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 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.
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.

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.

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.
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 reinsurers solvency since large firms
may have high attachment points and reinsurers are more
vulnerable to rate inadequacy.
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 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 Elements
Assets
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
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.

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
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
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.
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.
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. Todays 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 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.

12 Insurer Financial Statements

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