Accounting for Bonds
Hello, I am confused by a few items in the Accounting for Bonds section in the boot camp:
1) Why is it helpful to split those tables into Asset & Liability? What if a company is only holding an AFS bond as an asset, and not as a liability?
2) I'm not clear on how market changes affect the components. For example, if market goes up for AFS then why OCI go down? This is just one example, but I am unclear about some of the other ones as well.
These are probably elementary questions...but appreciate the clarification!
Comments
Hi,
I think there may be confusion when reading the tables in https://www.battleactsmain.ca/wiki6c/CIA.Accting. Hopefully, I can clear it up with an example.
To support policy liabilities, we have an asset portfolio. Assume our asset portfolio consists solely of AFS bonds. NOTE: As per the “Summary of Requirements...” table at the beginning of Section 4.2.1 of the paper (http://www.actuaries.ca/members/publications/2007/207002e.pdf), AFS bonds are measured at fair value, and gains/losses are recognized in OCI.
Now, suppose market rates increase. The tables provided in https://www.battleactsmain.ca/wiki6c/CIA.Accting answer 2 questions:
1. What is the impact of a market rate increase on each of Assets (the asset portfolio) and Liabilities (the policy liabilities)?
-- These are the columns titled “Assets” and “Liabilities”
-- Assets side: Your bond prices will decrease. As such, your assets will decrease.
-- Liability side: Discounting rate will increase. As such, your policy liabilities will decrease.
2. How does the impact noted in 1. flow through to NI, OCI and Equity?
-- These are the last three columns.
-- Assets side: Here, I’m only concerned with the impact of the AFS bonds on each of NI, OCI and Equity.
---- NI: No impact on NI since gains/losses for AFS are recognized in OCI
---- OCI: OCI decreases since we realize a loss (decrease in asset value) (This is the answer to your second question)
---- Equity: Since Equity = Assets - Liabilities, a decrease in assets would have a negative impact on equity.
-- Liability side: Here, I’m only concerned with the impact of the policy liabilities on each of NI, OCI and Equity.
---- NI: NI is impacted by a change in policy liabilities. A decrease in policy liabilities results in a decrease in NI.
---- OCI: OCI is not impacted by policy liabilities
---- Equity: Since Equity = Assets - Liabilities, a decrease in liabilities would have a positive impact on equity.
To summarize and to directly answer your first question, in the context of this paper, the bonds are being treated as assets (an asset portfolio), not liabilities. The tables are split by Asset and Liability to provide you with a better understanding of how market rates impact each of your asset portfolio and your (policy) liabilities, and furthermore, how these asset/liability impacts flow into NI, OCI and Equity.
Let me know if you have any further questions
thank you Javid!!! clears things up...
Quick follow-up Javid: In your comment under "Liability Side" at ----NI. A decrease in policy liabilities results in a decrease in NI? Or is it decrease in PL results in INCREASE in NI? Just clarifying...thank you.
Yes, you are right. I meant to say increase in NI.
thank you