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Please also see Insurance product lines and markets.
Insurance companies in the United States use Statutory Accounting Principles (SAP), which are actually more conservative than Generally Accepted Accounting Principles (GAAP) in the presentation of the financial statements of an insurance company. SAP guidelines are established by each respective state insurance commission. SAP presents the company's balance sheet as if the assets of insurance company were going to be liquidated for the financial period. Thus, under SAP guidelines liabilities (expenses) must be recognized earlier or at the maximum indicated value and assets (capital gains) are recognized later than GAAP guidelines and at the lowest indicated value.
For instance, under SAP guidelines bonds (long-term assets) must be presented at their amortized value, while under GAAP guidelines bond investments must be presented at their fair market value.
Insurance companies are always being managed for an unknown future environment. An insurance must constantly update its estimate of future claims. In the case of property coverage the insurance company may be saddled with the effects of a very large storm, which will throw off the estimate the company had been operating under. Casualty claim estimates may be invalidated by litigation related to an event or product liability.
Insurance companies also release quarterly and annual financial statements (Annual Report and SEC Forms 10-Q/10-K) in a GAAP-type format, however it is slightly different. On the asset side of the balance sheet one will see investments presented first before current assets:
Claims reserves
Unearned premium reserves; Redundant reserves are reserves in excess of actual losses.
As part of the their formal reporting every property and casualty insurance company must report an "Analysis of Consolidated Capital Net Losses and Loss Expense Reserve Development." This is a 10-year record which shows how much reserves were set originally set aside based on previous annual estimates, how much the actual claims really were and how much was actually payed out, how much the reserves had to adjusted based on losses and just how reliable the methodology for estimating losses was.
Does the company underwrite automobile insurance in the states of New York, New Jersey, Florida, California and Massachusetts, which are the states with the highest rates of fraudulent clains? Has the company increased rates in order to cover for the high rate of fraudulent claims, or is there pressure by the state regulator to put a cap on rates?
Has the company in the past sold variable annuity or universal life insurance products with guarantees? The guarantees provided full coverage on any loss on the initial principal invested in the variable annuity. Similarly the guarantee on the unviersal life policies specified that the premium would not increae during the life of the policy nor would the amount of the death benefit ever be reduced. The problem with this is that costs for the insurer are sure to rise in the future or investments may not perform as planned, thus the inurance company must set aside sufficient reserves to cover the potential future costs of the results of the guarantees. Additionally, the insurer must price the product with the guarantee accurately at time of sale, also make assumptions about whether a certain percentage of policies will lapse (the policy holder / insured ceases to make the premium payments) and then accurately estimate those potential future costs because if there are insufficient reserves then the additional payments to policy holders will have to come from current earnings and who knows if the company will be able to meet those costs in the future.
Market Consistent Embedded Value (MCEV) is a supplemental report provided by European life insurance companies. MCEV was implemented in June 2008, and is a measure of the risk of certain investments and spreads the earnings out over a longer period for assets with an elevated degree of risk. MCEV supersedes Embedded Value (EV), which is the present value of future profits plus adjusted net asset value. Future income for the insurer consists of premiums paid by policyholders whilst future cost comprises claims paid to policyholders as well as various expenses. The difference represents future profit. For insurance companies, the net asset value is usually calculated at book value. EV requires that it be adjusted to market value. EV measures the value of the insurer by adding the present value of the existing business to the market value of net assets.
