Risk-Based Capital - how the regulators look at P&I Clubs
According to MarineLog,
Standard & Poor's Ratings Services said yesterday (July 21, 2004) that it lowered its counterparty credit and financial strength ratings on American Steamship Owners Mutual P&I Assn. Inc. (American Club) to 'BB+' from 'BBB-' and then removed the ratings from CreditWatch.
The article makes a number of points about supplementary calls and other aspects of Club financials that should be familiar to most readers. Toward the end of the article, however, some less familiar terms appear.
Standard & Poor's says the rating on American Club was placed on CreditWatch with negative implications on May 4, 2004, due to the delay of 2003 financial statements caused by implementation difficulties from the Club's new IT system. The Club has made substantial progress toward correcting the situation. American Club has now filed year-end 2003 statutory financials and has provided Standard & Poor's with draft GAAP financials.
Although statutory financials show the Club's risk-based capitalization to be slightly below authorized control levels, Standard & Poor's believes year-end 2003 GAAP capitalization will be substantially higher than statutory surplus because GAAP accounting allows the full amount of assessments announced in June 2004 to be booked in 2003--unlike statutory accounting. The Club is expected to substantially improve its statutory capitalization by year-end 2004, as revenue from the June 2004 supplemental call becomes recognized in statutory revenue and as improved operating performance helps to build retained earnings.
What do these terms mean?
statutory financials
Statutory financials are the financial statements that all U.S.
insurance companies, including the American Club, must submit to the
insurance department of their domiciliary state at the end of every
calendar quarter. At the end of every calendar year, each company must
submit a comprehensive set of financial statements known variously as
the "Annual Statement", "the yellow book", "the blank" or "the
Convention statement". These statements are due on March 1, and
they are one of the special curses of doing P&I business in the
United States.
The Annual Statement must be prepared in accordance with statutory
accounting principles which are designed to show the value of the
company, not as a going concern, but as if it had stopped doing
business on the statement date. Regulators refer to "the liquidation
basis" as opposed to "the going-concern basis". Accordingly, some of
the rules concerning recognition of revenue are a little different from
the rules governing other financial institutions.
GAAP financials
GAAP financials are financial statements prepared in accordance with
generally accepted accounting principles. Because the American
Club has to comply with U.S. GAAP, its statements may look slightly
different from those prepared by the European Clubs, but the rules are
largely the same. These are the financial statements that are
distributed to members and brokers every year, and are the statements
which the brokers use in preparing their reviews of the Club.
risk-based capital ("RBC")
A system of measuring the amount of surplus (or "free reserves" or
"Members' Equity") an insurance company ought to have, given its size,
its investment portfolio, and the types of business it writes. [More to
come.]
authorized control level
The level of statutory surplus at which the regulators may step in
and take action to restore the company's surplus to a satisfactory
level. [More to come.]
statutory vs. GAAP accounting
The principal difference between statutory and GAAP accounting
concerns the recognition of revenue from unbilled supplementary
calls. Such calls are not generally recognized under statutory
accounting, because they are inchoate; the Club may have the power to
levy them, and deficits in open years may show that they are necessary,
but as long as they have not been billed, they will not be recognized
as revenue as of the statement date.
GAAP is more liberal; as long as the Club plans to levy supplementary
calls within a year of the statement date, and has a track record of
collecting its calls, revenue from unbilled calls can be recognized.
[More to come.]
