Odomirok.6-7-BS

These introductory chapters explain the basic layout of the balance sheet: assets, liabilities, surplus.

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

• layout of balance sheet
• identifying risks based on balance sheet information

reference	part (a)	part (b)	part (c)	part (d)
E (2012.Fall #18)	balance sheet: - construct from given info	financial health: - identify insurer risks

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In Plain English!

This chapter of Odomirok on the balance sheet is very important, but there are not very many old exam problems exclusively on this chapter. But to answer questions from later chapters, you have to have at least a general understanding of the balance sheet. We covered the basics of the balance sheet in Odomirok.8-9-IS but there are a few additional things you need to know.

Balance Sheet Layout

Question: why is the balance sheet important to actuaries

• loss & LAE are the majority of the liabilities and actuaries either set or have a significant role in determining the amount
• actuaries have a role in assessing the capital required to support an insurer's risks

Question: define the terms asset, liability, surplus

asset: a property, right, or claim arising from past events that has future value

liability: an obligation that the company must fulfill, based on past events or transactions, which will require the use of the company’s resources.

surplus: (sometimes called equity) is the difference between assets & liabilities

If you take a look at the exam question from 2012 that's listed in the BattleTable, you'll see that they ask you to construct the balance sheet based on the given information. To do this, you have to have a basic understanding of the layout of the 2 pages of the balance sheet. In very rough terms the asset side of the balance sheet looks like this:

item	ASSETS	nonadmitted assets	NET admitted assets	prior year
bonds	B	x	B – x	y
...	...	...	...	...
...	...	...	...	...
SUBTOTAL: cash & invested assets	...	...	...	...
uncollected premiums & agents balances	U	a	U – a	b
...	...	...	...	...
...	...	...	...	...
SUBTOTAL: non-invested assets	...	...	...	...
TOTAL: assets	...	...	...	...

You should memorize the layout of this table. Then first part of the exam problem isn't too hard. They provide the balance sheet items on an "admitted" basis – you just have to figure which items go in the top half (cash & invested assets) and which go in the bottom half (non-invested assets). To do that, it helps to know these 2 definitions:

• cash & invested assets: assets that could be readily sold in the near term to meet the insurer's liabilities
• non-invested assets: assets that are less liquid

The main examples of cash & invested assets are:

• bonds, preferred stocks, common stocks, real estate, cash & cash equivalents, other invested assets

Examples of non-invested assets include:

• uncollected premiums & agents balances, reinsurance recoveries, DTA (Deferred Tax Asset)

You can now take a pretty good as to how to construct the asset side of the balance sheet.

Let's now look at the layout of the liabilities & surplus side of the balance sheet

item	current year	prior year
losses	x	y
...	...	...
...	...	...
SUBTOTAL: liabilities	...	...
aggregate write-ins for special surplus finds	a	b
...	...	...
...	...	...
SUBTOTAL: surplus as regards policyholders	...	...
TOTAL: (liabilities + surplus) = assets	...	...

The main examples of liabilities are:

• loss, UEP (Unearned Premium), LAE, reinsurance payables for losses and premiums, funds held, provision for reinsurance

The main examples of surplus line items are:

• unassigned funds, gross paid in & contributed surplus, aggregate write-ins for special surplus funds, common capital stock

Tip: I'm not sure you specifically need to memorize these examples of line items in the balance sheet. My advice is just to pay attention as you go through Odomirok and old exam problems. You'll absorb what you need to know over time.

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Deferred Tax Asset (DTA)

A topic that seems to appear quite often is Deferred Tax Asset or DTA.

Question: define the term Deferred Tax Asset

• A DTA represents expected future tax benefits related to amounts previously recorded in the statutory financial statements not expected to be reflected in the tax return as of the reporting date.

Note that DTAs are reported net of DTLs (Deferred Tax Liabilities)

Question: identify & explain 2 examples of DTAs that are relevant to the actuary (note that DTAs are the largest single source of nonadmitted assets)

• difference in tax accounting & statutory accounting for loss reserves

- statutory loss reserves are discounted to find the reserves for tax reporting purposes

- in other words, the difference represents the time-value of money

• carryforward of net operating loss from previous years

- when losses in 1 year offset gains in future years

These details are probably giving you a headache but don't worry: If you persevere, you'll absorb everything without even realizing it!

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BattleCodes

Memorize:

Conceptual:

Calculational: