Reference no: EM1312406

Preparing an income statement  for Forgetful Insurance Company

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.
Hint: Record the ceding reinsurance commission as a reduction in the policy acquisition expenses.

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
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.

Forgetful Insurance Company Statutory Income Statement For the year ending Dec. 31, 2007
Underwriting income:	SAP	Common- size forcolumn F	SAP Adjusted for trans 1	SAP Adj'd for trans 1 & 2
Premiums earned	$	550,000
Losses incurred		-325,000
Loss adjustment expenses incurred		-65,000
Policy acquisition expenses		-100,000
Net underwriting gain/loss	$	60,000
Investment income:
Net investment income	$	35,000
Other income:
Other income	$	5,000
Income before dividends & income taxes		100,000
Dividends to policyholders		-10,000
Income before taxes		90,000
Income taxes		0
Net income	$	90,000
Statement of Changes in Policyholders' Surplus
Policyholders' surplus, January 1, 2007		470,000
Net income		90,000
Add: Decrease in non-admitted assets		10,000
Capital changes		0
Dividends to shareholders		0
Changes in surplus for the year		100,000
Policyholders' surplus, Dec. 31, 2007		570,000