Direct Changes to Surplus Confusion

Hi,

I am very confused. Looking at the income statement capital and surplus account, it seems as though all the 6 changes listed, rows 35 to 40, are all summed up to get the change in surplus (along with some other stuff). I noticed for example though the change in provision for reinsurance is defined backwards. As in it's last year minus this year, (so named poorly). Is that what you mean by the two changes are subtracted? So if a problem gives ANY change, we add. If they give us the numbers, we calculate the actual change and subtract for those two?

Thanks.

Comments

  • You are right that this is confusing. And you're also right that that's what I meant when I said the changes are subtracted. I think they calculated the change in provision for reinsurance "backwards" so they could just add all those rows to get the change in surplus. Otherwise the formula on line 38 would be more complicated because it would have both "+" terms and "-" terms.

    The reason provision for reinsurance is treated this way is that it's a liability so it's "bad" if the actual value goes up from 1 year to the next. For example if it is 50 in 2018 and 60 in 2019, it went up by 10 but the change according to the capital and surplus account is -10 (not +10). Then if you add -10, the surplus will go down, as intended, since the liability went up.

    As for how to deal with this on the exam, your reasoning is sensible. (If they give the changes without the underlying values, just add them. If they do give the underlying values, then calculate the changes "properly" but subtract the change in provision for reinsurance rather than adding it.) But unfortunately, exam questions are sometimes stated incorrectly. It still makes sense to do what you outlined in your post, but make sure you include a short note in your solution stating your assumptions. That way the graders will know you understand the concepts even if your solution is different from the official solution. (In other words, if the official solution is incorrect, which happens more often than you'd think.)

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