Let's take a look at a set of US GAAP life insurance financial statements, and we'll start with the balance sheet.
Now, as is usual for an insurance company, the largest item in assets is the investments balance, and that's the case here.
Similar to P&C insurance, typically most of the investments are in fixed income instruments. However, the investment portfolio includes much less liquid investments than a P&C business, such as investments in asset-backed securities. Since the duration of contracts is much longer, therefore allowing a greater risk appetite and less need for liquidity in the short-term. The next item are premiums receivable.
This reflects the premiums written where the amounts have yet to been paid by the policyholder.
The next item is deferred acquisition costs.
These are amounts which have been paid during the acquisition of new policies, which haven't yet been amortized to the income statement.
Typically, these balances are much more material than for P&C business, since the costs are being deferred and amortized over a much longer coverage period.
A new balance that we haven't seen previously is separate account assets.
These are investment accounts where the contract holder assumes all the investment risk and directs the investment objectives.
So these are effectively segregated funds, which hold investments on behalf of the policyholder, and the insurance company charges a fee for administering the funds. Note that there is also a matching liability below to show the account liabilities, which are then owed to the policyholder.
So that's the assets in the balance sheet.
Now let's look at liabilities and equity.
Our first liability item is future policy benefits.
These are the insurance reserves for term and whole life insurance policies, fixed annuities, and participating life insurance policies. They reflect the future benefits payable, net of any deferred net premium, and in the case of annuities, it includes the deferred premium liability.
Our second liability item is policyholder account balances.
These are for policies like universal life contracts, where the policyholder has flexibility over the premiums paid, where the investment risk is borne mostly by the policyholder, and therefore where the benefit is usually associated with the account value.
Therefore, the insurance risk is very low for the insurance company, and the account balances are presented separately from other insurance reserves. The final item here is equity.
This is an important item for insurance companies, as it's covered by regulatory capital requirements. That means that there is a minimum level of equity required relative to the amounts of insurance reserves.
Now let's take a look at the income statement.
Firstly, we see premiums for insurance contracts.
That's the premiums received for traditional life contracts and whole life contracts, and the amount of deferred premium recognized for annuity contracts. The next item are the fees that are received for universal life policies, which are similar to investment products, and also the fees charged on actual investment products, such as managed funds and segregated funds.
The fees here are typically a percentage of assets under management.
The next item is the investment income being generated on the investments balance. Although this will include any investment returns on segregated accounts.
So premiums, fees, and investment income are the three core revenue streams for a life insurance business.
We then start the expense items with policyholder benefits and claims, which is effectively the increase in reserves on existing policies in the balance sheet each year, and that includes interest accretion on those reserves.
This covers claims and benefits on all term life insurance, whole life insurance, and annuity business.
The next line item is interest credited to policyholder accounts for universal life contracts and other policies where the benefit is based on the policyholder account balance.
We then have other operating costs.
Although this includes the overheads of the business, such as staff costs, IT costs, and head office costs, it also includes amortization of deferred acquisition costs, which is typically a material portion of operating expenses.
The final item of note here is the tax expense.
Although all companies pay taxes on their profits, it's worth noting that insurance companies sometimes have lower tax rates than other corporates, and that's due to some of their investment income and dividends being tax-deductible or taxed at a preferential rate.
