Actuarial Notes

Financial Reporting Through the Lens of a Property/Casualty Actuary

By Kathleen C. Odomirok, Liam M. McFarlane, Gareth L. Kennedy and Justin J. Brenden · Casualty Actuarial Society · 2020

Study guide: Exam 6C

A CAS text on financial reporting and taxation as they affect reserving and statutory reporting, seen through a property/casualty actuary's lens. EY prepared it to replace a number of syllabus readings with a single publication: it walks through the U.S. statutory Annual Statement and the filings that accompany it, the measurement of financial health, the differences from GAAP, IFRS, Solvency II and U.S. tax, and Canadian-specific reporting. This version updates the Fictitious Insurance Company Annual Statement to 2018, reflects the U.S. tax law enacted in December 2017, and brings IFRS, Solvency II, Schedule F and the Canadian chapter current to 2018.

On the syllabus

  • Exam 6C — objectives C4 and C5; Chapters 1–5 (excluding Part III), 25 and 27.

Part I Introduction

  • 1 Financial Reporting in the Property/Casualty Insurance Industry
    • Importance and Objectives of Financial Reporting
      • Financial reports let stakeholders — policyholders, claimants, investors, directors and management — and regulators track performance and compare companies under a set of common rules.
    • Overview of the Bases of Financial Reporting (Statutory, GAAP, IFRS, Tax, Canadian) and Differences in Terms of Use
      • Statutory Accounting Principles serve regulators' focus on solvency and tend to be conservative to give early warning of deterioration; certain illiquid assets are not admitted despite having economic value.
      • GAAP is not built on conservatism: it presents results in line with performance, historically by matching revenues and expenses, so acquisition costs are deferred where SAP expenses them as incurred.
      • In the U.S. the starting point for an insurer's taxable income is SAP income, and the insurance-specific tax adjustments tend to accelerate income (discounting loss reserves, reducing unearned premiums).
      • IFRS is set by the IASB; at the time of writing IFRS 4 let insurers report under their local rules with slight modifications.
  • 2 Relevance of Financial Reporting to the Actuary
    • Importance and Objectives of Financial Reporting
      • An estimate of unpaid claims must match the accounting basis it is compared with: loss reserves are recorded net of reinsurance under SAP and gross under GAAP.
      • The accounting framework also changes the result of work on solvency monitoring, pricing, capital requirements, risk transfer of reinsurance, self-insurers' reserves, tax returns and valuations in mergers and acquisitions.
  • 3 Overview of this Publication
    • Roadmap
    • Annual Statements Referenced Throughout the Publication
      • The U.S. examples use excerpts of the Annual Statement of Fictitious Insurance Company (Appendix I), dated to year-end 2018; the Canadian examples use the 2018 aggregate experience of Canadian insurers published by OSFI.
    • Background on Fictitious Insurance Company

Part II Overview of Basic Accounting Concepts

  • Introduction to Part II
  • 4 Primary Financial Statements
    • Primary Financial Statements
    • Balance Sheet
      • Assets and liabilities at a point in time; under SAP their difference is statutory (policyholders') surplus, counting admitted assets only. The uncertainty in estimating loss reserves sets insurers' balance sheets apart.
    • Income Statement
      • Revenues less expenses over a period; insurance accounting standards address how premiums are earned and how and when claim costs are measured and recorded.
    • Capital and Surplus
      • Reconciles beginning to ending surplus for changes not recorded in the income statement, including items unique to insurers such as nonadmitted assets and the provision for reinsurance.
    • Cash Flow
      • Presents operations strictly from a cash perspective; less important for insurers, which collect premiums before paying losses, and not covered in detail.
    • Notes to Financial Statements
      • The notes disclose the basis of accounting and details of balances that rest on estimates or are subject to uncertainty.
  • 5 Key Accounting Concepts
    • Liquidation vs. going concern: investors are generally most interested in a business's value as a going concern, while regulators may think in terms of liquidation.
    • Fair value vs. historical cost: a trade-off between the reliability of historical cost, which is objectively verifiable, and the accuracy of fair value.
    • Principle-based vs. rule-based: rules may be easier to understand and to audit; principles adapt more readily to changes in the business environment.

Part III SAP in the U.S.: Fundamental Aspects of the Annual Statement

  • Introduction to Part III
  • 6 Introduction to Statutory Financial Statements
  • 7 Statutory Balance Sheet: A Measure of Solvency
  • 8 The Statutory Income Statement: Income and Changes to Surplus
  • 9 Capital and Surplus Account
  • 10 Notes to Financial Statements
  • 11 General Interrogatories
  • 12 Five-Year Historical Data Exhibit
  • 13 Overview of Schedules and Their Purpose
  • 14 Schedule F
  • 15 Schedule P

Part IV Statutory Filings to Accompany the Annual Statement

  • Introduction to Part IV
  • 16 Statement of Actuarial Opinion
  • 17 Actuarial Opinion Summary Supplement
  • 18 Insurance Expense Exhibit
  • 19 Risk-Based Capital
  • 20 IRIS Ratios

Part V Financial Health of Property/Casualty Insurance Companies in the U.S.

  • Introduction to Part V
  • 21 Measurement Tools

Part VI Differences from Statutory to other Financial/Regulatory Reporting Frameworks in the U.S.

  • Introduction to Part VI
  • 22 U.S. GAAP, including Additional SEC Reporting
  • 23 Fair Value Under Purchase GAAP
  • 24 International Financial Reporting Standards
  • 25 Solvency II
    • Solvency II is a principle-based regulatory system for insurers in the European Union, in effect from January 1, 2016, that links required capital to risk profile through three pillars.
    • Pillar I — Quantitative Capital Requirements
      • Technical provisions are the discounted best estimate of the liabilities plus a risk margin calculated by a cost-of-capital method at 6%.
      • The Solvency Capital Requirement is set at a one-year 99.5% value at risk, by the standard model or an approved internal model; below it the company faces regulatory intervention, and below the Minimum Capital Requirement it loses its licence.
    • Pillar II — Supervisory Activities
      • Requires internal audit, actuarial, risk management and compliance functions, and an own risk and solvency assessment (ORSA) reported to the supervisor.
    • Pillar III — Transparency
      • Disclosure of capital and regulatory position to supervisors and the financial markets, to increase market discipline.
    • Comparison to the U.S. Solvency Regime
      • The NAIC's Solvency Modernization Initiative gave state regulators "windows" into group operations while keeping the "walls" at the legal entity; the U.S. ORSA and its three-section Summary Report implement several of those windows.
  • 26 Taxation in the U.S.

Part VII Canadian-Specific Reporting

  • Introduction to Part VII
  • 27 Overview of Financial Reporting in Canada
    • Overview
      • Insurance is regulated federally and provincially; most insurers are regulated federally by OSFI, and since 1992 registered insurers have been required to appoint an actuary to value policyholders' liabilities and report on the insurer's financial condition.
    • Office of the Superintendent of Financial Institutions
      • OSFI supervises all federally regulated financial institutions under a principles-based framework and, unlike the NAIC, has authority over the entities it regulates.
    • International Financial Reporting Standards (IFRS)
      • Regulated insurers, as publicly accountable enterprises, adopted IFRS from January 1, 2011; IFRS 4 let them keep Canadian GAAP valuation, under which liabilities follow accepted actuarial practice — discounted, with a provision for adverse deviation.
      • Foreign branches differ in two ways: their assets are under the control of the Minister of Finance or the Chief Agent, and a head office account replaces share capital.
    • Canadian Institute of Actuaries
      • The CIA's Standards of Practice are binding on its members for work in Canada, and a deviation from a recommendation is presumed a deviation from accepted actuarial practice; educational notes are not binding.
    • Differences Between Statutory and Other Financial/Regulatory Reporting Frameworks in Canada
  • 28 Canadian Annual Return
  • 29 Financial Health of Property/Casualty Insurance Companies in Canada

Part VIII The Future of SAP

  • Introduction to Part VIII
  • 30 The Future of Financial Reporting and Solvency Monitoring of Insurance Companies

Appendix I Fictitious Insurance Company

  • Excerpts from the 2018 Annual Statement for Fictitious Insurance Company
  • Excerpts from the 2018 Insurance Expense Exhibit for Fictitious Insurance Company
  • 2018 Statement of Actuarial Opinion for Fictitious Insurance Company
  • 2018 Actuarial Opinion Summary for Fictitious Insurance Company
  • Results of IRIS Ratio Tests for Fictitious Insurance Company

Appendix II Canadian Financial Statements

  • 2018 Balance Sheet for all Property/Casualty Insurance Companies
  • 2018 Income Statement for all Property/Casualty Insurance Companies

Related readings

  • CIA CSOP — the CIA's Standards of Practice, whose authority Chapter 27 describes
  • OSFI MCT — the Minimum Capital Test, which Chapter 27 names among the guidelines of OSFI's principles-based framework

Sources