Financial Reports
The following reports are simplified sample reports illustrating some of the features and characteristics of AFTF. The example chosen is a life insurance company, but similar features would be present for any company. The reports are incomplete and may have other flaws, but they do exemplify relevant and reliable measures. See Chapter 7 for additional discussion of these reports. The following reports are shown,
Statement of Values and Value Added: Assets
The assets are the present values of expected cash flows into the company. The value added is the time-adjusted change from the prior year assets. Note that the values and the value added involve the same classifications. In traditional accounting assets and income may be unrelated. For example, a life insurance company’s major traditional accounting assets may be stocks and bonds, but the major revenue item may be premiums.
Statement of Values and Value Added: Equities
The liabilities are the present values of expected cash flows from the company. The value added is the time-adjusted change from the prior year liabilities. Again, values and the value added involve the same classifications. Shareholder equity is the company valuation, which equals AFTF assets less AFTF liabilities. The company valuation approximates the market capitalization, or vice versa.
Cash Flow Record
The Cash Flow Record shows the principal actual cash flow components and the expected cash flow components, for the just-completed period. Also shown are differences and ratios. The differences are important in that they represent the value added by the experience for the period. Once this is established we can obtain the value added by management by subtracting this difference from total value added. The actual-to-expected ratios have important uses.
Value Added Analysis
This exhibit shows the value added by the past year’s experience, by management assumptions and decisions, and in total.
Effect of Assumption Changes
This exhibit shows the contribution of each assumption change on the cash flow components. These assumption changes include new decisions and business plans as well as changes to prior assumptions. The effect on total value added is shown so that, if substantial value is being added
by an optimistic assumption, it is made visible.
Miscellaneous Comparative Figures
This exhibit shows the company’s historic cost of capital (discount rate), the company-estimated yield (that discount rate producing a current company valuation equal to the current market capitalization), and company valuations at standard 5%, 10%, and 15% discount rates, facilitating inter-company comparisons. Also shown is the historic actual-to-expected ratio; this is a five-year sum of actual net cash flows divided by a five-year sum of original expected net cash flows. This may be used to judge the credibility of the company-estimated yield.
Sensitivity of Company Valuation
This exhibit shows the effect of normal and abnormal variations on the company value
.
Sample Opinions
Report of New World Associates, Independent Auditors
We have audited the accompanying Statement of Values and Record of Cash Flows of the Future Life Insurance Company for the five-year period ending December 31, 2000. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on normal and customary auditing principles and practices. The accounting principles and practices used are intended to provide financial information relevant to the shareholder.
The Statement of Values and Value Added is based on a model that fairly represents the cash flows for the five-year period ending December 12, 2000. The historic cost of capital accurately reflects the relationship between projected cash flows and the Company's stock price for the five-year period ending December 31, 2000. Based on the cash flows projected by the Company's Valuation Actuary (modeler), the Statement of Values and Value Added fairly represent the financial position and financial results of operations of the Future Life Insurance Company as of December 31, 2000. In addition, the record of cash flows fairly presents the actual and expected cash flows for the year ending December 31, 2000.
N.W.A., Independent Auditors
Notes: The independent auditor’s opinion is restricted to those items, which can be exactly verified, and to the general application of accepted principles and practices. The auditor should be able to perform exact and detailed checks on the cash flow and market price five-year validations. Actual cash flows should tie exactly to the company books of account and expected cash flows come from prior year projections. The auditor does not specifically certify as the fairness or reasonableness of expected cash flows. This certification is left to the modeler. The auditor does make a general statement of the overall fairness of the financial reports based on modeled cash flows.
Sample Opinions
Management Certification
I have determined, or reviewed and approved, all significant assumptions used in projecting cash flows. These have been furnished to the Valuation Actuary (modeler) together with the business plans of The Future Life Insurance Company. These business plans are based on management decisions and commitments and include an assessment of the costs and benefits in sufficient detail to permit cash flow projections. These plans have been reviewed by the company's Valuation Actuary and have been incorporated into the projection of future cash flows. The assumptions and business plans furnished fairly represent the judgments, expectations, and commitments of management. It is management’s opinion that the Statement of Values and Value Added fairly represent shareholder values and changes therein.
Louis Cannon, President
Notes: Management would not cite compliance with GAAP, unless GAAP is changed. Management does not opine on the expected cash flows. Management does take responsibilities for what it has de facto control over, namely the assumptions and its business plans. It becomes management’s duty to perform cost/benefit analyses for two reasons: proper management decisions and to facilitate modeling. Management does opine on the final results of expected cash flows. This is a weaker statement than opining on the expected cash flow because of the normalization. In this way, management assumes final responsibility, but does not have to certify or even understand the complex contingencies and interactions of the asset and liability models.
Sample Opinions
Actuarial (Modeler’s) Certification
I, Tom O. Row, Valuation Actuary, have modeled the cash flows of The Future Life Insurance Company. The cash flow model reproduces actual cash flows for the five-year validation period. The discount rate used is that rate for which the average company valuation equals the average market valuation for the five-year validation period. The model also incorporates the assumptions, decisions and business plans as furnished to and approved by management. Based on these assumptions and business plans, the modeled cash flows are reasonable and consistent estimates of future cash flows.
Tom O. Row, FSA, MAAA, Valuation Actuary
Notes: The modeler’s job is to translate historic patterns and management’s expectations and plans into expected cash flows. The modeler certifies as to the reasonableness of the cash flows, but not of the assumptions, or business plans. That is left to management. The modeler may also translate expected cash flows into present values for valuation purposes, but this may be left to the staff accountants who prepare the financial reports. The modeler is responsible for all technical aspects of the cash flow model.
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