Give me a brief explanation of financial reporting, tax, regulatory, and ethical considerations affect the loss reserve estimate when looking at the calculation below? Reasoning.

Discuss how tax and non-tax considerations affect the decision to capture additional tax savings through a higher loss reserve estimate in the insurance case. There were two tax changes that provided an incentive to record a higher loss reserve: (1) the tax rate decrease from 46% to 34%, and (2) the fresh start benefit.  Combined, both tax incentives provide a present value tax savings (based on a one-year reversal) of $0.21 for each additional dollar of loss reserve recorded in 2007 that is not considered reserve strengthening, computed as follows:  

Marginal tax benefit (MTB) = MTB from tax rate change + MTB from fresh start adjustment
= {$1.00*46% - (($1.00*34%)/1.101)} + (($1.00(0.20)34%)/1.101)
= ($0.46 - $0.3091) + $0.0618
= $0.1509 + $0.0618
= $0.2127 [if n=5 years then .2489 for tax change, .3107]

Based on the above assumptions, an 'extra' dollar of 2007 total loss reserve implies a net present value tax savings of more than $0.21. This marginal tax benefit amount establishes a value to contrast against the (harder to quantify) nontax considerations. The above computation is in the 'class notes' file in the Insurance case subfolder in the module A main folder. 

 

Your memo should discuss how financial reporting, tax, regulatory, and ethical considerations affect the loss reserve estimate and how a firm might balance these various items. You can refer to your original case loss reserve estimate and any revision you would make to your original total loss reserve amount, but this is not required.  The response should specifically refer to how ethical considerations should be incorporated  into the determination of the 'optimal' 2007 total loss reserve amount.  You can also address how ethical considerations and ESG reporting affects tax decisions.  You may refer to any items on the TBS Canvas site, including the ethics packet, or outside materials.