CAS Financial Analysis and Reporting 3 — Questions and Answers
Question 1: Under IFRS 17, what is the 'contractual service margin' (CSM)?
- The difference between incurred losses and paid losses
- The unearned profit on insurance contracts recognized over the coverage period (Correct answer)
- The present value of future claim payments
- The risk adjustment for non-financial risk
Correct answer: The unearned profit on insurance contracts recognized over the coverage period
The CSM represents the unearned profit embedded in insurance contracts, released into income as services are provided over the coverage period.
Question 2: What is 'loss adjustment expense' (LAE) in insurance financial reporting?
- The cost of settling and defending claims, both allocated and unallocated (Correct answer)
- The difference between written and earned premiums
- Investment expenses related to the claims portfolio
- Reinsurance premiums ceded for excess losses
Correct answer: The cost of settling and defending claims, both allocated and unallocated
LAE includes all costs to investigate, defend, and settle claims, divided into allocated LAE (case-specific) and unallocated LAE (overhead).
Question 3: Which financial statement best reflects an insurer's ability to pay claims as they come due?
- Income statement
- Statement of cash flows (Correct answer)
- Balance sheet equity section
- Underwriting gain/loss exhibit
Correct answer: Statement of cash flows
The statement of cash flows reveals operating, investing, and financing cash flows, indicating actual liquidity to meet obligations.
Question 4: In insurance accounting, what is 'fronting' and its key financial reporting implication?
- An insurer issues a policy but cedes 100% of risk to a reinsurer; the cedant retains credit risk (Correct answer)
- A reinsurer assumes 100% of premium without issuing a policy
- An insurer underreports premiums to avoid regulatory review
- A method of deferring loss recognition to future periods
Correct answer: An insurer issues a policy but cedes 100% of risk to a reinsurer; the cedant retains credit risk
In a fronting arrangement, the licensed insurer issues the policy and cedes all risk to a reinsurer but remains liable if the reinsurer defaults, creating credit risk.
Question 5: How does the 'paid loss development method' differ from the 'incurred loss development method'?
- Paid method uses case reserves; incurred method excludes IBNR
- Paid method uses only cash payments; incurred method includes case reserves and IBNR estimates (Correct answer)
- Paid method is required under GAAP; incurred method is required under SAP
- There is no practical difference between the two methods
Correct answer: Paid method uses only cash payments; incurred method includes case reserves and IBNR estimates
The paid development method relies solely on actual cash payments, while the incurred method incorporates case reserves plus IBNR in the development data.
Question 6: What does the 'operating ratio' measure for a P&C insurer?
- Net investment income as a percentage of surplus
- Combined ratio minus the net investment income ratio (Correct answer)
- The ratio of operating expenses to total assets
- Premium growth rate relative to industry average
Correct answer: Combined ratio minus the net investment income ratio
The operating ratio equals the combined ratio minus the net investment income ratio, measuring overall operating profitability including investment returns.
Question 7: Which NAIC IRIS ratio is used to detect rapid premium growth that may signal underwriting risk?
- Two-year overall operating ratio
- Change in net premiums written ratio (Correct answer)
- Estimated current reserve deficiency ratio
- Investment yield ratio
Correct answer: Change in net premiums written ratio
The change in net premiums written ratio flags insurers whose premium volume has grown rapidly, which may indicate underwriting standards have been relaxed.
CAS Financial Analysis and Reporting 3
Under IFRS 17, what is the 'contractual service margin' (CSM)?