Fall 2018 #16

According the the Examiner's Report, common errors were:
 Not including the Federal and foreign income tax
 Not including the Capital gains tax

I guess I'm missing where these pieces fit in? What part of the PHS or Statutory Net Income formula do they come from?

Comments

  • Okay, I see that in the Income Statement article, you updated "other income" to include fed/foreign taxes... I'm guessing this should include all taxes? since capital gains tax is here too.

  • First of all, the examiner's report solution is confusing. It all boils down to calculating:

    • 2017 net income = -49
    • 2017 direct charges for surplus = -59
    • 2016 surplus = 358 (given)

    Then the 2017 change in PH surplus = -49 -59 = -108.
    And IRIS 7 = -108/358 = -30% which is out of range.

    The hard part is calculating net income and direct charges. You can do it with the formulas I've provided in the wiki, but it might be better to look at the pdf solution to 2017.Fall Q10 from Odomirok Chapter 8,9 in the wiki:

    I have made 2018.Fall Q18 fit into the format and the pdf below shows how to get the -108 for the change in surplus:

    But there are a couple of tricks they threw at you:

    • In the 2017.Fall problem, the realized capital gains were already net of capital gains tax. In 2018.Fall, the values were before capital gains tax. That means you have to explicitly subtract capital gains tax in the 2018.Fall problem.
    • In 2017.Fall, you were given the investment income in a different way. In 2018.Fall, they gave you:
    • ==> Investment Gain Attributable to Insurance Transactions
    • ==> Investment Gain Attributable to Capital & Surplus
    • You have to sum these to get net investment income earned but this already includes realized gains. If you add add realized gains, you'll be double-counting the realized gains.

    The other more direct way of approaching the problem is to go through the given information line by line and pick out the income separately from the direct charges to surplus then sum them to get the total change in surplus.

    But however you solve it, it's a pretty hard problem.

  • Thanks! I went through it the more direct way, but agreed, definitely a tough one!

  • Yup! And even if you do it the direct way without referring directly to the 2017.Fall problem, this is a good example of how it helps to do the practice templates many times over.

    The template for 2017.Fall Q10 is in quiz 4 of the chapter 8/9 (which you probably already know). If you know how to do that in your sleep then then when you get a problem like 2018.Fall (even though it's a little different) you have a very strong foundation. You would already be thoroughly familiar with the various line items that are typically required to calculate surplus so as soon as you read the problem you'll feel like you're in familiar territory.

    The "location" quiz will have the same effect on making these kinds of problems feel familiar and solvable on the exam. The "location" quiz is part of quiz 2 in the chapter 8/9 of Odomirok. (That's where you have to state where in the annual statement various line items appear: B/S, I/S, etc...)

  • Thanks! Hoping to get to those quizzes soon :)

  • I think the key thing to realize here is that they are giving you IEE items rather than balance sheet items. The trick to solving this is actually in mentioned in the really boring details of the Odomirok IEE chapter. IEE profit is pre-tax, but can be reconciled to statutory net income by adding back in the income statement tax items capital gains tax (which itself is some sort of sub line item) and federal and foreign taxes). They then further complicated it by adding in the never before tested IRIS 7. I think whoever created this question tried really hard to make it something new.

  • When you say:

    "You have to sum these to get net investment income earned but this already includes realized gains. If you add add realized gains, you'll be double-counting the realized gains"

    How do you recognize the bolded is true?

  • The simple answer is:

    • investment income DOES NOT include realized gains
    • investment gain DOES include realized gains

    You can remember this because investment gain goes with realized gain (so investment gain includes realized gain.)

    I couldn't find where this is explicitly stated in Odomirok, but it's implied by the way the exhibits are constructed in the annual statement. According to the "STATEMENT OF INCOME":

    • line 09 shows net investment income earned
    • line 10 shows net realized capital gains less taxes
    • line 11 shows net investment gain as 09+10

    Then in the IEE exhibit "COMBINED PART II - ALLOCATION TO LINES OF BUSINESS NET OF REINSURANCE", columns 33-42 demonstrate the main formula (given in the Odomirok.18-IEE wiki article):

    • Total Profit (Loss) = (Pre-tax profit excluding InvGain) + InvGain(Insurance Transactions) + InvGain(Capital & Surplus)

    There is no separate term in this formula for realized gains so it must already be included in the last 2 terms on the right side of this formula.

  • Gotcha, okay cool. Thanks for the explanation.

  • After spending _way _too long trying to figure out why I wasn't getting the correct answer, I realized there is a typo in the Excel format version of this problem: https://www.battleacts6us.ca/wiki6us/Excel_Practice_Problems

  • This is now fixed in the Excel format. Sorry about the confusion. Thanks for pointing it out.

  • So can we say that there are two ways of finding Inv Income for PHS:
    1) Net inv. income earned + Net realized capital gain
    2) Inv gain from funds from ins transations + Inv gain from capital & surplus - capital gains tax

  • Yes, these are two legitimate ways of finding this, except that you need to subtract capital gains tax from (1) as well.

  • Sorry, can you confirm that we need to subtract capital gains tax from (1) even though the realized capital gain is already NET?

  • Yes. That "Net" doesn't refer to "net of tax." See Item 10 in Statement of Income.

  • edited September 2022

    Hey, so you say above
    "You have to sum these to get net investment income earned but this already includes realized gains. If you add add realized gains, you'll be double-counting the realized gains"

    So then why do we have net investment income = (net investment income earned) + (net realized capital gains)
    isn't this double-counting?

  • So I think I figured it out based on my other comment
    https://www.battleacts6us.ca/vanillaforum6us/discussion/528/2018-fall-11#latest

    But to add to mnrber's comment above:
    Net Investment gain =
    1) Net inv. income [earned] + Net realized capital gain - capital gains tax
    2) Inv gain from funds from ins transations + Inv gain from capital & surplus - capital gains tax

    where Net inv. income [earned] = gross investment income - (investment expense + TLF (not fed))

  • I just need some clarification on something in the wiki that seems to contradict what is listed in this forum. Above graham says that "Investment income DOES NOT include realized gains." However, in the wiki it says for investment income that the investment revenue in the formula "DOES Include realized gains." I think the correct answer is in this forum but it seems the wiki article has not been updated. Basically I believe it should say that investment revenue does not include realized gains.

  • While this is an NAIC.IRIS section problem, Odomirok.8-9-IS section covers the handling of investment gain in the income statement. Have a look at this linked note and table:

    https://battleacts6us.ca/wiki6us/Odomirok.8-9-IS#:~:text=On%20Oct%2018.%202022%2C%20a%20correction%20was%20made%20of%20a%20typo%20in%20the%20formula%20for%20%22Total%20Income%22%20on%20the%20last%20row%20of%20the%20table%20below.%20It%20is%20highlighted%20in%20orange.%20The%20term%20%22income%22%20was%20crossed%20out%20and%20replaced%20by%20the%20term%20%22gain%22%20(shout%2Dout%20to%20JH!)

    It explains the distinction between investment income and investment gain. This note was revised as a result of this thread.

  • Thank you for the response; however, I still think that this section has a typo in the wiki in the footnote #2. I am not asking about the difference between net income earned and net income gain. I understand they are different; however, the footnote says that investment revenue INCLUDES realized capital gains. If that is true and Investment revenue is in the formula for net income earned, then that means net income earned includes realized capital gains. If we then add realized capital gains in the formula for net income gain we would double count it like mentioned in the forum posts above. I believe footnote 2 should say that investment revenue excludes realized capital gains. Then Investment income gain would include it since we add it in for that formula.

  • Ok, that should now be sorted. Thx @Jaarndt!

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