An insurer reports $500 million in assets but only $460 million counts. The other $40 million is furniture, past-due agent balances, and other items that cannot readily be turned into cash to pay policyholders. That single filter, admitted versus nonadmitted, drives everything statutory accounting tells you about solvency.
Statutory accounting (SAP) exists to protect solvency, not to smooth earnings. It is conservative on purpose, but conservative does not mean liquidation-minded. The Preamble makes the balance sheet the principal focus, keeps the income statement as a secondary focus, and explicitly stops short of a liquidation basis of accounting. You read four statements together.
The balance sheet is a point-in-time snapshot. The statement of income covers the year. The capital and surplus account reconciles beginning surplus to ending surplus. The cash flow statement tracks actual cash. The notes disclose reserves, reinsurance, and accounting choices.
Statutory surplus rests on a simple identity.
KEY: A nonadmitted asset has economic value but is charged against surplus because it is not readily marketable to meet policyholder obligations, now or in the future.
Common mistakes
- Counting nonadmitted assets in surplus. Only admitted assets enter the surplus identity. Including the $11,000 of nonadmitted assets would overstate Redwood's surplus by that amount.
- Running unrealized gains through net income. Unrealized capital gains hit surplus directly via the surplus account. Only realized gains reach the income statement. Adding the $6,000 unrealized gain into net income is wrong.
- Dropping dividends to policyholders. The Statement of Income deducts policyholder dividends (Line 17) before federal income tax. Skipping Redwood's $2,000 overstates net income by that amount.
Bottom line
- Statutory surplus (policyholders' surplus) equals admitted assets minus liabilities; nonadmitted assets are excluded because they are not readily marketable to meet policyholder obligations. SAP is conservative, not a liquidation basis.
- The four core statements are the balance sheet (assets, liabilities, surplus), the statement of income, the capital and surplus account (roll-forward), and the cash flow statement; the notes explain them.
- Underwriting income equals earned premium minus incurred loss, minus loss adjustment expense, minus underwriting (other) expenses.
- Net income equals underwriting income plus net investment income plus other income, minus dividends to policyholders, minus federal income tax; realized capital gains are in net income, unrealized gains are not.
Exam shortcut
Build income top-down in one line: earned premium minus loss minus LAE minus expense gives underwriting income; then add net investment income, add realized gains (already net of capital gains tax), subtract policyholder dividends, subtract federal income tax for net income. Never let unrealized gains into that chain.
The full lesson (about 2,284 words, 15 min read) adds 2 worked examples, all 7 common mistakes, a self-check, free in the app.
Learning objectives
- C1
Browse all free Exam 6U lessons or jump into free Exam 6U practice questions.