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

298 THE APPLICATION OF FUNDAMENTAL VALUATION PRINCIPLESCodified SAP now requires the accrual of a deferred tax asset(DTA) or liability (DTL). Consider a company that purchases oneshare of stock on January 1, 2001, for $100. If the company holdsthe stock and it appreciates to $1,000 as of December 31, 2001,the company will be required to accrue a DTL for the unrealizedcapital gain. (The DTL is calculated as t £ (1,000 ¡ 100), where tis the corporate tax rate.) Conversely, the determination of federaltaxes using discounted loss reserves results in the accrual of aDTA. As a result, a company’s statutory surplus is affected bynecessary adjustments for DTAs and DTLs.A premium deficiency reserve (PDR) is required to supplementthe unearned premium reserve (UEPR) when the UEPR isinadequate to fund for future liabilities related to the unearnedexposure.Each of these changes resulting from codification affects thestarting statutory surplus in a valuation and, as a result, the entity’sfuture earnings. Prior to codification, a shortfall in theUEPR or the value of a DTL or DTA would have been recognizedin future earnings as losses are incurred or assets aresold. Codified SAP reflects the associated value immediately onthe balance sheet. In computing value prior to codification, thevalue associated with the PDR, DTA, or DTL would have beenrecognized on a discounted basis through the present value offuture earnings component of the DCF or EVA valuation methods.After codification, value associated with the PDR, DTA, orDTL is as recorded in the statutory balance sheet.Fair Value AccountingFinancial assets and liabilities are accounted for in numerousways under current U.S. accounting rules. For property/casualtyinsurance companies there is GAAP accounting, statutory accounting,and tax accounting. Each of the various measuringapproaches has its advantages and disadvantages. In general,GAAP accounting for property/casualty insurance companies isaccounting for a “going concern.” It reflects adjustments that