PROCEEDINGS May 15, 16, 17, 18, 2005 - Casualty Actuarial Society

284 THE APPLICATION OF FUNDAMENTAL VALUATION PRINCIPLESamount of accumulated earnings and minimum capital and surplusrequirements. Both of these amounts must be determinedon a statutory accounting basis. Distributable earnings consistof statutory earnings, adjusted as appropriate in recognition ofminimum capital and surplus levels necessary to support existingbusiness. Therefore, statutory accounting determines the earningsavailable to the equity owners.While future earnings calculated according to GAAP or anotherbasis will often be of interest to the user of an actuarial appraisal,the free cash flow calculations contemplated within thedefinition of actuarial appraisal in ASOP No. 19 should be developedin consideration of statutory earnings, rather than someother basis.GAAP earnings and GAAP net worth, however, are often thebasis of the relative valuation methods involving market multiples.As the major difference between GAAP and SAP accountingis DAC, which may be recognized as an asset on the GAAPbalance sheet immediately instead of through future earnings,GAAP net worth is typically higher than SAP net worth. SAPnet worth may be greater, however, when the amortized value ofbonds in the SAP asset portfolio is higher than the market valueof bonds in the GAAP asset portfolio.4.2. Estimating Free Cash Flows or Value AddedEstimating free cash flows for a DCF valuation or changesin value of the company in each period for an EVA valuationrequires the use of after-tax operating earnings from accountingstatements. However, accounting earnings may not represent trueearnings because of limitations in accounting rules and the firms’own actions.For a property/casualty insurance company, changes in the equityof the firm derive not only from (i) after-tax operating earnings(net income in the statutory income statement) and (ii) cap-