Q16

sdeibert

Hi,

I'm having trouble conceptually understanding the bigger picture of this problem.

In part b you calculate the FCF which is negative AKA this contract is profitable and a CSM is established for that same amount to recognize the profit as the contract is earned over the coverage period.
Next, you calculate the LRC under GMA which is 0 at recognition since FCF and CSM offset each other.
Since it is not at initial recognition, acquisition costs are not included in the FCF calculation, and you deduct the first premium which has already been received from premium receivable.
GMA LRC = FCF + CSM but this results in a negative LRC which is where I get confused.

Could you please help me understand how it gets from having a -FCF (profitable) to -LRC, I've never seen a -LRC under GMA before.

Thanks

Staff-T1

The negative LRC just follows from the calculation where we exclude whatever cash flows have been received. It's conceptually possible and while more common under PAA, it just means you have a negative liability since a large portion of your total premium is up front costs which you have already incurred and are expected to get them back later as you receive the premiums. This doesn't happen for losses as you usually get them later but acquisition costs all drop out of the formula immediately which leads to a negative LRC when it is large enough.

kybazzi

Afterwards, PAA LRC is calculated as (prem received) - (acq cost)/18 = 7 .1 - 10.2/18

I'm confused as the full acquisition costs have been paid upfront. At this time, nothing has been amortized, so why isn't it (prem received) - acq cost = 7.1 - 10.2?

I'm mostly confused because premium received is at the beginning of the month, and acquisition cost is paid upfront, so if one is able to be amortized in the LRC the other should be as well.

Staff-T1

No, I think you are right and I agree with you. It should be 10.2 rather than 10.2/18. I'll need to get that edited