Casualty Actuarial Society
Insurance Accounting for Actuaries
May 17, 2005
Presented by: Kevin Wick, FCAS, MAAA
PwC
Financial Reporting Context
“The most appropriate reserve within a
range of actuarially sound estimates
depends on … the financial reporting
context in which the reserve will be
presented.”
• Current Loss Reserving Principles
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PricewaterhouseCoopers
Financial Reporting Context
“The most appropriate reserve within a
range of actuarially sound estimates
depends on … the financial reporting
context in which the reserve will be
presented.”
• Current Loss Reserving Principles
“Loss reserves are utilized for a variety of
purposes, including financial reporting,
valuation, commutation and
ratemaking.”
“The context in which loss reserves are
presented may indicate elements to be
reflected in the loss reserves.”
• Proposed Loss Reserving Principles
PricewaterhouseCoopers
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Financial Statements
• Purpose is to communicate
financial information to the users
• Standards established on how to
account for various items
• Objective is to account for various
items in accordance with
standards
- reaction of users not relevant
• A good financial statement is one
that accounts for all the items
appropriately
- results may be good or bad
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PricewaterhouseCoopers
Current Accounting Standards for Loss Reserves
• “Best estimate” of the unpaid claim
costs
• Basic consistency between GAAP
and Statutory
• Conceptual framework for current
guidance
- SFAS 5: Accounting for
Contingencies (March 1975)
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PricewaterhouseCoopers
Key issues confronted when accounting guidance (SFAS 5)
established
•
•
Overall issue
- “Accounting Accruals”
versus “Financial Decisions”
Specific contentions
1. Financial “protection”
provided by accruals
2. Income fluctuation
3. Comparability of financial
statements
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“Accounting Accruals” versus “Financial Decisions”
“Accounting Accruals”
“Financial Decisions”
• Simply a method of allocating
• Choosing how to financially deal
costs among accounting periods
with a contingency
• No effect on an enterprise’s cash
• Example includes “to buy first
flow
dollar insurance coverage or be
self-insured”
• FASB “…the presence or absence
of an accrued credit on the
balance sheet will have no effect
on the consequences of that
decision”
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Contention 1: Financial “protection” provided by accruals
Contention
• Accruals provide financial
“protection” similar to reinsurance
• Without reserve margins,
enterprises will be forced to
purchase insurance or
reinsurance because they will not
have the protection provided by
the reserve margin
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Contention 1: Financial “protection” provided by accruals
FASB Response
Contention
• “accruals … in no way protect the
• Accruals provide financial
assets available ... to pay claims”
“protection” similar to reinsurance
• “Accrual, in and of itself, provides
• Without reserve margins,
no financial protection that is not
enterprises will be forced to
available in the absence of accrual”
purchase insurance or
reinsurance because they will not
have the protection provided by
the reserve margin
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Contention 2: Income fluctuation
Contention
• It is important to set aside
reserves to avoid reporting net
income that fluctuates widely from
period to period
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Contention 2: Income fluctuation
FASB Response
Contention
• “Financial statement users have
• It is important to set aside
indicated that information about
reserves to avoid reporting net
earnings variability is important to
income that fluctuates widely from
them”
period to period
- Consider both “expected” return
and “variability”
• “If the nature of the business is
such that there are variations in
periodic net income, that fact
should not be obscured”
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Contention 3: Comparability of financial statements
Contention
• Regular periodic accrual of
losses, whether or not they have
occurred, is justified on the
grounds of comparability of
financial statements
- Self-insurance costs versus
insurance costs
- Various amounts of
reinsurance purchased
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Contention 3: Comparability of financial statements
Contention
• Regular periodic accrual of
losses, whether or not they have
occurred, is justified on the
grounds of comparability of
financial statements
- Self-insurance costs versus
insurance costs
- Various amounts of
reinsurance purchased
FASB Response
• “to report activity when there has
been none would obscure a
fundamental difference in
circumstances between enterprises
that transfer risks and others that
do not”
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Principles/Quotes underlying SFAS 5
•
“The sole result of accrual, for financial
accounting and reporting purposes, is
allocation of costs among accounting
periods”
•
“The use of an accounting reserve does not
reduce or eliminate risk”
•
“Earnings fluctuations are inherent in risk
retention, and they should be reported as
they occur”
•
“The Board cannot sanction the use of an
accounting procedure to create the illusion of
protection from risk when, in fact, protection
does not exist”
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What is the Financial Reporting Perspective?
“The consulting actuary continues to
feel that conservative reserve margins
are necessary because of the
uncertainty in original reserve
estimates due to the limited
experience base, large potential
swings in ultimate liabilities, and the
Company’s relatively small total
capital position”
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PricewaterhouseCoopers
What is the Financial Reporting Perspective?
Financial Reporting Perspective
“The consulting actuary continues to
feel that conservative reserve margins
• Translation “The consulting actuary
are necessary because of the
seems to be having trouble
uncertainty in original reserve
distinguishing between funding for
estimates due to the limited
uncertain reserves versus financial
experience base, large potential
reporting of uncertain reserves.”
swings in ultimate liabilities, and the
Company’s relatively small total
capital position”
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What is the Financial Reporting Perspective?
“I know my reserve point estimate is
well above all the indications from my
methods. The 2004 loss year looks
extremely favorable but the 2005 year
is much worse. Lowering the reserves
will just create large swings in their
claim costs”
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PricewaterhouseCoopers
What is the Financial Reporting Perspective?
Financial Reporting Perspective
“I know my reserve point estimate is
well above all the indications from my
• Translation “It is imperative that the
methods. The 2004 loss year looks
users of the financial statements be
extremely favorable but the 2005 year
kept unaware of the risks this
is much worse. Lowering the reserves
company is involved with”
will just create large swings in their
claim costs”
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What is the Financial Reporting Perspective?
“I have some concerns regarding the
various changes at the Company … I
believe it is appropriate to be
conservative at this time”
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PricewaterhouseCoopers
What is the Financial Reporting Perspective?
“I have some concerns regarding the
various changes at the Company … I
believe it is appropriate to be
conservative at this time”
Financial Reporting Perspective
• Is what this actuary “believes”
relevant?
• Translation “I am ignorant of the
financial reporting standards my
work is being used for”
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What is the Financial Reporting Perspective?
“The reserves are presented both
reasonably and conservatively…it is
much more likely than not they will
develop favorably…my actuarial
judgment calls (used for deriving my
BEST estimate) tended to be
conservative…I can see your concern
regarding the bias…my preference is
to bring the estimates down over the
next few years.”
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PricewaterhouseCoopers
What is the Financial Reporting Perspective?
“The reserves are presented both
reasonably and conservatively…it is
much more likely than not they will
develop favorably…my actuarial
judgment calls (used for deriving my
BEST estimate) tended to be
conservative…I can see your concern
regarding the bias…my preference is
to bring the estimates down over the
next few years.”
Financial Reporting Perspective
• Translation “I am going to help this
company misrepresent their
financial statements, but mind you
only for a few years. An added
bonus on this approach is the
company will be able to take
advantage of tax deductions they
are not entitled to”
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PricewaterhouseCoopers
What is the Financial Reporting Perspective?
“As long as a company maintains the
same level of conservatism in their
reserves, the income is not distorted”
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PricewaterhouseCoopers
What is the Financial Reporting Perspective?
“As long as a company maintains the
same level of conservatism in their
reserves, the income is not distorted”
Financial Reporting Perspective
• Translation “it is okay to
misrepresent financial statements
as long as you do it consistently”
• Why would you do this?
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What is the Financial Reporting Perspective?
“Accounting tells the story, it does not
write the story”
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PricewaterhouseCoopers
What is the Financial Reporting Perspective?
“Accounting tells the story, it does not
write the story”
Financial Reporting Perspective
• Translation “I can distinguish
between my role in financial
reporting versus my role in making
financial decisions”
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