Spring 2015 Question 26
When calculating Surplus change from the commutation, is there a difference between the total benefit to the insurer and the amount of Surplus change? If this problem would have given us the discounted ceded reserves and the non-discounted ceded reserves, which ones would we use for the change to the surplus?
Comments
The benefit to the insurer and the surplus change are the same (at least for this narrow problem.) Surplus equals assets minus liabilities and the commutation is just shifting the assets and liabilities. Assets increase due to the payment from the reinsurer to take back the liabilities but (net) Liabilities also increase at the same time. They don't increase by the same amount though so that's why there's a change in surplus.
The problem is a bit tricky because you have to use both the discounted reserves and undiscounted reserves to get the final answer.
Based on this, without considering taxes, there would be a surplus decrease of $400. Ok, now let's figure out the tax implication:
If you put this al together you get:
So just to emphasize the answer to your question. You use undiscounted reserves to get the change in surplus without the tax implication. But then you have to use the discounted reserves to calculate the change in taxes. The final step is to put these 2 items together as shown above.
Thank you again Graham!
So what is the point of calculating the total benefit to the insurer? What I mean by that is when you discount reserves both economically and for the potion considered the taxation benefit. Is this a GAAP versus SAP difference where you would realize the full benefit in GAAP, but in SAP the discount only affects the taxable portion of the benefit? Potentially because that aligns with the more philosophically conservative nature of SAP? Sorry , my question got a tad murky... Let me know if I need to unpack that a little more clearly...
Let me try to answer your questions in turn, although I may not be answering exactly what you intended to ask:
Why calculate the total benefit?
SAP vs GAAP
Let me know if this doesn't properly address your question.
That helps!
Sorry, I should have mentioned that I was talking about a theoretical scenario where we would have enough information to calculate the GAAP surplus. I should've elaborated more clearly.
For whatever reason the decision making aspect that you mentioned didn't come to mind. I was trying to wrap my head around the why without that vein of thought, and just confusing myself. This clears up a ton about the topic.
Thanks again.
I'm not sure if this has been asked before but is the commutation price received by primary insurer recorded under the balance sheet as an asset? Would this be considered as 'other amounts receivable under reinsurance contracts'?
Sorry, I guess it will be treated as an asset under cash received?
It most likely goes under cash, like premium.
Would it also be recorded in the income statement as other income? Income statement will also be impacted by commutation, correct where the incurred losses will increase
Yes, correct.