevails though NAIC has developed

standards for reporting that most states follow. If insurer’s 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.


Annual Statement http://www.naic.org/documents/store_idp_deguide_PropertyAnnual.pdfTitle page and JuratAssetsLiabilities, Surplus and Other FundsUnderwriting and Investment Exhibit Statement of Income Underwriting Income Investment Income Other Income Capital and Surplus AccountCash Flow Cash from Operations Cash from Investments Cash from Financing and Miscellaneous Sources Reconciliation of Cash and Short-Term InvestmentsUnderwriting 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 InterrogatoriesFive-Year Historical DataSchedules A - Real Estate, B – Mortgage Loans, BA – Other Long-Term Invested Assets, D – Bonds

and Stocks, DA – Short-Term Investments, DB – Derivative Investments, E – Cash and Special Deposits, F – Reinsurance, P – Analysis of Losses and Loss Expenses

http://www.naic.org/documents/store_idp_deguide_PropertyAnnual.pdf


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 insurer’s 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 insurer’s domicile state.


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 year’s 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 – actuary’s 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.

SAP vs. GAAP

Chapter 12.30


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. Today’s assets

should be able to meet all claims. SAP began with GAAP rules and then made appropriate

changes to the rules.


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 > 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.


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.


SAP vs GAAP Differences 5 – subsidiaries, controlled or affiliated entities (SCAs) must be

listed on parent’s 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 parent’s. 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.