Moving Forward: The Future of Insurance Industry Investments

1. Moving Forward: The Future of Insurance Industry Investments Accounting Firm Perspective Presented by: William J. Scannell, CPA Johnson, Lauder & Savidge, LLP NYIA Educational Seminar, February 12, 2009

2. Presentation Outline • Accounting Issues • Tax Issues • Regulatory Changes • Strategies • Questions & Answers

3. Accounting for Stocks • Carry on books at cost • Adjust to market value at reporting date • Adjustment is recorded as a change in surplus

4. Accounting for Bonds • Carried on books at ‘amortized cost’ • Premium or discount is written off over the life of the bond • Presumption is the Company will hold to maturity

5. Asset Impairment For bonds: An impairment shall be considered to have occurred if it is probable that the reporting entity will be unable to collect all amounts due according to the contractual terms of a debt security in effect at the date of acquisition

6. Asset Impairment For stocks: A decline in the fair value of a stock that is determined to be ‘other than temporary’.

7. Impairment Determination • Performed at the individual security level • Indicating factors: • Length of time to which fair value has been less than cost • Financial condition and short-term prospects of the issuer • Intent and ability to retain investment for sufficient time to allow for recovery in value

8. Asset Impairment measurement Rules of Thumb developed to assist in evaluation of impairment: • 20% below water • 6 months below cost Identifying impairment is only the beginning of the analysis

9. Accounting for Impairment • Write down cost to impairedvalue • Loss become ‘recognized’ – reduces net income • For stocks, moves surplus adjustment ‘above the line’ but no impact on surplus • bonds, results in immediate reduction in surplus

10. Required Disclosures • Each stock & bond in unrealized loss position for which other-than-temporary declines in values have not been recognized • Aggregate loss • Segregated by losses longer than 12 months and less than 12 months • General categories of information considered

11. Deferred Taxes • Assets and liabilities with different statement and tax values create deferred tax assets and/or deferred tax liabilities • Deferred tax liabilities are always recognized • Deferred tax assets, however, are subject to an admissiblity test

12. Deferred Taxes • Impaired bonds and stock portfolios give rise to deferred tax assets • Admissibility typically limited to the amount realizable in one year unless other deferred tax liabilities can offset • Typically can only be admitted to the extent there are realized capital gains in the current and two previous years

13. Deferred Tax Example #1 • Unearned Premium Reserve - $5,000,000 • DTA = $340,000 ($5M x 20% @ 34%) • 100% reverses in one year • Unpaid Losses & LAE - $6,000,000 • Discount rate of 10% = $600,000 • DTA = $204,000 ($600K @ 34%) • $100,000 reverses in one year • Unrealized capital GAIN - $2,000,000 • DTL = $680,000 ($2M @ 34%)

14. Deferred Tax Example #1 Deferred Tax Asset (Liability): CurrentNoncurrent • UPR $ 340K $ 0 K • Loss Reserve 100 104 • Unrealized Loss (680) $ 440 $ (576) • Net Deferred Tax Liability $ (136) K

15. Deferred Tax Example #2 • Unearned Premium Reserve - $5,000,000 • DTA = $340,000 ($5M x 20% @ 34%) • 100% reverses in one year • Unpaid Losses & LAE - $6,000,000 • Discount rate of 10% = $600,000 • DTA = $204,000 ($600K @ 34%) • $100,000 reverses in one year • Unrealized capital LOSS - $2,000,000 • DTL = $680,000 ($2M @ 34%)

16. Deferred Tax Example #1 Deferred Tax Asset (Liability): CurrentNoncurrent • UPR $ 340K $ 0 K • Loss Reserve 100 104 • Unrealized Loss 680 $ 440 $ 784 • Net Deferred Tax Asset = $ 1,224 K • Net ADMITTED Tax Asset = $ 440K

17. Deferred Tax Example Comparison TotalAdmitted DTL - $ 2 M unrealized gain $ 136 K $ 136 K DTA - $ 2M unrealized loss 1,224 440 Effect on ledger 1,360 Effect on surplus 576 Additional surplus hit $ (784) K (20% of the unrealized loss for the year)

18. Tax Implications • No deduction for unrealized losses • Realized capital losses can only offset realized capital gains • Remaining loss can be carried back 3 years, then carried forward 5 years – then is lost

19. Regulatory Changes for 2008 • NAIC pending changes relaxing admissibility of deferred tax assets • NYSID stress testing • Disclosure of sub-prime mortgage disclosure • Regardless of materiality

20. Strategies • Review portfolio for impaired assets • Develop a watch list • Involve investment & business advisors • Document procedure and conclusions • Analyze deferred assets • Consider sale of below market assets to recoup capital gain tax paid in 2006, 2007 and 2008 • Consider non-tax factors as well before selling

21. Questions ?

22. For further information contact: William J. Scannell, CPA Managing Partner Johnson, Lauder & Savidge, LLP (607) 723-8216 bill@jlscpa.com