1) What are the four (4) main financial statements?
- 1) Income statement
- 2) Balance sheet
- 3) Statement of retained earnings
- 4) Statement of comprehensive income
2) What is the accrual basis of accounting?
- Allocates financial transactions recorded in the account period to which it belongs.
- Revenue and expenses are matched to the appropriate accounting period.
3) What is the difference between a fiscal year and a calendar year?
- Companies prepare annual financial statement for 12-month periods that do not necessary fall in line with the calendar year (Jan-Dec).
4) What are FIVE (5) basic techniques used to analyze financial statements?
- 1) Time comparison: compare figures reported in current report to that of previous accounting periods. Caution if the company has changed the manner it calculates statements.
- 2) Budget comparison: compare current results to the budget/plan.
- 3) Relationship comparison: usage of ratios to compare results to the results of another area or of another period.
- 4) Detailed breakdown: determine what has been included in each item of the financial statement.
- 5) Benchmark comparison: compare the results to external sources.
5) What does a statement of operations show?
- Shows how a company has performed (earnings made or loss) during a specific accounting period.
- Underwriting revenue (premiums) – underwriting expenses (overhead, acquisition costs, claims costs, taxes) = net income/loss
- The statement also indicates the company’s sources of revenue and also what it anticipates in its future.
- If the company has discontinued operations, withdrawn from unprofitable lines of business or opened new operations, the statement of operations will show all of these things.
6) For accounting purposes, how is earned premium calculated?
- Earned premium identifies that part of a premium allocated towards a policy period that has gone by.
- Total of premiums written during the period + unearned premium reserve at the beginning of the period – unearned premium reserve at the end of the period = premiums earned for the period
7) What FOUR (4) elements are considered does an insurance company consider when setting up its outstanding claims reserve?
- 1) Claim Reserves: unless an insured is immediately paid in full once their claim is calculated, an adjuster makes a record of the claim’s estimated amount and then sets up an outstanding claim reserve. The reserve is adjusted periodically as the claim develops or as payments are made. The longer a claim’s file remains open, the more likely its reserve will change.
- 2) INBR: a claim can go unreported for a variety of reasons and an insurer may not receive a notice of claim for all losses occurring within the accounting period. Actuaries calculate reserve amounts for such losses and add them as a bulk adjustment to the claims reserve.
- 3) Adverse Loss Development Reserve: represents the quantitative change in claims reserves from year to year and is usually an increase in the original claims reserves and is added as a bulk adjustment. Also captures those closed files that will be reopened in order to make a payment.
- 4) Claims Adjustment Costs: consists of external expenses such as independent adjusters’ fees, legal fees, and other claims services for which the company will be invoiced.
8) How does an insurer’s distribution method affect commissions?
- Direct writers tend to spend a higher percentage of revenue on expenses but a lower proportion on commissions than companies that use independent brokers.
- This is because employees and captive agents are often paid a salary or a lower level of commission than independent brokers.
9) What are the main components of a balance sheet?
- 1) Assets: things of value that the company owns
- 2) Liabilities: debts owed to creditors
- 3) Equity: company’s net assets.
10) What are the main accounts receivable for an insurer?
- The largest receivables are usually premiums due from brokers or in the case of direct-billed policies, from insured’s.
- Insurers typically extend credit to brokers for the period of time between the day a policy is sold or bound and the deadline for premium delivery to the insurer.
11) Why is new business sometimes considered to be a negative result for an insurer?
12) What is the formula to calculate incurred losses?
Outstanding loss reserve at the end of the period
+ Loss payments (including loss expense payments)
-- Salvage or recoveries
-- Outstanding loss reserve at the beginning of the period
= Incurred losses for the period
13) What are some of the reasons that cause an insurance company to underestimate its reserves?
- Company’s actuarial department or management overly optimistic in setting up estimates.
- Technical related issues to court cases that may invoke social inflation for a specific type of claim.
- General economic inflation that caused the price of goods and services to rise.
- Inexperienced claims staff or a lack of appropriate training may have also caused claims to be overpaid or led to errors that initiated lawsuits and larger settlements.
14) What does the combined ratio measure?
- Used by insurance companies to measure overall underwriting performance and shows profitability of the insurance operations.
- Indicator of management’s efficiency.
- Ratio of less than 100 indicates profit, whereas over 100 indicate a loss.
- Does not take investment income into account.
15) What comprises the combined ratio?
- It is the combined total of three key individual ratios:
- 1) Incurred claims to premiums earned
- 2) Commissions and other acquisition costs to premiums earned
- 3) Operating expense to premiums earned
16) How is ROE developed?
- Measures how efficiently a company generates profits from its net assets.
- Shows how well a company uses shareholder investment to generate earnings growth.
Net come after taxes x 100 = ROE
Equity
Net written premium = Ratio of written premium to equity (to determine capacity)
Equity
17) What is the difference between a common share and preferred share?
- Common represents part ownership of a company with voting rights. Receives a portion of its profits after dividends are paid to preferred shareholders.
- Preferred represents part ownership of a company with no voting rights. Have priority over common shares concerning payment of dividends and repayment of capital. The rate of dividend is usually fixed.
18) What is a balanced investment portfolio?
- Primary concern of the insurer’s investment portfolio is safety.
- Achieved by diversifying investments over a number of different securities and types of securities by industry, geographical location or maturity (bonds).
- Any sudden problem with the value of any one investment will not significantly affect a portfolio or the operations of the insurer.
19) What do investors generally expect bonds to yield?
- There is an inverse relationship between interest rates and market value of fixed income securities.
- Investors typically expect an overall yield to maturity that is roughly equivalent to the current interest rates.
20) What is asset liability management?
- It is the management of assets in relation to liabilities in order to optimize the balance between risk and return.
- Measures to assess risks assumed and constraints or boundaries on such measures form part of the management process.
18) How may regulatory intervention in the automobile insurance industry affect insurers?
- While regulatory intervention tends to please consumers, price regulation is an unnecessary and expensive administrative burden.
- The free market system anticipates a self-regulating market that will ensure that prices reflect the true cost of doing business; rating boards and commissions only create imbalances in the free market pricing system.
- Higher staffing requirements or different software applications to rate and report data might be required.
- Increased operating costs and politically-imposed premiums could reduce the insurer’s profitability and return on equity.
19) What are some disadvantages that may flow from an insurer exerting excessive internal cost-cutting?
- They may find that the company’s functional competence suffers, questionable risk selection occurs, succession plans cannot be developed and the company’s financial results are negatively affected.
20) What action might an insurer take when the effects of government imposed reforms are unknown?
- Projects for premium, loss ratio, and ROE made before the changes must be redeveloped.
- Some insurers may shelve business strategies to achieve organic growth or to expand territorially until the effects of government actions are made clear.
- Other insurers may consider withdrawing from their jurisdiction, adjusting marketing plans for the affected area, or reserving any financial decisions until the regulator’s plans are announced.
- This in turn reduces automobile insurance capacity in the insurer’s jurisdiction.
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