Discount factor
"Since year AY is 12 months old, we may use it as a proxy for the discount factor for AY+2".
Why is this true?
What discount factor should we use if we need to discount AY +1 or AY +3?
Thank you.
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"Since year AY is 12 months old, we may use it as a proxy for the discount factor for AY+2".
Why is this true?
What discount factor should we use if we need to discount AY +1 or AY +3?
Thank you.
Comments
The key fact here is that the given table for Schedule P - Part 1 is for year-end 2010. In that table, AY 2010 is 12 months old.
Now, the other table provided in the question is for year-end 2012, so AY 2012 would be 12 months old in that 2012 table. Even though AY 2010 and AY 2012 could be very different, we don't have enough information for 2012 to do the required calculation. We have to make the assumption that AY 2010 in 2010 is similar to AY 2012 in 2012 because they are both 12 months old.
For AY+1 in the 2012 table, (which would be AY 2011) I suppose you could use AY 2009 from the 2010 table since they would both be 24 months old.
For AY+3, you can't do anything because that would be AY 2013 and that hasn't happened yet. (The information in the problem only goes to the end of 2012.)
Thank you.
Also, in Spring 2016 #18 c. The solution says the missing 2 pieces to calculated income tax incurred is discount rate for both year.
I thought we have have already calculate discount rate for 2012 in part a and we could also calculate discount rate for 2011 by calculating discount rate for year 2009 from the 2010 annual statement.
Could you please help me understand the solution?
I think you might be confusing accident year and tax year. The short answer to your question is that to calculate the tax for tax year 2012, we need discount factors for each prior accident year separately. But from part (a) you only have the discount factor for AY 2012. This and other things are explained below.
Here's what you're asked to calculate in each part of this problem:
To calculate income tax for tax year 2012 (in other words, calendar 2012) you have adjust the statutory income for tax year 2012 to get TBI (Tax-Basis Income) for tax year 2012. Recall the formula for TBI:
To get TBEP, you need to do the revenue-offset adjustment and this is described in the wiki. There is no missing information regarding the calculation of TBEP.
To get TBIL, you have to discount the unpaid losses. (The statutory losses used in part (b) are not discounted.) This discounting is done separately for each accident year, but you are not given the accident year breakout for unpaid losses. You are only given the total unpaid losses at the end of calendar year 2011 & 2012
Now, even if you had the accident year breakout for calendar year 2011 & 2012 unpaid losses, you would still need the discount factors for all of those accident years. You calculated the discount factor for AY 2012 in part (a) but you would need to do the same calculation for all prior accident years. That is a time-consuming calculation and you really couldn't do it in the time allotted. Also, there could be unpaid amounts for accidents years further back than 10 years. (But you are only given 10 years of information in the second table.)
Note the 3th and 4th bullet points for the answer to part (c) in the examiner's report, :
This is equivalent to the 2nd bullet point. (Instead of having the discount factors separately for each AY for tax-years 2011 & 2012, we could use an average for tax-year 2011 and an average for tax-year 2012. But we don't have those average values either.)
The 5th bullet point of missing information refers to DTAs or Deferred Tax Assets. Recall from Odomirok.6-7-BS that 2 sources of DTAs are:
The first point refers to the discounting of losses for tax purposes. The second point, the carryforward, is not given in the problem so this is another piece of missing information.
That may have been a longer answer than you needed but I wanted to make sure I covered everything.
how to calculate TBIL? if we use CY Incurred loss - change in reserve discounted and change in reserve discounted = Undiscountod reserve CY 2012 x (1-discounted CY2012) - Undiscountod reserve CY 2011 x (1-discounted CY2011) --> is this correct? how do we come up with discount factor for CY since part a method only give us AY discount factors.
Also, why using a revenue offset (EP + 20% UEPR) would prevent insurer from claiming a loss due to acquisition expenses by increasing taxable income? Could you give me an example on how insurer can claim a refund?
For the TBIL calculation, it would be very messy to try to do it in this problem even if you did have the AY breakout of the CY unpaid losses. There is an exam problem where you have to calculate TBIL, 2018.SpringQ4, but it's much easier because there is only 1 claim. See also 2017.FallQ21 for another example. In that problem, they tell you the discounted values so you don't have to do any of the discounting calculations yourself.
The formula you wrote would work if you had the average discount factor for each tax year. But you don't and the way to get it would be to apply the discounting to the AYs and then sum to get the CY discounted value. That would be very time-consuming even if you had the AY breakout.
Regarding your second question about the revenue-offset: the text seems to say that according to IRS rules, an insurer cannot claim a loss due to acquisition expenses even if their true acquisition expenses are greater than 20%. They must use the 20% assumption.
I recommend not spending too much more time on this problem. Make sure you can do parts (a) and (b) and then just memorize the answer to part (c). You can practice the TBIL calculation using 2018.SpringQ4 and 2017.FallQ21. (It seems to me that you understand this problem quite well already. And remember there are lots of standard types of tax problems that are much more likely to be on the exam so definitely make sure to work on those if you haven't already.)
Sure. Thank you!