Accounting Chapters 26-27

[JL24]

Hello, I have a few questions on the last 2 chapters, mainly on investment income and return (but there are others as well). Any help is appreciated!

Chapter 26
1. If there is AURR, where should this be accounted for in each of the revenue account, profit and loss account, and balance sheet?

2. For accident-year accounting, the Glossary says 'for accidents occurring on or before the balance sheet date'. But we are in fact including UPR as well in our balance sheet liabilities. Isn't this inconsistent with the Glossary?

3. In Section 5's example question, the investment income is split between insurance funds and other funds.
- What makes up the insurance funds? Is it always outstanding claims + unearned premiums (as UPR) - DAC?

4. Practice Question 26.4:
(a) This equation is used
accumulated capital of $1m + accumulated premiums (net of expenses) - accumulated claims paid = assets at end of year
- How does this equation relate to any of the 3 accounts' (revenue account, profit and loss, balance sheet) components?
- From what I understand, capital = assets - liabilities. Why are we using initial capital as a starting point, rather than initial assets?

(b) The investment income is split into income on initial capital, and premiums less claims and expenses.
- Is this the same as item (3) above (insurance funds vs other funds), or is it a different splitting?
- How was the splitting obtained? I've tried using $1m vs written premium - claims paid - expenses paid, but it doesn't give the figures in the solution.

5. Practice Question 26.5:
(a) To obtain investment income, the solution looks at the investment income on retained profit + technical reserve
- Is technical reserve = insurance funds?
- As in item (3) above, how is the technical reserve obtained? Is it outstanding claims brought forward + unearned premiums brought forward + increase in DAC? I understand that the difference with item (3) is that here we want the total starting funds invested (at one point in time, rather than throughout the year), hence we are looking at the brought forward figures. But why do we use increase in DAC instead of DAC brought forward, which is just 0 since we are only looking at a single policy?

(b) In part (ii) on AURR, it is mentioned that there should be no change in investment income. Why is that so? Is investment income earned only on cashflows, rather than reserves?
- Consolidating all the investment income questions from items (3), 4(b), 5(a) above; is there a general equation that can be used to obtain investment income (i.e. is it applied on cashflows or reserves), and how the splitting is done between insurance funds and other funds?

Chapter 27
1. When calculating return on capital,
- Do we use profit after tax but before dividends?
- Are free reserves = shareholder funds in the balance sheet (i.e. just assets - liabilities)?

2. Practice Question 27.8:
(a) Non-invested funds
- Is there another way to obtain the average amount of funds held by the broker? I don't completely understand the equation shown. I've tried taking a sum of the amount of funds held by the broker over all months in the year, divided by 12 to get a simple average; but I got a different value.

(b) In the calculation of free reserves, why does the broker fund get a full year interest?
- Also, how does this adequately adjust for the full 1800 x 0.75 premium that was included in the 87.34 mid-year cashflow, including the timing that the insurer should expect to receive the funds from the broker?

3. Practice Question 27.11(i): 2017 claims paid for travel business is 7 months of claims (start date 1 April, 2 months delay for claim payments so payments start 1 June)
- Are we assuming that claim events occur right from the start of the policy? Since we are counting the 2 months' delay from 1 April onwards (rather than say 6 months from 1 April for average claim event date, and a further 2 months for first claim payment date).

 

[Busy_Bee4422]

Hi

Chapter 26
1. I have seen it taken after the underwriting profit as the solution. I have also seen it taken off the premiums and then put it as part of the technical reserves in the balance sheet.
2. It's not inconsistent since the objective of subtracting the UPR is to leave only premiums earned in the financial period being reported on.
3. This generally depends on the question but it is normally the technical reserves less DAC. Your technical reserves are your premium and claims (for events before the reporting date) reserves.
4a) This is from accounting where surplus at the end of the period is surplus at the beginning plus profit ( Surplus@t = Profit@t +Surplus@(t-1)). Your equation with capital just gives you the surplus at a point in time.
4b) This is more financial maths where your initial assets earn income as well as your net new money to get your total investment income. So they just calculated the investment income on those two components separately. You can split the income into that earned on insurance assets and that not earned on insurance assets after that.
5a) Yes insurance funds are technical reserves. The UPR is 120 (balance sheet number) which is 150 -30 where the 30 is the DAC. It is being done consistently to #3.
5b) When we subtract DAC from reserves we do so because it is a notional asset not matched by any actual assets. The actual assets would have been spent at the acquisition stage so they are not there to earn interest. AURR would also be a notional cash flow so it doesn't change your actual assets. Your investment income is dependent on the actual assets that you are holding.

Chapter 27
1. At the end of the year yes.
Yes again.
2 a) The total amount received from brokers will be 75% of this year's premiums and 25% of last year's premiums. the 75% for this year's premiums will come in the last 3 quarters of the year and the 25% from last year will come in the first quarter of the year so the average amount is the equation there. For last year's premium, they assumed the business volume is stable and therefore discounted this year's premium by the premium increase at the start of the year.
I did the calculation the way you said you did and got the same answer as the one in the notes.
2b) The 333.48 is the average balance the broker holds throughout the year so it earns interest for the whole year. The assumption in the calculation is that the cashflows occur in full but the delay means that some of the 0.75*1800 will not be available to earn interest so we subtract the interest that would have been earned by assets held at the broker.
3. The policies were written from 1 January but had an average start date of 1 April. Therefore the average date for claims is 1 June. We would likely have had claims before that but this is just the average date.

 

[JL24]

Hello Busy_Bee4422,

Thank you so much for your explanations! Just 2 follow-up questions on Chapter 27:
1. In 2a) above, I notice that the 0.25 x (0.75 x 1800 / 1.05) part of the solution assumes that in each of Jan-Mac, the broker holds 3 months' worth of the previous year's premium. However, this does not account for the fact that in Feb, the balance held by the broker in fact consists of 2 months of the previous year's premium (1800/1.05 x 0.75) plus 1 month (Jan) of the current year's premium (1800 x 0.75), similarly for Mac.

2. In Practice Question 27.12 (ii), under Profitability, investment return is calculated with average investments in the denominator (instead of average assets as suggested in Section 3.3 of the notes). Does this mean that I should only consider the assets that are invested in funds in my investment return calculation? Though this is only possible if I have the asset breakdown.

 

[Katherine Young]

Hi JL24,

1. In 2a) above, I notice that the 0.25 x (0.75 x 1800 / 1.05) part of the solution assumes that in each of Jan-Mac, the broker holds 3 months' worth of the previous year's premium. However, this does not account for the fact that in Feb, the balance held by the broker in fact consists of 2 months of the previous year's premium (1800/1.05 x 0.75) plus 1 month (Jan) of the current year's premium (1800 x 0.75), similarly for Mac.

You are quite right, of course, that the broker holds a different amount of premium for each of the first few months of the year. That is why the solution only concerns itself with the average amount held by the broker.

You could, if you like, work it out your way. You would be using something akin to the 24ths method. Since this is a slightly different method (ie a different form of simplification), you will get a slightly different answer. I would expect both methods to score fine in the exam.

2. In Practice Question 27.12 (ii), under Profitability, investment return is calculated with average investments in the denominator (instead of average assets as suggested in Section 3.3 of the notes). Does this mean that I should only consider the assets that are invested in funds in my investment return calculation? Though this is only possible if I have the asset breakdown.

That's right. The solution has injected a little bit of common sense and only considered investible assets. In the exam, you would be expected to make reasonable use of the information available... when in doubt, state your reasoning and you should do fine.

 

[JL24]

Hi JL24,



You are quite right, of course, that the broker holds a different amount of premium for each of the first few months of the year. That is why the solution only concerns itself with the average amount held by the broker.

You could, if you like, work it out your way. You would be using something akin to the 24ths method. Since this is a slightly different method (ie a different form of simplification), you will get a slightly different answer. I would expect both methods to score fine in the exam.



That's right. The solution has injected a little bit of common sense and only considered investible assets. In the exam, you would be expected to make reasonable use of the information available... when in doubt, state your reasoning and you should do fine.

Thank you for your help, Katherine!