Can someone differentiate between stockholders equity, using an assets minus liabilities definition, and surplus for an insurer? How is surplus different than equity?
Also can we differntiate between insurance reserves and insurance surplus?
insurance reserve is the amount insurance company keeps aside to meet unexpected liability. Surplus is the excess amount which company can use for its growth. Surplus is achieved by investing in the stock portfolio. Insurance company first meet its liabilities and reserves and then only invest in surplus account.
Do i have this right? So surplus is equal to the portion of its assets equal to its equity, essentially. For instance FMV of liabilities is 1 billion, you have portfolio assets of 1.3Billion. 1 billion is in fixed income and 300 million is your surplus, invested in equities, venture cap, real estate etc. Are reserves invested? Are they a part of the surplus?
reserves can be invested in liquid assets so can be sold when needed. I guess you got it correct but make sure after matching liabilities, you put some money aside for reserves. Also insurance companies can’t invest more than some amount in risky assets like stocks to achieve surplus.
How would reserves come up in a question do you think? Would it just be the amount in an asset allocation you would assign to Treasury bills/cash equivalents?
Ok I think I have it. Let me know if I’m wrong. A new insurance company, XYZ insurance company writes $1 Billion in policies receiving $1 billion in cash and has equity proceeds of $500 million for a total of $1.5 billion in cash. To Immunize the liabilities the company purchases $350 million in BBB bonds with an asset valuation reserve of 20%, so only $280MM of the bonds apply to reserve. $500 million in Treasuries are purchased with an asset valuation reserve of 5% so $475MM applies to the reserves. The remaining $245MM in held in cash equivalents with a 0% asset valuation reserve. $280MM + $245MM + $475MM = $1 billion reserve, but used $1.095 billion in assets due to AVR. The remaining $405 million is surplus.
I got some confusion, Could someone confirm if my following concepts are correct or not ? Insurance reserve is not equal to liquidity reserve. Liquidity reserve is kept for unexpected liability. Usually in liquid asset. Insurance reserve is to earn interest credited to policyholder. (so it is usually invested in fixed income) Positive interest spread (ie. interest earn - specified rate credited to reserve a/c) goes to surplus. Surplus are invested for growth
> Can someone differentiate between stockholders equity, using an assets minus liabilities definition, and surplus for an insurer? How is surplus different than equity? Surplus = total assets - total liabilities of an insurance company; same as equity for a stock company >Insurance reserves vs. Surplus A valuation reserve is an allowance, created by a charge against earnings, to provide for losses in the value of the assets, much like ”Allowance for bad debts” deducted as accrual expense in normal company to provide for FUTURE ACTUAL loss. The reserve % varies from asset class to asset class and is determined by National Association of Insurance Commissioners (NAIC) in the US. The company needs to evaluate mkt value of assets regularly. If they have to write down --> deduct first to reserve. If losses due to writedown on assets > assets’ valuation reserve , the company needs to charges the excess directly as a reduction in surplus. This reserve requirement applies for life insurance companies, not casual insurance companies, i.e., no need to charge an allowance in advance, but all loss to writedown will go directly to surplus. The accumulated valuation reserve is shown as liabilities on the balance sheet. Insurance regulators worldwide have been moving toward risk-based capital (RBC) requirements to assure that companies maintain adequate surplus to cover their risk exposures relating to both assets and liabilities, i.e., no need to charge a reserve before hand but the surplus must be high enough to tolerate loss based on risk assessment of the portfolio. > Liquidity reserve vs. Insurance reserves No relation with each other. Liquidity reserve is just liquid assets firms hold to meet their (unexpected) cash needs. >Positive interest spread (ie. interest earn - specified rate credited to reserve a/c) goes to surplus net interest spread is the difference between interest earned and interest credited to policyholders. This results in positive financial income and goes to surplus.
elcfa, Excellent explanation / clarification. TKVM !
Thanks elcfa for the clarification. But I still have some question. On. textbook Vol 2. P.410. it mentions that “Historically, a life insurance company’s return requirements have been specified primarily by the rates that actuaries use to determine policyholder reserve” May I know the meaning of “policyholder reserve”, what is that ? It is not the same thing as valuation reserve or liquidity reserve. right ? Thanks
policyholder reserve is an estimate of future payments to the policyholders, very much like the PBO in pension. The rates of interest credited to a policyholder reserve account is called credited rates and are defined by contracts. The value accredited so far is called accumulated cash value. Some policyholders can borrow against this cash value or surrender their policies and get back this cash value. This causes the problem of disintermediation. This reserve is classified as liabilities on the balance sheet. As it should be clear now, this reserve has nothing to do with valuation reserve or liquidity reserve.
All clear now. Thanks elcfa!
Sorry, elcfa. It’s me again. According to Text Book. Vol 2. PRACTICE PROBLEMS FOR READING 20. Q8 D The answer write. D. The focus of the “return requirement for policyholder reserves” is on earning a competitive return on the assets used to fund estimated liabilities. Life insurance companies are considered spread managers, in that they manage the difference between the return earned on investments and the return credited to policyholders. Spread management can take various forms, such as a yield approach versus a total-return approach, but the objective remains the same. Policyholder reserve here looks like an asset more than liabilities. Do you agree?
B_C Wrote: ------------------------------------------------------- > Sorry, elcfa. It’s me again. > > According to Text Book. Vol 2. PRACTICE PROBLEMS > FOR READING 20. Q8 D > > The answer write. > > D. The focus of the “return requirement for > policyholder reserves” is on earning a competitive > return on the assets used to fund estimated > liabilities. Life insurance companies are > considered spread managers, in that they manage > the difference between the return earned on > investments and the return credited to > policyholders. Spread management can take various > forms, such as a yield approach versus a > total-return approach, but the objective remains > the same. > > Policyholder reserve here looks like an asset more > than liabilities. Do you agree? Actually, no. “earning a competitive return on the assets used to fund estimated liabilities” --> i.e., policyholder reserves What they mean is that they focus on earning additional spread on assets used to finance the policyholder reserves --> i.e., “Positive interest spread” definition on my post above. Hope it is clear.
Thanks for the clarification!