CAS Exam 9 Spring 2015, Question 21
Study guide: Exam 9
The Basic Equation for Total Return on Equity can be expressed as follows:
T/S = I/A\,(1 + R/S) + U/P \times P/S
Where:
T= Total after-tax return to the insurerI= Investment gain or loss (after appropriate tax charges)U= Underwriting profit or loss (after appropriate tax charges)P= Premium incomeA= Total assetsR= Reserves and other liabilities (excluding equity in unearned premium reserves)S= Stockholders' equity (capital, surplus, and equity in unearned premium reserve)
Identify which term in the above equation is the "insurance leverage factor" and explain the purpose of this factor in the calculation of total return on equity.
The explanation should address all of the following (assume all else being equal, i.e., this factor was not recently affected by any forces outside management control):
- What is being leveraged?
- What is the impact on total return on equity of changes to this leverage factor?
- What is a potential problem of this factor being too high?
- What is a potential problem of this factor being too low?
Part a (2 points)
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