2013 Q18 a)

Could you please let me know what's covered in the coming exam for this calculation? It looks complicated. I want to know if I need to know all the steps in the calculation or just part of it. Thx

Comments

  • All parts of this solution are in the syllabus, except that the regular income tax rate is no longer 35%, and except alternative minimum tax, which is replaced by base erosion and anti-abuse tax.

  • Do you have the current version solution for this problem? Or part of the solution that is relevant to the current syllabus? I just want to make sure I have the correct answer. Thx

  • If you send me your solution, I can look over to see if it's correct.

  • I'm not quite sure about how they derive taxable investment income from dividends. I can't find it on Wiki. Could you please explain it?

  • why isn't policyholder surplus used to calculate the SAP net income?

  • Surplus is not a component of income.

    Surplus = Assets - Liabilities.

    Income = Premium - loss - expense - ph dividends.

    Surplus is a snapshot, as-of concept. Income is calculated for a calendar year.

  • thanks! sorry i was confusing it with policyholder dividends. that helps.

  • Sure, good luck.

  • With updated syllabus not worrying about dividends, I got $8,800 as my final tax based income. Is this the correct solution? Or can i send my work and have it checked? Thanks!

  • It is the "dividend income" that is no longer covered. "Policyholder dividends" still need to be netted from final income.

  • Got it. Do you have an updated final answer to this problem based on the current syllabus that I can use as a check to see if I'm doing things correctly?

  • edited September 2023

    I believe your answer of 8,800 for TBI (Tax-Based Income) is correct. We will double-check this however and make a final determination.

    Following the examiners' report and making the required adjustments:

    First note that the given information needs to be adjusted slightly:

    • Regular Income Tax Rate = 21% (changed from 35%)
    • We don't need the "Alternative Minimum Tax Rate" anymore.

    Then the calculations are:

    • Net EP = 65,000 (same)
    • Net IL = 48,000 (same)
    • InvInv
    • = 1,000 + 1,500 + 2,800 (don't use the 800 for dividends received from unaffiliated entities)
    • = 5,300

    Then

    • Net Income Pre-Tax
    • = (U/W Income) + (Investment Income)
    • = (Net EP - Net IL - U/W Expenses) + (Investment Income)
    • = (65,000 - 48,000 - 16,250) + 5,300
    • = 6,050

    Now we have to make all the adjustments for the taxes:

    • TBEP (including U/W expenses)
    • = EP + 20% x (change in UEP) - (U/W/ Expenses)
    • = 65,000 + 20% x 5,000 - 16,250
    • = 49,750

    And:

    • TBIL
    • = IL - change(discount)
    • = 48,000 - 4,050
    • = 43,950

    But InvInc also needs to be adjusted for investment income from municipal bonds, which is not fully taxable. It is taxable at 25% (not given in the problem so you just have to know this) so we must remove 75% of the 2,800 of investment income from municipal bonds so the new taxable investment income is:

    • 5,300 - 75% x 2,800
    • = 3,200

    This then gives:

    • TBI (including the removal of policyholder dividends which are not taxable in SAP)
    • = TBEP + InvInc - TBIL - (policyholder dividends)
    • = 49,750 + 3200 - 43,950 - 200
    • = 8,800

    Apply the updated tax rate of 21% to get a final income tax of 21% x 8,800 = 1,848. We then subtract this from the pre-tax income to get the final net income after tax:

    • net income after tax
    • = pretax income - income tax
    • = 6,050 - 1,848
    • = 4,202
  • Thank you very much for doing this! Should be helpful for others that also come across this good problem :smile:

  • Great! I am going to post a step-by-step solution to this.

    (There is 1 small change I need to make to what I wrote above however. I believe the TBI of $8,800 is correct but I should have subtracted the policyholder dividends from the Net Pre-tax Income instead of waiting until the TBI calculation to do that.)

  • You can now find an updated solution in Excel to this problem. It is in footnote 4 of the BattleTable for the tax chapter (Chapter 26) of Odomirok:

  • edited March 17

    Hi, in Graham's solution above...

    1. For TBIL, shouldn't TBIL = Paid Loss - change(discount)? Why do we use IL instead of PL?
    2. Why are we deducting U/W expense from TBEP?

    I was trying to understand the updated solution in the Excel workbook but I couldn't follow the solution for the whole of Step 2. I have been trying to follow the formula TBI = TBEP + InvInc - TBIL from the text but the solution in Excel doesn't seem to be using the same formula (it seems more complicated than the usual formula :( )

  • 1) “change(discount)” is the difference of the reserve discount according to SAP and the reserve discount according to Tax. So, it needs to be added to incurred loss, which includes reserves.

    2) Graham seems to have thrown UW expense into the TBEP formula, to make the tax-based income formula work. Essentially, Income = EP – IL – UW Expense, for either SAP or Tax.

    3) Step 2 applies all three tax adjustments directly to SAP income, instead of applying them separately to EP, IL and InvInc. So in this sense, it does not exactly follow the formula you mention. It actually saves some calc work when you do it this way.

  • Okay, finally understanding the Excel solution when I look at it again today with a clearer mind. Thanks for the explanation!

  • Sure, good luck.

  • Hi, I have a question on this again. In Step 2a in the Excel solution, why is chg(UEP) the difference between WP2012 and EP2012? That just gets us UEPR for 2012. Is there no UEPR for 2011?

  • WP - Chg(UEP) = EP. Follows from this.

    WP and EP are calendar-year concepts, whereas UEPR is cumulative. You reduce WP by the amount that you increased UEPR to get EP.

Sign In or Register to comment.