Reference no: EM1312415

Finding Capacity ratio, Liquidy ratio for Forgetful Insurance

Background
This project provides a set of annual statements for Forgetful Insurance Company. These annual statements are based on statutory accounting principles. The account balances & results for the year are reported in column F. However, the figures reported in column F fail to take into account two transactions described below:

Transactions omitted:
1. On August 1, 2007, Forgetful underwrote a $150,000 one-year policy. Forgetful collected the premium in cash less a 18% commission.
By December 31 2007, $40,000 of losses and $5,000 of loss adjustment expenses were incurred but neither of these expenses were paid.
2.To minimize the company's risk and to gain surplus relief, the company ceded 75% of the policy described in transaction 1 to a reinsurer on August 1, 2007. The reinsurer's commission was 20%. Forgetful received the commission in cash. The reinsurance is a pro rata reinsurance contract.
 Instructions
I. Adjust Forgetful Insurance Company's 2007 annual statements to reflect transaction 1 and report these adjusted results in column "I". Adjust the annual statements to reflect both transaction 1 and transaction 2 and report these adjusted results in column "K".
II. Compute each of the following ratios using the "unadjusted" data as provided in column "F". For additional practice, recompute the ratios using the data you generate for the other columns.
a. Capacity ratio
b. Liquidity ratio
c. Return on policyholders' surplus
d. Loss ratio
e. Pure loss ratio (refer to lecture notes for its definition)
f. Combined ratio (financial basis and trade basis)
g. Investment earnings ratio
 III. In column "G", prepare a common-size income statement and common-size balance sheet based on the annual statement data provided in column "F".

Other information & data:
1. Assume the insurer is exempt from taxes.
2. Admitted assets at the start of 2007 totaled $1,675,000.
3. Invested assets' fair market value at year-end is $1,500,000.
4. Net premiums written, ignoring transactions 1 and 2 is $600,000.

	SAP	SAP Adjusted for trans 1	SAP Adj'd for trans 1 & 2
Capacity ratio
Net premiums written/Policyholders' surplus
Liquidity ratio
(Cash + Invested assets @FMV)/Reserves
Investment income ratio
Net investment income/Ave admitted assets
Return on policyholders' surplus
Return on policyholders' surplus = NI/Ave Policyholders' Surplus
Pure loss ratio
Pure loss ratio = Losses incurred/Premiums earned
Loss ratio
Loss ratio = (Losses incurred + LAE)/Premiums earned
Financial basis expense ratio
Financial basis expense ratio = OtherUnderExp/PremEarned
where "OtherUnderExp" equals "policy acquisition expenses"
Trade basis expense ratio
Trade basis expense ratio = OtherUnderExp/NetPremWritten
where "OtherUnderExp" equals "policy acquisition expenses"
Financial basis combined ratio
Financial basis combined ratio = Loss + Expense ratio
where "OtherUnderExp" equals "policy acquisition expenses"
Trade basis combined ratio
Trade basis combined ratio = Loss + Expense ratio
where "OtherUnderExp" equals "policy acquisition expenses"