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Page 7, col. 2, line 10 + Page 7, col. 2, line 19 + Page 7, col. 3, line 10 + Page 7, col. 3, line 19 + Page 7, col. 4, line 10 + Page 7, col. 4, line 19 + Page 7, col. 5, line 10

+ Page 7, col. 5, line 19 = E

D

÷ E

= F

If D and E are both zero or negative, let F equal zero. positive and E is zero or negative, let F equal 1.0.

[blocks in formation]

If D is

TEST 9: CHANGE IN RESERVING RATIO

1973 only (approximation)

Current Year Statement

Page 5, col. 2, line 17 + Page 5, col. 3, line 17 = A

Page 7, col. 2, line 10 + Page 7, col. 2, line 19 + Page 7, col. 3, line 10 + Page 7, col. 3, line 19 = B

A

÷ B = C

If A and B are both zero or negative, let C equal zero.
positive but B is zero or negative, let C equal 1.0.

Prior Year Statement

Page 5, col. 2, line 17 + Page 5, col. 3, line 17 + Page 5, col. 4, line 17 + Page 5, col. 5, line 17 = D

Page 7, col. 2, line 10
+ Page 7, col. 2, line 19
+ Page 7, col. 3, line 10
+ Page 7, col. 3, line 19
+ Page 7, col. 4, line 10
+ Page 7, col. 4, line 19

+ Page 7, col. 5, line 10
+ Page 7, col. 5, line 19
= E

If A is

D

÷ E

= F

If D and E are both zero or negative, let F equal zero. positive and E is zero or negative, let F equal 1.0.

[blocks in formation]

If D is

TEST 9: CHANGE IN RESERVING RATIO

1974 and subsequent years

Current Year Statement

Page 5, col. 2, line 17 + Page 5, col. 3, line 17 = A

Page 7, col. 2, line 10 + Page 7, col. 2, line 19 + Page 7, col. 3, line 10 + Page 7, col. 3, line 19 = B

A ÷ B

= C

If A and B are both zero or negative, let C equal zero. If A is positive but B is zero or negative, let C equal 1.0.

[blocks in formation]

If D and E are both zero or negative, let F equal zero.
positive but E is zero or negative, let F equal 1.0.

C

- F

= G

G

× 100

= Result (round to nearest integer)

A 23

If D is

ADJUSTED EARNINGS AND

BALANCE SHEET TESTS

Appendix B

1

Some of the tests that we evaluated for possible inclusion in the Early Warning System employed the concept of adjusted earnings and adjusted balance sheet figures. Although these tests would marginally improve the effectiveness of the Early Warning System, they would also add significantly to the complexity of understanding and using the tests. Therefore, we do not recommend that these tests be adopted. In order, however, to permit the task force to review our decision on this point, this appendix describes

our:

1. Calculation of adjusted tests

2. Evaluation of adjusted tests.

CALCULATION OF

ADJUSTED TESTS

One essential element in the financial solidity of an insurance company is the profitability of the business. A company with unprofitable business

is bound, over a period of time, to experience financial difficulty. On the other hand, a company with a cash flow problem - but with profitable business can frequently avoid financial difficulty by raising additional capital, either in the market or through merger with a more strongly capitalized company. Thus, the underlying profitability of the business is frequently the essential question in determining whether a company can survive or must be liquidated.

During the past decade, there has been a growing consensus that statutory net gain is an inadequate measure of the true profitability of a life company, and that statutory reserves and surplus are highly conservative measures of the liabilities and net worth of the company. Concern has focused on three primary factors influencing the calculation of statutory net gain and balance sheet figures:

1. Charging off acquisition expenses as incurred rather than matching them with the premium income to which they give rise

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