An important topic for an Actuary as there could be risks associated with a company that are not disclosed on a balance sheet directly.
For the most part these are stipulated by accounting guidelines like GAAP: due to being immeasurable, or unlikely to occur (< 50% chance). As a result it would be wise to be somewhat familiar with them.
Off-balance sheet (OBS), or Incognito Leverage, usually means an asset or debt or financing activity not on the company’s balance sheet. Total return swaps [investopedia] are an example of an off-balance sheet item.~ Wikipedia 2019
- Non-traditional lease: Operating lease [investopedia] obligations (Lessor)
- Derivative instruments (market, credit, management, legal) – non-ownership of asset, but obligation for future payments
- Contingent liabilities or losses (tax, litigation)
- Letters of Credit and pledged assets (default)
- Capital maintenance agreements: written agreements to support a subsidiary in the event of difficulty.
- Structured settlement
- Employee benefit agreements (pensions [investopedia])
Fall 2017 Q22 C – examples
- The credit risk associated with the insolvency of the annuity company used to satisfy a structured settlement Contingent liabilities or losses due to tax, litigation, etc.
- The risk that a lending institution defaults on a letter of credit, or a call on pledged assets
- The parent company not honoring the capital maintenance agreement
- The risk of derivative instruments.
- Pension under-funding
Common mistakes include: Commenting on balance-sheet risks or questioning the quality of the balance sheet numbers.