Income Statement

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BattleTable

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

• surplus: calculation of surplus, surplus changes, non-I/S surplus changes & reasons for surplus changes
• statutory income: calculation of statutory income
• basic accounting terms and concepts: (SAP = Statutory Accounting Principles)

   => balance sheet, income statement, assets, liabilities, revenue, expenses, reinsurance

• calculation of of bond values

reference	part (a)	part (b)	part (c)	part (d)
E (2018.Spring #9)	define: - insurer recoverable	define: - insurer payable	define: - reinsurer funds held	define: - reinsurance provision
E (2018.Spring #10)	statutory income: - calculate	expense allocation: - impact on profitability	expense allocation: - actuary's involvement
E (2017.Fall #9)	statutory income: - calculate	users & purpose: - B/S & I/S 1
E (2017.Fall #10)	surplus: - calculate surplus
E (2017.Fall #13)	calculate: - value of bonds	regulator concerns: - regarding assets
E (2016.Fall #14)	surplus: - calculate surplus	financial health: - evaluate
E (2015.Fall #15)	surplus: - non-I/S surplus changes	surplus: - total surplus change	surplus: - reasons for surplus chg
E (2014.Fall #12)	surplus: - calculate surplus	see NAIC.IRIS	see Odomirok.10-Notes
E (2013.Fall #19)	SAP: - identify errors	surplus: - calculate surplus	reinsurance: - reasons to purchase	regulator concerns: - fair value
E (2012.Fall #14)	surplus: - impact on surplus	see Odomirok.19-RBC

¹ B/S stands for Balance Sheet, and I/S stands for Income Statement.

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In Plain English!

If you've taken a university course in accounting then you're in good shape because you're already familiar with the layout of financial statements. If you haven't, it's not a great problem, but it might be a little harder to understand the big picture.

Some of the content in this wiki article is from other chapters of Odomirok. It's basic accounting material but since we're covering the chapters in a different order, I just threw it in here.

SAP versus GAAP

Before doing anything else, you need to know the frameworks that companies use for accounting.

Question: define SAP and GAAP

• Both are frameworks of accounting principles/rules for reporting financial transactions and operating results:

==> SAP: prescribed by an insurer’s domiciliary state

==> GAAP: used by public & private companies (insurers & non-insurers)

Obviously there is a difference between how insurers and non-insurers do their accounting.

Question: why do insurers follow different accounting rules versus non-insurers [Hint: intended user & purpose]

==> SAP:

• used by regulators
• primary concern is solvency
• SAP is more conservative (protects policyholders)

==> GAAP:

• used by investors/creditors
• primary concern is measurement of earnings

That's all well and good, but what do we mean when we say SAP is more conservative? Well, GAAP came first and SAP evolved from GAAP to satisfy the specific goal of monitoring for solvency.

Question: identify 3 important differences between SAP and GAAP

The answer is covered in detail in a another chapter of Odomirok, Odomirok.22-23-GAAP, but just to give you a taste, here are a few important differences: [Hint: ART]

item	SAP treatment	GAAP treatment
Asset recognition	asset is recognized when expense is incurred	may defer recognition to to achieve matching of revenue & expenses 1
Reinsurance in loss reserves	loss reserves are recorded NET of reinsurance	loss reserves are recorded GROSS of reinsurance
Taxes	taxes not deferred	tax can be deferred

¹ An example of GAAP asset recognition to achieve matching of revenue & expenses is for DAC (Deferred Acquisition Costs). Acquisition costs like advertising are not "counted" immediately. Rather they are earned over the term of the policy that was acquired by that particular advertising.

Elements of Financial Statements

If you google "elements of financial statements" you'll find many websites that list the 5 elements as follows:

• Assets (Ex: cash, investments)
• Liabilities (Ex: loss reserves)
• Equity (= net assets = assets minus liabilities)
• Revenue (Ex: premiums)
• Expenses (Ex: salaries, advertising)

Now, the 5 statements in a completed set of financial statements are:

• B/S or Balance Sheet (Statement of Financial Position – Chapter 7 in Odomirok)
• I/S or Income Statement (Statement of Financial Performance – Chapter 8 in Odomirok)
• Statement of Change in Equity
• Statement of Cash Flow
• Notes the the Financial Statement

These are different but related to the 5 elements.

We're not going to delve too deeply into all of this, but here are couple of basic definitions:

Balance Sheet: shows a company's assets, liabilities and equity at a specific point in time

Income Statement: shows a company's revenue and expenses over a particular period

Notice that the Balance Sheet shows the first 3 elements: assets, liabilities, equity, and the Income Statement shows the last 2: revenue, expenses. Everything fits together nicely! Here's an example of each. (You might want to first duplicate the tab so you can have the wiki and the exhibit open at the same time.)

Balance Sheet example (Liberty Mutual)

Spend a minute or two looking at it and observe:

• The Balance Sheet consists of 2 pages: 1 page shows assets, the other page shows liabilities & equity
• Note the columns for admitted assets and non-admitted assets.
• Line 37 on the second page shows Surplus as regards policyholders which is something you have to calculate in old exam problems (see BattleTable above)

Income Statement example (Liberty Mutual)

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BattleCodes

Memorize:

Conceptual:

Calculational: