Premium Deficiency Reserves under U.S. GAAP John G. Aquino FCAS MAAA Executive Vice President

1. Premium Deficiency Reserves under U.S. GAAP John G. Aquino FCAS MAAA Executive Vice President Aon Re Services, Inc.

2. Overview Definition Calculation Scope Calculation Methodology

3. Definition - FAS 60 Paragraph 32: Definition Paragraph 33: Calculation Paragraph 34: Recognition Paragraph 60: Disclosure Of Investment Income

4. FAS 60, Paragraph 32 “A probable loss on insurance contracts exists if there is a premium deficiency relating to short-duration or long-duration contracts. Insurance contracts shall be grouped consistent with the enterprise’s manner of acquiring, servicing, and measuring the profitability of its insurance contracts to determine if a premium deficiency exists.”

5. FAS 60, Paragraph 33 “A premium deficiency shall be recognized if the sum of the expected claim costs and claim adjustment expenses, expected dividends to policyholders, unamortized acquisition costs, and maintenance costs exceeds related unearned premiums.”

6. “A premium deficiency shall first be recognized by charging any unamortized acquisition costs to expense to the extent required to eliminate the deficiency. If the premium deficiency is greater than the unamortized acquisition costs, a liability shall be accrued for the excess deficiency.” FAS 60, Paragraph 34

7. FAS 60, Paragraph 60. e. “Insurance enterprises shall disclose the following in their financial statements … e. whether the insurance enterprise considers anticipated investment income in determining if a premium deficiency relating to short-term contracts exists.”

8. Calculation Scope Grouping Criterion “Acquiring, Servicing & Measuring” Interpretations GAAP Reporting Segments GAAP Segments May Be Inadequate FAS 60, Paragraph 37 Applies To Long Duration Contracts Specifies “Line Of Business” Recognition

9. FAS 131: Disclosures about Segments 10. An operating segment is a component of an enterprise: a. That engages in business activities from which it may earn revenues and incur expenses (including revenues and expenses relating to transactions with other components of the same enterprise), b. Whose operating results are regularly reviewed by the enterprise's chief operating decision maker to make decisions about resources to be allocated to the segment and assess its performance, and c. For which discrete financial information is available. Also see paragraph 17, “Aggregation Criteria”

10. Calculation Methodology Components Time Value Of Money Alternatives Reinsurance Refinements

11. Components Unearned Premium Reserve Related Costs Acquisition Costs Maintenance Costs Loss and LAE Costs Policyholder Dividends

12. FAS 60: Maintenance Costs “Costs associated with maintaining records relating to insurance contracts and with the processing of premium collections and commissions” Lower than total other underwriting expense Examples: Aquino - 0.83%, Blanchard - 5%

13. Time Value Of Money Alternatives Unearned Exposures Or In-Force Exposures Investment Income Or Present Value Initial Election To Discount May Be Considered A Change In Accounting Principle APB 20 Rules Then Apply

14. Calculation Details

15. Reinsurance GAAP Balance Sheet Is Gross Liabilities Are Gross Reinsurance Recoverables Are An Asset

16. Reinsurance Offset Condition FAS 113, Paragraph 15 “Amounts receivable and payable between the ceding enterprise and an individual reinsurer shall be offset only when a right of setoff exists, as defined in Interpretation 39.” APB Opinion 10: "it is a general principle of accounting that the offsetting of assets and liabilities in the balance sheet is improper except where a right of setoff exists."

17. Refinements Contingent Commissions Agents’ Balances Installment Premiums Audit Premiums Federal Income Taxes