Odomirok.10-Notes

Reading: Financial Reporting Through the Lens of a Property/Casualty Actuary - Chapter 10 - Notes to Financial Statements

Author: Kathleen C. Odomirok, FCAS, MAAA, Liam M. McFarlane, FCIA, FCAS, Gareth L. Kennedy, ACAS, MAAA, Justin J. Brenden, FCAS, MAAA, EY

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BA Quick-Summary: Notes to Financial Statements The "Notes to Financial Statements" provide additional qualitative and quantitative information necessary to more fully assess the financial health of an insurer. It highlights the critical role actuaries play in preparing and analyzing these notes, which include disclosures on reinsurance, changes in incurred losses, premium deficiency reserves, discounting of liabilities, and asbestos/environmental reserves. The chapter also discusses notes potentially relevant to actuaries, such as accounting policies, subsequent events, intercompany pooling, structured settlements, and high deductibles, all aimed at providing a detailed portrayal of an insurer's financial condition.

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Multiple Choice (mini BattleQuiz 5) ← for general review of topic

Study Tips

This is a chapter with more information than you can reasonably memorize, but many of the prior exam questions require mainly general knowledge. If you can also throw a few specific facts about the Notes to the Financial Statements into your answers, you should score good points. Memorize the list of 10 Notes, then study the reinsurance section in more detail. If you don't have time to memorize the rest of it, at least read through this wiki article a couple of times. Much of it is common sense and if you read through it, some of it should stick.

Estimated study time: 2 hours (not including subsequent review time)

BattleTable

Based on past exams, the main things you need to know (in rough order of importance) are:

• reinsurance "Notes" - contents & required disclosures
• credit risk - what are the indicators, how effective are the indicators

Questions held out from most Fall 2019 exam: #16. (Skip these now to have a fresh exam to practice on later. For links to these questions, see Exam Summaries.)

reference	part (a)	part (b)	part (c)	part (d)
E (2017.Spring #16)	PDR "Notes": - disclosure items	SCENARIO: → PDR = 0 or PDR ≠ 0	SCENARIO: - stay in market?
E (2015.Fall #16)	SCENARIO: - identify relevant Notes	SCENARIO: - provide numerical values	evaluate financial health: - how are Notes helpful
E (2015.Spring #11)	credit risk: - B/S & I/S indicators 1	credit risk: - assess indicators	credit risk: - 'Notes' indicators	credit risk: - assess indicators
E (2014.Fall #12)	see Odomirok.8-9-IS	see NAIC.IRIS	reinsurance "Notes": - disclosures
E (2014.Spring #15)	reinsurance "Notes": - actuary's questions	reinsurance "Notes": - actuary's questions (cats)
E (2013.Fall #17)	reinsurance "Notes": - disclosures	reinsurance "Notes": - disclosures	reinsurance accounting: - B/S & Schedule P 2

¹ B/S = Balance Sheet, I/S = Income Statement. This is another question where the location quiz would be helpful. See quiz #2 here. (Note however that this exam problem turns the question around. Instead of asking where a given line item is located, you are asked to provide a line item that satisfies a given condition. In this case the given condition is assessment of credit risk. If I asked you right now to list any 5 B/S line items and any 5 I/S line items, could you do it? If not, review B/S & I/S examples in Elements of Financial Statements)

² Even though this is an older question, part (c) strikes me as important. It relates to earlier accounting material and similar types of exam questions have appeared elsewhere.

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In Plain English!

List of "Notes" Discussed in Odomirok

There are many, many different notes included in Notes to the Financial Statements, but Odomirok restricts attention to 10 of them and divides them into 2 categories:

Category 1: notes requiring direct involvement by actuaries [Hint: noteCARD +PDR] (I changed the order in which they're listed and omitted the Note #)

Change (incurred loss & LAE)

Asbestos & environmental reserves

Reinsurance

Discounting (unpaid loss & LAE)

PDR (Premium Deficiency Reserves)

Category 2: notes that are relevant to actuaries: [Hint: SHIES] (I changed the order in which they're listed and omitted the Note #)

Summary of significant accounting principles (This is Note #1. I just thought you should know. Totes important!)

High deductibles

Intercompany pooling

Events subsequent (usually known as 'subsequent events'. why back-asswards here?)

Structured settlements

This leads directly into part (a) of the following exam problem:

E (2015.Fall #16)

A good strategy is to quickly write out the list of 10 Notes, then select 5 from that list as your answer. Most of them are obvious. For example, you're given a table of information with incurred loss for year-end 2014 & 2013, so one the answers would be Change (incurred loss & LAE). One little trick is that you're told in the bullet points under the tables there's no reinsurance, but one of the acceptable answers is the Note about Reinsurance. I suppose having no reinsurance is important enough to mention. Anyway, you have 10 Notes to choose from and the examiner's report accepted 7 of them.

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Content of "Notes" Discussed in Odomirok

Let's start by looking at part (c) of:

E (2014.Fall #12)

To answer this question, you had to know more than just the name of the particular note - you had to know something about the content. In this case, you had to know what the reinsurance note discloses. To me, sample answer #1 in the examiner's report didn't seem detailed enough for 0.75 pts. All it said was:

• Reinsurance Assumed & Ceded - need to disclose ceded premium reserve & contingent commission (This is Section C of the reinsurance Note.)

Then sample answer #4 said:

• if disputed reinsurance recoverable is >5% of surplus from one entity and >10% of surplus from all entities → must disclose amount in dispute

That does seem like enough for 0.75 pts, but who's going to memorize that? You'd have to either be very lucky or have a very good memory to come up with that answer.

Question: what approach should we use in studying this chapter on Notes to the Financial Statements

Near the beginning of that chapter, Odomirok says the following information will be covered for each note:

1. Information contained in the note
2. Importance of the note to actuaries
3. Example of information from the 2011 Fictitious Notes

Now, #2 you can usually figure out using general knowledge. You can read those sections of Odomirok, but I wouldn't try to specifically memorize anything - just get the feel. And we don't really care about #3. The "Fictitious" example is probably quite helpful in understanding the Notes, but that's not what we're interested in. We're interested in being able to answer exam questions, and this reading is not highly ranked. We need to pay attention to the types of past exam questions and how often they're asked. (And they are not asked very often.)

Anyway, I counted how many pages Odomirok devoted to each of the 10 Notes. Reinsurance was the longest and it's the most frequently asked on the exam so you should spend most of your time on that. Then just do a cursory review of the other Notes.

Category 1: notes requiring direct involvement by actuaries [Hint: noteCARD +PDR] (I changed the order in which they're listed and omitted the Note #)

Change (incurred loss & LAE)

page count: 1

→ shows prior AY changes

→ affects current CY U/W income

→ disclose change & reasons for change (segment, LOB,...)

Asbestos & environmental reserves

page count: 2

→ significant adverse development over several decades

→ must disclose detailed quantitative & qualitative information regarding reserves

→ these reserves relate to exposures other than for policies specifically covering A&E

Reinsurance (has 8 sections, A → H, but we only discuss sections A, B, D below.)

page count: 3

→ reserves are net of reinsurance on the B/S & I/S

→ reinsurance can significantly lower the B/S reserves and affect the surplus

→ must understand credit risk associated with reinsurance (use Sections A,B,D of reinsurance notes)

→ A: unsecured recoverables, B: disputed recoverables D: uncollectible recoverables

→ questions the actuary might ask about each section

→ A: why wasn't security provided? did a cat increase recoverables unexpectedly? are the unsecured amounts concentrated with 1 reinsurer?

→ B: what is the nature of the dispute? is the disputed amount material? is there a legal opinion on the dispute?

→ D: what was the reason for the uncollectible insurance? could other unpaid amounts become uncollectible for similar reasons?

→ other comments

→ A: a note is required if (unsecured amounts) / surplus > 3%

→ B: recoverable is considered to be in dispute once a formal written refusal to pay is received from the reinsurer

→ D: uncollectible amount is treated as an expense

Discounting (unpaid loss & LAE)

page count: 1

→ disclose whether discounting is used for reserves

→ if so, then disclose type of discounting: tabular (for WC) or non-tabular

PDR (Premium Deficiency Reserves)

page count: 1

→ inclusion of investment income to offset PDR is optional

→ disclose amount and effective date of PDR

→ if PDR is recorded as part of UEP then this Note is the only way to know if PDR exists

Category 2: notes that are relevant to actuaries: [Hint: SHIES] (I changed the order in which they're listed and omitted the Note #)

Summary of significant accounting principles (This is Note #1. I just thought you should know. Totes important!)

page count: 1

→ disclose source of rules (usually NAIC APPM and the SSAPS)

→ disclose exceptions to rules

High deductibles

page count: 0.5

→ insurer pays the full claim and then seeks reimbursement from the insured for the deductible

→ creates credit risk that isn't shown on the B/S

→ disclose amount recorded & billed but not collected

Intercompany pooling

page count: 0.5

→ this is when companies in a group cede all business to lead company

→ each member of group then assumes back a specified percentage

→ note must disclose pooling arrangements

→ pooling affects: U&IE, Schedule F Parts 1 & 3

→ Schedule P shows only pool member's share of pooled results

Events subsequent (usually known as 'subsequent events'. why back-asswards here?)

page count: 1

→ must disclose Type 1 (recognized) & Type 2 (non-recognized) subsequent events (see NAIC.SSAP-9)

Structured settlements

page count: 0.5

→ usually WC - insurer buys annuity from life insurer for structured settlement payments

→ disclose total amount of structured settlement payments for which insurer might be liable

→ if payments from single life insurer >1% of surplus ==> disclose life insurer & amount

→ pertains to credit risk and is not shown on the B/S

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Exam Problems

More recent exam problems:

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Older exam problems:

Pay attention to part (c) of:

E (2013.Fall #17)

As mentioned in the footnote to the BattleTable at the top of this wiki article, the part (c) seems important because it relates to earlier accounting material. Similar exam questions have appeared elsewhere.

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