Odomirok.18-IEE

This chapter has a TON of formulas. It's ridiculous. It's comparable to NAIC.IRIS on the number of formulas you have to learn, but it generally only accounts for about half as many points on the exam as the IRIS ratios. There are a bunch of pdf practice problems and a couple of practice templates in the quiz. I don't see any shortcuts here - you just have to practice the calculations relentlessly. One compensation is that you don't have to memorize as many facts (aside from the formulas). If you are really pressed for time, you can focus on the surplus allocation material and skip the investment gain material. (That would be a gamble but if you don't have time for everything, it's your best bet statistically. It's better to learn one thing well than two things poorly.)

  Forum

BattleTable

Based on past exams, the main things you need to know (in rough order of importance) are:

• surplus allocation - calculate the surplus value/ratio, explain & evaluate the method
• investment gain - calculating the investment gain value/ratio
• IEE profit (loss) - calculating the profit (loss)
• miscellaneous IEE topics - impact on stakeholders, prepaid expenses, capital gains, comparison to UIE (U/W & Investment Exhibit)

reference	part (a)	part (b)	part (c)	part (d)
E (2019.Spring #12)	investment gain: - calculate value	surplus allocation: - evaluate method for HO
E (2017.Spring #11)	investment gain: - calculate value	surplus allocation: - impact of exposure shift
E (2016.Fall #10)	investment gain: - calculate ratio	surplus allocation: - calculate ratio	IEE (commercial): - impact on stakeholders
E (2016.Spring #11)	investment gain: - calculate value	prepaid expenses: - treatment of
E (2015.Fall #13)	surplus allocation: - calculate value	surplus allocation: - evaluate method
E (2015.Spring #13)	IEE profit (loss): 1 - calculate ratio to surplus	surplus allocation: - evaluate method
E (2014.Fall #11)	income statement: - shortcomings vs IEE	IEE vs UIE: - 2 differences	unrealized capital gains: - exclude from tot. inv. gain	surplus allocation: - IEE vs ratemaking
E (2014.Spring #13)	surplus allocation: - calculate value	surplus allocation: - evaluate method	IEE vs Page 14: - presentation of data
E (2013.Fall #15)	surplus allocation: - explain method	surplus allocation: - evaluate method	surplus allocation: - propose new method	IEE (commercial): - impact on stakeholders
E (2012.Fall #17)	IEE profit (loss): 1 - calculate	IEE profit (loss): - how is it used	rate adequacy: - based on IEE

¹ The 2015 problem asks you to calculate pre-tax profit (loss) while the 2012 problem asks you to calculate total profit (loss). But if you look at the examiner's report solution, both simply calculate pre-tax values. This is confusing because Odomirok makes a definite distinction between pre-tax and total. In any case, the 2012 problem doesn't provide any tax information so you have to choice but to calculate only the pre-tax value.

Full BattleQuiz You must be logged in or this will not work.

  Forum

In Plain English!

Intro

When I filled in the BattleTable above, it became blazingly obvious what the most important topic was: surplus allocation. It's also obvious that on the past few exams, they emphasized the calculation of investment gain. This gets to the heart of the unwritten rule of Exam 6. There is lots of repetition. If this weren't the case, nobody would have a chance in hell of passing. Note the very low pass ratios on exams following major syllabus changes.

There are 2,500 pages of material so there's no way you can learn everything. (You could probably pass the exam by restricting your studying to only 200 pages of material - the trick is which 200 pages? That's where BattleActs helps! The wiki articles are way shorter than the actual readings, but still have all the important information. Tastes great - less filling.) The key is paying attention to what's been asked in the past. Now, the questions usually aren't exactly the same, but they're close enough so if you know how to solve past questions, you'll have a good chance of answering current questions. But every now and then, they throw in something totally new and that's always tough. To prepare for questions that haven't appeared before, always ask yourself as you're reading the material: Would this make a good exam question? If you think it would, then write down the question & answer, and memorize it. Sometimes you'll be right, sometimes you won't.

An interesting aside is that about half-a-dozen articles for Exam 6-US are also on Exam 6-Canada (not this one) but I can't copy the wiki articles verbatim. You would think I could, but the exam questions are generally different and the wiki articles have to be modified to reflect that. Someone who aces the Canadian questions would likely have trouble with the U.S. questions, and vice-versa, even though the Canadian and U.S. exams purportedly cover the same material.

But let's get back to the topic at hand. Recall that the Income Statement shows an insurer's profitability over the past year on a net of reinsurance basis. But only on an aggregate level.

Question: what information is shown on the Insurance Expense Exhibit (IEE) versus the Income Statement

• IEE shows statutory profit (loss), both direct & net of reinsurance, by line of business whereas the Income Statement shows only aggregate information net of reinsurance.

That is the most important characteristic of the IEE - that it shows profits & expenses by line.

Question: identify uses of the IEE to actuary, policyholder, investor, competitor, regulator, rating agency

• The answers are just the "normal" things these different stakeholders do, but they can do it better if they have detail by line of business:

actuary:

   - examine premium, loss, expenses by line

   - benchmark company performance by line

policyholder:

   - examine expenses by line

   - may affect purchase decision because lower expenses mean lower rates

investor:

   - examine profitability versus premium growth by line

   - may affect investment decision if growth is in unprofitable lines

competitor:

   - examine profit & expenses by line

   - may affect market entry decision in lines where profits are high

regulator:

   - examine data/trends by line

   - highlights solvency and/or rate concerns by line that the income statement may mask

rating agency:

   - examine profit by line

   - highlights subsidies from strong lines to weak (or are all lines independently strong)

• The underlined word in each item above gives you a memory hook. But even if you don't specifically memorize this list, you could take an educated guess based on general knowledge. See part (c) of the following problem:

E (2016.Fall #10)

Let's see how the IEE is organized and what it actually looks like. It consists of 3 parts:

IEE – Part 1

- allocates expenses (from Part 3) into 22 different expense groups

- doesn't show profit (loss)

IEE – Part 2

- shows pre-tax profit (loss) net of reinsurance (see columns 41, 42)

IEE – Part 3

- shows pre-tax profit (loss) direct of reinsurance (see columns 33, 34)

- excludes all investment gain

IEE – interrogatories

- explanatory notes for Parts 1,2,3 (comes before Parts 1,2,3)

- interrogatory question #4 is very important: provides info on the allocation of profits & expenses to line

- if the allocation is done in a standard way then no further info is required (this is the case with Liberty Mutual)

mini BattleQuiz 1 You must be logged in or this will not work.

Surplus Allocation

The most important topic related to the IEE (Insurance Expense Exhibit) is: surplus allocation.

• surplus is shown on an aggregate basis on the balance sheet
• then IEE allocates surplus to line of business

Let's see how this is done. Let

m(x) = mean of ( prior CY value of x , current CY value of x )

and

L = Loss reserve,    LAE = LAE reserve,    UEP = UEP reserve,    NEP_CY = NEP for current year

Then apply the following formulas for SR (Surplus Ratio) and S_A (surplus allocated to line of business A):

Formula:   SR    =    m(S)    /    [   m(L)   +   m(LAE)   +   m(UEP)   +   NEPCY   ]

and

Formula:    SA    =    SR    x    [   m(LA)   +   m(LAEA)   +   m(UEPA)   +   NEPA(CY)   ]

Note:

• The quantity S_A represents the allocation to LOB A in the IEE exhibit for the current calendar year CY.
• This is the same as the mean surplus m(S_A) over the last 2 years.
• In the solution to the problem below, the notation S_A(CY) is used to represent the allocation of surplus for LOB in the IEE for the current calendar year CY.
• The source text does not use this notation. (The source text refers to these quantities using English sentences, but it's easier to remember if the quantities are encapsulated in more concise notation.)

This calculation is demonstrated here in Alice's solution to this old exam problem on surplus allocation:

IEE Surplus Allocation - 2015.Fall #13

And here is a practice problem. (There is also a practice template for this problem in the quiz.)

1 practice problem like - 2015.Fall #13

Now, it isn't enough just to know how to do the calculation. Alice calls this next question the Star Wars question.

Question: identify advantages & disadvantages for this method of surplus allocation

• advantages [Hint: R2-DC ← that's R2-D2's cousin from Star Wars ]

   - not distorted by Reinsurance

   - uses 2 years of data to smooth results (reduces distortions)

   - easy to obtain Data (from annual statement)

   - easy to Calculate & compare across companies & lines of business

• disadvantages [Hint: FARCe → May the FARCe be with you ]

   - does not reflect Future business or growth (it is retrospective)

   - does not allow for Actuarial/management input (method is formulaic)

   - does not reflect Risk characteristics of line of business (Ex: short vs long-tail)

   - does not recognize Catastrophe potential

   - (the e doesn't stand for anything - I just needed it to spell Farce)

The quiz covers the above material as well as miscellaneous exam problems on surplus allocation. Note that sometimes exam problems ask you to relate these advantages and disadvantages to a specific line of business such as personal auto. To get full credit, it wouldn't be enough to reproduce the above list - you must fully explain how your answer relates to the stated line of business.

mini BattleQuiz 2 You must be logged in or this will not work.

Investment Gain - Part 1

Let's jump right in with a calculation problem for the Net Investment Gain Ratio. You need the following notation:

NIGR = Net Investment Gain Ratio

NIG = Net Investment Gain

TIA = Total Investable Assets

Then the first formula you need is:

Formula:    NIGR    =    NIG    /    TIA

If

re = ceded reinsurance premium payable

S = Surplus

AB = Agents' Balances

then the second formula is: (which can also be applied on a 'by line of business' basis by adding subscripts to the terms of the formula)

Formula:    TIA    =    m(L)    +    m(LAE)    +    m(UEP)    +    m(re)    +    m(S)    –    m(AB)

Here is Alice's solution to an old exam problem:

IEE Net Investment Gain Ratio - 2016.Fall #10

The next problem ties together the previous section on surplus allocation to line with the net investment gain. You don't need any new formulas - you just have to rearrange the NIGR formula and apply it to a particular line of business A, rather than in aggregate. (Note that NIGR is not particular to a line of business - the same ratio is used across all lines.)

Rearranged Formula:    NIGA    =    NIGR    x    TIAA

Here it is:

IEE Net Investment Gain - 2017.Spring #11

The next quiz has just a few old exam problems.

mini BattleQuiz 3 You must be logged in or this will not work.

Investment Gain Part - 2

Warning: You are about to become very confused. To solve the next problem, we need a new concept:

• Net investment Gain attributable to Insurance Transactions (NIGIT)

It's confusing because it's so similar to the plain old NIG from the previous section. Basically, you have to understand that there are 2 components of TOTAL Net Investment Gain:

1. investment gain attributable to Capital & Surplus
2. investment gain attributable to Insurance Transactions

The problems in the previous section asked about the TOTAL investment gain. The problem we're discussing here asks about #2 only. To solve the Insurance Transaction version of the investment gain problem we need 2 more formulas. Recall that a subscript of A means the quantity refers to line of business A. (Recall also that NIGR is an aggregate ratio - all lines of business use the same ratio.)

Let FAIT = Funds Attributable to Insurance Transactions:

Formula 1:    NIGITA    =    NIGR    x    FAITA

• If you compare this formula for NIGIT_A to the formula for NIG_A in the previous section, you'll see that here FAIT takes the place of TIA. In other words, you apply the ratio NIGR to a different base amount. (Apply NIGR only to Funds Attributable to Insurance Transactions versus Total Investable Assets)

Formula 2:    FAITA    =    m(LA)    +    m(LAEA)    +    m(UEPA)    +    m(reA)    –    m(ABA)    –    (PPE for UEP)A

Oops, I lied, you need still another formula (for the last term in FAIT_A above). But WTF is (PPE for UEP)_A anyway, and how do you calculate it? Well, it's the prepaid expenses in the UEP for the current CY, not the mean. (In other words, the portion of the UEP that goes towards the current CY pre-paid expenses.)

Formula 2a:    (PPE for UEP)A    =    PPERA    x    m(UEPA)

I don't know about you but I'm getting kind of annoyed at having to memorize all these formulas. And we're still not done. You need also need PPER_A (Pre-Paid Expense Ratio)

Formula 2b:    PPERA    =    (net acquisition expense)A    /    NWPA

But at least in the exam problem below, they give you the value of PPER as 30%, so you don't have to calculate it.

Here's the problem & my solution: (Oops, I mean Alice's solution.)

IEE Net Investment Gain attributable to Insurance Transactions - 2016.Spring #11

This quiz has a practice template for the basic IEE quantities TIA & FAIT (Total Investable Assets & Fund Attributable to Insurance Transactions)

mini BattleQuiz 4 You must be logged in or this will not work.

Total Profit (Loss)

The last major type of problem from this chapter is calculating the profit (loss).

Mar 9, 2023 edit:

• The qualifier "Pre-tax" was inserted to the left side of the equation below to make it clear this formula gives the pre-tax Profit (Loss).
• But note that in the exam problem from 2012-Fall described below, they ask for Total Profit (Loss) but you cannot calculate the after-tax value because no tax information is provided.
• Here is a brief forum discussion.

Main Formula:    Pre-tax Total Profit (Loss)    =    (Pre-tax profit excluding InvGain)    +    InvGain(Insurance Transactions)    +    InvGain(Capital & Surplus)

• the 'Pre-tax profit (loss)' is explained in the solution to the exam problem given below
• the 2 'InvGain' terms (Investment Gain) were discussed in the previous section.

Here are 2 old exam problems on the profit (loss) calculation:

E (2015.Spring #13)

E (2012.Fall #17)   → Side note on 2012.Fall #17

Here is Alice's solution to the 2015 problem, along with 4 practice problems:

Profit (loss) - 2015.Spring #13 shout-out to LK for finding the typos!

4 practice problems like - 2015.Spring #13

The quiz just covers the 2 exam problems listed above. (Note that the 2012 problem specifically asks for Total profit (loss) which Odomirok defines as net of taxes. But the problem doesn't provide any tax information so all you can do is calculate pre-tax profit.)

mini BattleQuiz 5 You must be logged in or this will not work.

Final Comments on IEE

There are a few things near beginning of chapter 18 that we should probably cover. I skipped over it before because it's so insanely boring. The first couple of pages in the section: Part I - Allocation to Expense Groups explains how IEE and U&IE are related. (U&IE is the Underwriting & Investment Exhibit)

If you want a quick break, I found a website where someone made 5 flash cards for the U&IE. Take a look - can't hurt!

Anyway, here's what the 3 parts of the U&IE exhibit look like, but only Part 3 is relevant to this discussion:

U&IE Part 1    Part 1 - Premiums Earned,    Part 1A - Recapitulation All Premiums,    Part 1B - Premiums Written

U&IE Part 2    Part 2 - Loss Paid & Incurred,    Part 2A - Unpaid Loss & LAE

U&IE Part 3    Part 3 - Expenses

A good exercise might be to view the IEE and U&IE side by side so you can see the differences.

Odomirok notes an important (but boring) difference between IEE and Part 3 of U&IE regarding the level of detail for other U/W expenses. In particular, IEE separate other U/W expenses further into:

• acquisition , field supervision, and collection expenses
• general expenses
• taxes, licenses, and fees (shout-out to KP!)

Question: identify other differences between IEE and Part 3 of U&IE

LOB breakout:

   - IEE shows expenses by LOB, U&IE doesn't

reinsurance:

   - IEE shows direct & net, U&IE shows net only

display format:

   - IEE in 000's, U&IE to nearest dollar

The quiz covers a couple of other miscellaneous topics. (But don't worry, it's short.)  ← shout-out to AB!

mini BattleQuiz 6 You must be logged in or this will not work.

Full BattleQuiz You must be logged in or this will not work.

  Forum