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  • A Proposal to Standardize the Use of Net Operating Profit Among Life Insurance Companies

A Proposal to Standardize the Use of Net Operating Profit Among Life Insurance Companies

Akira Komatsubara 
Kunio Ogihara 

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For commercial companies, the accepted measures of profit are operating profit or recurring(ordinary) profit. But due to the peculiarities of financial services, banks and insurance com-paniesdo not have something corresponding to operating profit, while recurring profit fails asan appropriate measure of profit for the business.

For example, since both banks and insurance companies hold substantial assets in securities,recurring profit (in the short term) can be overstated by including realized gains from the saleof securities because valuations are based either on cost or the lower of cost or market.

Furthermore, valuation methods used by insurance companies can greatly affect incomebecause many expenses such as increases in liability reserves are based on valuation. Thus anaccurate grasp of valuation methods is critical.

To take another example, in recent years, mutual companies have expanded their equity capi-talby relying in part on Fund financing. While the economic effect of such financing is identi-calto ordinary borrowing, the legal requirement to treat interest from Funds separately as asurplus distribution tends to obscure actual conditions.

Such accounting methods of life insurers only invite confusion among concerned parties.Thus in addition to recurring profit and unappropriated retained earnings, income statementsneed to devise a profit indicator that accurately expresses net profit.

Banks already have a profit indicator called "net operating profit," which is separate fromprofit reported on income statements and has been disclosed since the fiscal 1989 interim peri-od.In addition, the property & casualty insurance industry has been reporting an "insuranceunderwriting profit" since fiscal 1996 (see below).

Life insurers do not presently report information that corresponds to net operating profit anddirectly expresses net income for the core business. There have been isolated attempts to use net operating profit; one company has voluntarily reported net operating profit since fiscal1997, while publications such as Nikkei Kinyu Shimbun (June 10, 1999) have tried to calculatethe net operating profit of life insurers. However, these attempts are not necessarily based on astandardized format.

This paper briefly examines how banks and p/c insurers report net operating profit and insur-anceunderwriting profit respectively, and then proposes a definition of net operating profitsuitable for life insurers.

Akira Komatsubara

Kunio Ogihara

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