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Insurer Financial Statements Chapter 12
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 get any. • 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 os very important because it directly affects financial strength and solvency. • 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.
Assets Bonds Stocks Cash Premium balances Reinsurance recov Liabilities Losses Loss Adj Expenses Unearned Premiums PH Surplus Principal Balance Sheet Elements 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
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) Main Elements of Income Statement 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/insprod/de_guides/2003_Property_AnnualX.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 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 oprations 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.