This blog is intended to provide a brief overview on insurance accounting, with a focus on the account balances that you are most likely to encounter working offshore as an external Audit Senior or a Financial Accountant.

First off, you need to understand that, when they sell policies, insurance companies will spread their risk by buying insurance of their own from reinsurers, meaning that they will bear a lesser burden of paying out on claims but will also pass on (‘cede’) some of the premium income and related commission to the reinsurance company as part of the package of spreading the risk (and reward) on the insurance provided.

For accounting purposes, you treat ceded transactions as being the negative of the regular accounting entries. We’ll look at the income statement and balance sheet in turn.

Income statement

The main income is going to come from premiums sold on insurance policies, which is known as the Gross Written Premium:

  • As with any contract income, some of it will fall into another accounting period so there will be an element of deferral necessary – hence there is an Unearned Premium Reserve (UEPR) showing up in the balance sheet under liabilities and there will be a Change in UEPR representing the year’s movement in the income statement
  • Since reinsurance with another insurance company has been bought to spread risk, ceded premium will be deducted, to show Net Earned Premium

Moving to claims, actuaries will form a view as to what the expected total final claims liability will be on the policies sold by the insurance company, and these are known as Incurred Losses. This balance is made up of Paid Losses + Loss Reserves for claims that have not been specifically identified or paid out yet:

  • Again, since the risk has been spread, there will be a deduction to reflect the ceded claims to be borne by the other insurer, to arrive at final Net Losses

As with any insurance policy, another expense area will be Commissions:

  • This will be reduced to the extent of commissions that have been ceded

Taking all the activity into account, we arrive at net Underwriting Profit.

Much of the cash received for the premiums will have been invested in the cash, bonds and the stock market, meaning that Investment Income is being earned every year. Adding this in, we arrive at final Profit (or Loss).

EXAMPLE INCOME STATEMENT:

Gross Written Premium   100
Change in UEPR               –   (10)
Ceded to Reinsurers        –  (20)
—————————————-——
Net Earned Premium         –70

Gross Incurred Losses       (55)
Ceded to Reinsurers             13
—————————————-——
Net Incurred Losses           (42)
—————————————-——
——————————————28

Direct Commissions           (30)
Ceded Commissions               6
—————————————-——
Net Commissions                (24)
—————————————-——
U/w PROFIT                          —   4

Investment Income                –6
—————————————-——
PROFIT (OR LOSS)              –10
—————————————-——

Balance sheet

Assets

On the balance sheet, the main insurance-related assets will be Cash & Investments, which comes from the premium received, prior to losses on claims being paid out.

Liabilities

As discussed above, there will be some deferred income in the Unearned Premium Reserve due to timing differences between policy dates and the accounting year end.

There will also be the Loss Reserves, representing actuaries’ estimates of the total claims provision likely to be incurred on the policies sold, less the value of the claims already paid out.

In addition, there will be various Reinsurance Recoverables covering, for example, the reimbursement of paid losses that can be claimed back from the insurance cover that was ceded to the reinsurers.

Loss Reserves: OSLR & IBNR

The claims provision made for Loss Reserves is composed of two elements: Outstanding Loss Reserves (OSLR) and Incurred But Not Reported Reserves (IBNR).

The former provision represents claims that have been reported but not yet settled/paid; the latter represents a provision for claims as yet unreported, and is arrived at mathematically by taking the actuaries’ calculation of expected total final losses and subtracting the paid claims and also the reported claims (OSLR).

To put it another way: Total Losses = Paid Claims + Reported Claims (OSLR) + Unreported Claims (IBNR).

Learn more: Introduction to Special Purpose Vehicles 

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