K. 35-37

Front 1

Differences SAP and GAAP (objective, intended users, asset recognition, deferred taxes)

Back 1

a. GAAP stresses measurement of emerging earnings of a business from period to period, (i.e., matching revenue to expense), while SAP stresses measurement of ability to pay claims in the future.

b. GAAP is designed to meet the varying needs of the different users of fmancial statements. SAP is designed to address the concerns of regulators, who are the primary users of statutory fmancial statements.

c. GAAP has recognized certain assets such as deferred policy acquisition costs, while SAP treats it as expense when incurred.

d. Deferred income taxes have been recognized by GAAP but not SAP.

Front 2

liquidation vs going concern (2)

Back 2

Liquidation (one of the following): Liquidation sees assets and liabilities as a run-off.

Values of assets and liabilities if the company is forced to liquidate (shut down) today. Liquidation is important for the regulator.

Going concern (one of the following):

Going concern sees assets and liabilities as an ongoing business. Evaluation as if company will still operate in the future.

Going concern is more important to investors or shareholders .

Front 3

fair value vs historical cost (3)

Back 3

Fair value (one of the following):

Fair value is a value that it would be bought or sold for in the open market. Fair value is the current market value.

It is more accurate than historical price.

Historical cost (one of the following):

Historical cost means valuing it at the original purchase price less depreciation.

It is easier to obtain or calculate than fair value.

Front 4

principle-based vs rule-based (3)

Back 4

Principle-based (one of the following):

A principle describes a general accounting approach that must be interprets and applied. More adaptable to changes vs. rule-based.

Rule-based (one of the following):

A rule provides specific accounting guidance on how something should be done.

Easier to understand and audit than principle-based .

Front 5

difference OSFI and NAIC (2)

Back 5

a. OSFI covers all federally regulated fmancial institutions, not just insurance

b. OSFI has authority, whereas NAIC is a coordinating body working with state insurance regulators

Front 6

difference accounting foreign branches and domestic insurers (2)

Back 6

i. Assets of foreign branches must be under control of either Minister of Finance of Canada or branches' Chief Agent in Canada.

(1) Amount of assets under this control determined by branch test of adequacy of assets

(2) These assets to be placed in a trust.

ii. No share capital account, as entity operates as branch of its parent; therefore, a head office account instead

Front 7

discount rate depends on (4)

Back 7

(1) method of valuing assets and reporting investment income

(2) allocation of those assets and that income among lines of business

(3) return on assets at balance sheet date

(4) yield on assets acquired after balance sheet date

(5) capital gains and losses on assets sold after the balance sheet date

(6) investement expenses and losses from default

Front 8

retained earnings includes (formula)

Back 8

Retained earnings at beginning of period

+ Net income earned during period

- Dividends and changes in reserves required

+ any prior period adjustments

Front 9

motivation to commute (reinsurer - 3, insurer - 3)

Back 9

a. For reinsurer:

i. Bring certainty to its results

ii. Capital relief

iii. Savings in claims adjusting and administrative costs

b. For insurer:

i. If concerned about creditworthiness of reinsurer

ii. Will save administrative costs

iii. But also risk future adverse loss development and must hold capital for this risk

Front 10

considerations when commuting (4)

Back 10

a. Undiscounted value of future loss and LAE on reported and unreported claims

b. Expected timing of payout of undiscounted loss and LAE

c. Expected investment income on assets supporting these cash flows

d. Income tax

e. Appropriate risk load to provide for volatility

Front 11

commuted value (formula)

Back 11

= sum of CFt/[RF^(t-0.5)]

+ sum of

Undiscounted Future Payments Remaining

x Req Margin

x (Target Capital/Required Capital)

x Cost of Capital (%)

/ RF^t

Front 12

premium liabilities (definition + where to find)

Back 12

Premium liabilities:

expected costs in connection with unexpired portion of the in-force insurance contract and other liabilities related to premium development adjustments (e.g., retro-rated premium, etc.)

Currently, premium liabilities not shown explicitly in financial statements.

Main elements related to premium liabilities are in the regulatory expression of opinion in the AA report

Front 13

premium liabilities (estimations AA (2))

Back 13

1. Since 2012,the AA's estimate of premium liabilities used in Interest Rate Risk Margin in MCT.

2. With 2015 modifications to MCT formula, estimated premium liabilities will also be used to derive Insurance Risk Margin

a. Replacing unearned premium in calculation of a premium-related margin.

b. Insurance Risk Margin to be calculated by class of insurance.

Front 14

unearned premium reserve

Back 14

portion of written premium associated with exposure remaining under a contract of insurance. Usually based on written premium, policy term, and earning pattern

Front 15

equity in the gross/net UPR

Back 15

Equity in the gross UPR: amount by which gross UPR exceeds gross policy liabilities in connection with unearned premium.

Equity in the net UPR: amount by which net UPR plus unearned (reinsurance) commissions exceeds net policy liabilities in connection with unearned premium, also referred to as maximum deferrable policy acquisition expenses.

Front 16

adjustments to historical experience by AA for prem liab (5)

Back 16

a. Loss trend: bring historical experience to cost level of average accident date of UPR

b. Impact of legislative changes (e.g. mandated benefit changes)

c. Impact of relevant recent court decisions

d. Rate changes (on-level factors): adjust historical experience to UPR rate level

e. Catastrophes and large losses loadings

Front 17

expected reinsurance costs depend on type of treaty (2 types - 2 + 3)

Back 17

a. Proportional reinsurance treaty:

i. Net unearned premium < Gross unearned premium

ii. Loss ratio same on gross and net basis

b. For an excess of loss treaty expiring at valuation date

i. Gross and net unearned premium are the same

ii. Ceded unearned premium is $0 at end of contract period

iii. But cost of reinsurance in relation to unexpired portion of policies would be taken into account, with assumptions reflecting

(1) Reinsurance rates

(2) Expected recoveries consistent with reinsurance structure of exposure period of the unearned premium

Front 18

maintenance expenses (meaning + 3 considerations)

Back 18

Reflect future cost of servicing policies in force. These expenses include endorsements, midterm cancellations and changes in reinsurance contracts.

Maintenance expenses may vary by business, considerations include:

a. Availability of expense information by line of business

b. Distribution model of insurer

c. Characteristics of insurer's portfolio (e.g. 2 year contracts)

Front 19

MfaD (2)

Back 19

1. SOP state (2250.02) The selected margin for adverse deviations should vary between premium liabilities and claim liabilities, among lines of business, and among accident years, policy years, or underwriting years, as the case may be, according to haw those considerations so vary.

2. AA would consider different MfADs if premium liabilities and claim liabilities exhibit different levels of uncertainty.

3. Generally more uncertainty for claims that have yet to occur such as those underlying unearned premiums.

Front 20

AA compares carried DPAE to equity in UPR (2)

Back 20

i. If carried DPAE > maximum estimated, reduce DPAE to maximum estimated amount.

ii. If negative equity in UPR, reduce DPAE to zero and establish premium deficiency.

Front 21

maximum DPAE (formula)

Back 21

a. Net UPR

+ Premium deficiency

+ Unearned (reinsurance) commissions

- Net policy liabilities in connection with unearned premium

b. UPR, unearned (reinsurance) commissions and initial DPAE are usually provided by accounting department.

Front 22

equity in unearned premium calculation on… basis (2)

Back 22

1. Equity in unearned premium usually calculated on an all lines combined basis.

2. Deficiencies in some lines are offset by redundancies in others.

3. Appropriate for going concern basis if mix of business does not change much

Front 23

premium development on retro - reinsurance ceded (3 examples)

Back 23

i. Changes in subject matter premium, usually unknown until end of contract period

ii. Swing-rated excess of loss treaties which call for a rate adjustment based on the loss experience during the coverage period

iii. Reinstatement premium for catastrophic or other layer

Front 24

Equity in Unearned Premium Reserve (formula)

Back 24

Unearned Premium booked

- APV Loss & LAE

- reinsurance cost

- maintenance cost

Front 25

impact of assets supporting liabilities at fair value (US - 4, CA - 3)

Back 25

U.S.

1) Policy liabilities not discounted

2) Invested assets generally classified as available for sale

3) Changes in the fair value of these assets flow comprehensive income

4) No impact on net income

Canada:

1) Change in the measurement of the value of assets affects the measurement of the investment return rate and the NPV of policy liabilities

2) Net income affected even if invested assets categorized as available for sale

3) Impact on DCAT analyses

Front 26

held-to-maturity investments (measurement + 3 considerations)

Back 26

Measurement: amortized cost basis (same as bonds)

a. Changes in fair value does not affect income except in the case of impairment

b. No change in volatility associated with net income, asset values, or equity values

c. If sell more than an insignificant amount of those assets, must reclassify all held­ to-maturity assets as available for sale for at least two years

Front 27

held-to-maturity investments - market rate increase

Back 27

No change in volatility associated with net income, asset values, or equity values

Front 28

available-for-sale assets - measurement

Back 28

Carried on the balance sheet at fair value

Front 29

avialable-for-sale assets - items to net income (3)

Back 29

1) Regular investment income, i.e., dividends and bond income

2) Changes in amortized cost

3) Realized gains or losses

Front 30

available-for-sale assets - items to comp income + consequences (2)

Back 30

Changes in the difference between fair value and amortized cost booked to comprehensive income

1) Segregates the volatility of fair value measurement of invested income

2) But new standards produce greater volatility

Front 31

available-for-sale assets - impact on policy liabilities (3)

Back 31

1) Increase in fair value of invested assets underlying policy liabilities decreases the portfolio yield

2) This decreases the discount rate and increases the value of discounted policy liabilities

3) Flow through net income

Front 32

available-for-sale assets - market rates increase

Back 32

investment assets values

decreasediscount rate for actuarial liabilities

increaseliability net income increases

other comprehenesive income decreases

asset equity increase

Front 33

held-for-trading assets - measurement + 3 considerations

Back 33

Marked to fair value

a. Gains and losses recognized immediately in net income

b. Treatment may produce greater volatility of assets and investment gains/losses

c. If all assets classified in this category, discount rate to reflect a market yield, increasing volatility

Front 34

held-for-trading assets - requirements for fair value option (2)

Back 34

Values are reliable and one of the following is met:

1) Can be proven that option would eliminate or greatly reduce an accounting mismatch attributable to measuring assets and liabilities or associated gains or losses on different bases

2) Two conditions

a) Institution has a documented risk management strategy to manage group of financial instruments together

b) Can demonstrate that significant financial risks are eliminated or significantly reduced

Front 35

held-for-trading assets - market rates increase

Back 35

investment assets values decrease

discount rate for actuarial liabilities increase

asset net income increases

liability net income decreases

asset equity increase

Front 36

advantage of fair value (3)

Back 36

1) Most relevant basis for a financial instrument if it can be reliably measured

2) Reflects market risk preferences and market expectations regarding the amounts, timing, and uncertainty of cash flows

3) Based on discounting at the risk-adjusted rate of return available in the market place

Front 37

four-level measurement hierarchy (4)

Back 37

1) Observable market price, including market-based adjustments

2) Accepted valuation models or techniques; inputs are consistent with those of market

3) Current cost or possibly historical cost

4) Models and techniques that use entity inputs

Front 38

loans and receivables (subsequent measures, gains/losses)

Back 38

measurement on amortized cost basis using the effective interest method

gains and losses are recognized in net income when an asset in this category is derecognized. Impairment write-downs and foreign exchange translation adjustments are recognized immediately in net income

Front 39

held-to-maturity investments (subsequent measures, gains/losses) + 2 requirements

Back 39

Subsequent measurement and gains/losses -same treatment as loans and receivables

Requirements for the category

a) Fixed cash flows, i.e., fixed maturity date and fixed or determinable coupons/payments

b) Positive intention and ability to hold to maturity

Front 40

held-for-trading assets/liabilities (subsequent measures, gains/losses) + 2 conditions

Back 40

a) Is not a loan or receivable and is held mainly to sell or repurchase in the near term

b) fair value can be reliably measured and as long as it was not an instrument transferred in a related party transaction

1) Cannot reclassify a fmancial instrument in or out of this category while held or issued

2) Subsequent measurement -fair value

3) Gains/losses -recognized immediately in net income

Front 41

available-for-sale assets (subsequent measures, gains/losses)

Back 41

1) Subsequent measurement - generally fair value but cost for equity instruments that do not have a quoted market price in an active market

2) Gains/losses -recognized in other comprehensive income

3) Gains/losses -transferred to net income when asset is derecognized

4) Gains/losses -impairment write-downs and foreign exchange translation adjustments recognized immediately in net income

Front 42

other financial liabilities (subsequent measures, gains/losses)

Back 42

1) Subsequent measurement - amortized cost using the effective interest method

2) Gains/losses - recognized in net income when the liability is derecognized

3) Gains/losses -foreign exchange translation adjustment recognized immediately

Front 43

Financial and non-financial considerations when commuting (2+2)

Back 43

Financial:

1) Dicount rate

2) Payment pattern

Non-financial:

1) Mortality or morbidity of claimant

2) Unfavourable court decisions