Ettlinger, Chapter 6: Solvency Regulation
the firm’s inability to cover fixed debt obligations as they come due.
Risk Unique to Insurance
Price Inadequacy – true cost of product can’t be determined until after the policy has expired.
Reserve Error – includes inadequate assessment of reported losses; misestimation of IBNR losses; changing economic conditions that inflate future loss costs; or even deliberate misstatement to bolster surplus position.
Underwriting Risk – when exposures U/W-en change during the policy term (the insured doesn’t disclose all info) or a common occurrence affects multiple risks (CAT loss).
Insolvency is More Than Just Bankruptcy – in other industry, consumers actually benefit from a firm’s bankruptcy, but not so in insurance.
Costs to Insureds and Insurers – covered insureds are directly affected, but this branches out, affecting all insureds through increased premiums.
Regulatory Activities To Ensure Solvency – includes: maintaining a uniform system of financial reporting; monitoring insurer solvency; monitoring capital adequacy through RBC (covered in other paper); accreditation of state insurance departments.
Maintaining a Uniform System of Financial Reporting
Financial Reporting Requirements
The Annual Statement
Insurance Expense Exhibit
The Quarterly Statement
Statutory Insurance Accounting
Valuation Principles – SAP valuation should result in a conservative statement of P/H’s Surplus; and it should prevent sharp fluctuations in PHS.
As PHS = Assets – Liabilities, valuation should minimize assets and maximize liabilities.
Admitted assets = allowed to be reported by state insurance statutes; and are highly liquid (easy to convert to cash w/o significant loss of value).
Liability example: loss reserves reported at non-discounted FV.
GAAP = going concern: operations will be long-term in nature and ownership interests can be transferred w/o liquidating the business.
SAP = liquidation perspective: able to satisfy insured claims and refund unearned premiums if contracts are canceled.
GAAP = revenues recognized as earned & associated costs matched to same accounting period when revenues are recognized. (matching principle)
SAP = revenues recognized as earned, but in the case of acquisition costs, expenses are recognized immediately, and not matched to premiums over time.
Monitoring Insurer Performance and Solvency
Insurance Regulatory Information System (IRIS)