Income Statement

Study guides: Exam 6U, Exam CFE-101

The Income Statement reports an insurer's profit for a period. The statutory version — page 4 of the NAIC Annual Statement — builds net income from three blocks, underwriting, investment and other income, then deducts policyholder dividends and federal income tax; the lower half of the same page is the Capital and Surplus account.

$\text{UW income} = \text{EP} - \text{Losses} - \text{LAE} - \text{UW expenses}$

$\begin{aligned} \text{Net income} = {} & \text{UW income} + \text{Net investment gain} \\ & + \text{Other income} - \text{PH dividends} \\ & - \text{Federal income tax} \end{aligned}$

Underwriting income (Underwriting Profit) is premiums earned less losses, LAE and other underwriting expenses incurred, all net of reinsurance. Losses incurred are calendar-year amounts: the current accident year's losses plus development on prior years' reserves, so a reserve strengthening lands entirely in the year it is recognised.
Net investment gain is net investment income earned plus net realised capital gains, the latter shown net of capital gains tax. Unrealised gains and losses never pass through statutory income; they go straight to surplus.
Other income collects finance and service charges, agents' balances charged off, and write-ins such as a retroactive reinsurance gain.
Federal income tax on the statement is current tax only; the change in deferred tax is a direct entry to surplus.
Across regimes. GAAP amortises acquisition costs through DAC instead of expensing them, runs fair-value changes on equity securities through net income and unrealised gains on available-for-sale bonds through other comprehensive income, and includes deferred tax in tax expense. IFRS 17 replaces premium with insurance revenue and separates the insurance service result from insurance finance income or expense.
The ratios built on it — loss, expense and combined ratios, the operating ratio — are the core Key Financial Measures; the Insurance Expense Exhibit allocates the same income by line of business.

Building Statutory Net Income For the year, in $ millions: premiums earned $1{,}000$ ; losses incurred $620$ ; LAE incurred $110$ ; other underwriting expenses $290$ ; net investment income $90$ ; realised capital gains $19$ , less capital gains tax of $4$ ; finance and service charges $2$ ; policyholder dividends $7$ ; current federal income tax $12$ . Common stocks also appreciated by $25$ after tax, unrealised.

Compute statutory net income and say where the unrealised gain goes.
Answer
 $\begin{align*} \text{UW income} &= 1{,}000 - 620 - 110 - 290 \\ &= -20 \\ \text{Net investment gain} &= 90 + (19 - 4) \\ &= 105 \\ \text{Pre-dividend, pre-tax} &= -20 + 105 + 2 \\ &= 87 \\ \text{Net income} &= 87 - 7 - 12 \\ &= 68 \end{align*}$ 
Statutory net income is $\$68$ M: a $102\%$ combined ratio on earned premium was rescued by investment income. The $\$25$ M unrealised gain bypasses the income statement and is credited directly to surplus in the capital and surplus account. Under GAAP, fair-value changes on equity securities run through net income, so GAAP income would include it.

Calendar-Year Losses Hide Reserve Development Of the $\$620$ M of losses incurred above, $\$580$ M relates to the current accident year and the rest is adverse development on prior accident years. Compare the calendar-year and current-accident-year loss ratios.
Answer
 $\begin{align*} \text{Prior-year development} &= 620 - 580 \\ &= 40 \\ \text{CY loss ratio} &= \frac{620}{1{,}000} \\ &= 62.0\% \\ \text{AY loss ratio} &= \frac{580}{1{,}000} \\ &= 58.0\% \end{align*}$ 
Four points of the reported loss ratio are about business written in earlier years. The income statement alone cannot show that; Schedule P Part 2's development by accident year can. A reader judging current pricing should use the accident-year figure, while one judging reserve adequacy should ask why the prior years moved.