Financial Accounting in

Insurance Companies
Basic Concepts

Reference:
1.  LOMA 361(Accounting and Financial Reporting in Life Insurance Companies) Course Material
Prepared by Avik Saha (mail@aviksaha.com)
2.  Essentials of Financial Accounting by Asish K, Bhattacharyya
 Basic Terms
Accounting: A system or set of rules and methods for collecting, categorizing,
measuring, recording, summarizing, reporting, analyzing and monitoring financial
information about the financial condition and performance of a company as a whole,
Financial Accounting in Insurance Companies

as well as of segments, product lines or divisions within the company.

Financial Reporting: The process of presenting financial data about a company’s
financial position, the company’s operating performance, and the flow of funds for an
accounting period.
Business Transaction: A transaction to which a company must assign an objective
monetary value, whether the impact on the company is large or small, actual or
expected.
Solvency: Company’s ability to meet its financial obligation on time and with
available cash.
Profitability: Degree to which a company is successful in consistently generating
money for its owners.

Prepared by Avik Saha

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 Financial Statements
Balance sheet (Account form) Balance sheet (Report form)

Assets Liabilities Assets

Owners’ Equity Liabilities
Owners’ Equity
Financial Accounting in Insurance Companies

Income Statement
Revenues
(-) Expenses
Earning Before Interest and Tax (EBIT)
(-) Interest Expense

Earning Before Tax (EBT)

(-) Income Tax

Net Income

Cash Flow Statement

Cash Flow from operating activities

(+) Cash Flow from Investing activities
(+) Cash Flow from Financing activities
Net Increase (Decrease) in Cash
(+) Beginning Period Cash Balance

Ending Cash Balance

Prepared by Avik Saha

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 User of Accounting information
Financial Accounting in Insurance Companies

External Users Internal Users

•  Individual Policy Owners •  Employees

•  Group Policy Owners •  Directors
•  Beneficiaries •  Officers
Direct Interest •  Insureds
•  Stockholders
•  Producers
•  Creditors

•  Competing Companies
•  External Auditors
•  Insurance Commissioners
Indirect Interest •  Independent Rating Agencies
•  Tax Authorities

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 Accounting Equation
Asset (A)
Financial Accounting in Insurance Companies
Items of value owned by
the company
•  Cash
•  Investments (stocks, bonds)
•  Premium due and receivable
•  Accrued Income
•  Equipment
•  Real Estate etc
Prepared by Avik Saha
Liability (L) Owner’s equity (E)
Monetary value of a Owner investment in the
company’s current and company
future obligations
•  Contractual reserves •  Common Stocks outstanding
•  Commissions payable •  Preferred Stock outstanding
•  Accrued Expense •  Additional Paid-in capital
•  Retained Earnings
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 Chart of Accounts
An account is a tool that a company uses to record, group, and summarize similar
type of business transactions which typically involve Assets, Liabilities, Owner’s
Financial Accounting in Insurance Companies

Equity, Revenues and Expenses. Chart of Accounts is a numbered or an alphabetical

list of all the company’s account names.
Example:
1000 Assets Permanent Account is a balance sheet
1001 Bonds
account that has a balance at the
1002 Common Stocks
1003 Mortgages beginning of each accounting period.
2000 Liabilities E.g. Asset, Liability and Owner’s Equity
2001 Contractual Reserves Accounts
2002 Other Liabilities
3000 Owner’s Equity
3001 Capital Temporary Account or a nominal account is
3002 Surplus an account that is closed out to a
4000 Revenues
permanent account on the balance sheet
4001 Premium Income
4002 Investment Income at the end of each accounting period.
5000 Expenses E.g. Revenue and Expense accounts. At
5001 Contractual benefits the beginning of each account period
5002 Operating Expenses temporary accounts have zero balance

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 Double Entry Accounting
1.  Every business transaction has at least one debit and one credit
2.  The total monetary amount of debits must equal that of the credits for that transaction
3.  Each accounting entry maintain the balance of the basic accounting equation (A=L+E)
Financial Accounting in Insurance Companies

Debit (Dr.)/Credit (Cr.): Specified change made to the monetary value of an account

Debit increases values of Asset and Expense accounts; decreases values of Liability, Owner’s Equity and Revenue Accounts

Credit decreases values of Asset and Expense accounts; increases values of Liability, Owner’s Equity and Revenue Accounts

Dr. Cr.
Asset = Liabilities + Owner’s Equity
+ +
- -
Cr. Expense Revenue Dr.

Prepared by Avik Saha

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 Accounting Cycle
Journalisation (making journal
entry) of transactions and
business events
Financial Accounting in Insurance Companies

General Ledger posting and

balancing

Preparation of Trial Balance

Preparation of final accounts

(Balance Sheet, Income
Statements, Cash Flow
Statements)

Prepared by Avik Saha

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 Accounting Entries
Accounting entry or journal entry is a record of a business transaction that includes
at least one debit and one credit and shows the monetary transactions in balance on
a specified date
Financial Accounting in Insurance Companies

Simple Accounting Entry

Insurer A receives $2000 annual premium on a life insurance policy:

Cash…………..2000 Dr.
Premium Income………..2000 Cr.

Compound Accounting Entry

Insurer A paid a claim of $10000 plus interest of $100 to a beneficiary:

Death Claim Paid………10000 Dr.

Interest Expense………..100 Dr.
Cash…………………………10100 Cr.

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 Types of Accounting Entries
Closing Entry is an accounting entry that a company makes at the end of each accounting period to start
the next accounting period with zero balance in the temporary accounts. E.g.
Suppose in an accounting period Insurer A has $3000 of Revenue and $2000 of Expense. As
Revenue and Expense accounts are temporary, their balances will be $0 at the beginning of the next
Financial Accounting in Insurance Companies

accounting period. So a closing entry is made to transfer the net income of $1000 to the Retained
Earnings or Surplus account (permanent Owner’s Equity account).

Adjusting Entry is an accounting entry that a company makes to record accruals for revenues and
expenses, unearned revenues and prepaid expenses. Other adjusting entries include depreciation, changes
made to reserve accounts and corrections to previous accounting periods.
Accruals refers to expense incurred but not yet paid or revenue earned but not yet received.
Unearned revenues refers to the income e.g. unearned premium which has been collected in one
accounting period but coverage to be provided in the next period but before policy anniversary date.
Prepaid expense are those expenditures, remitted in advance, that the insurer expects will provide a
future value of benefits
The adjusting entry for salary earned by the producer but not yet paid:

Accrued Salaries Expense……….XXX Dr.

Salaries Payable………………………….XXX Cr.
When salary is paid to the producer:
Salaries Payable…………………..XXX Dr.
Cash………………………………………XXX Cr.

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 Normal Balances
Account balance is the monetary amount (Debit minus Credit) in an account on a
particular date.

If Debit > Credit, the account has normal debit balance

Financial Accounting in Insurance Companies

If Credit > Debit, the account has normal credit balance

Normal balance is the side of the account, whether debit or credit, to which
increases to the account is recorded.

Normal Debit Balance Normal Credit Balance

Asset Liability
Expenses Owner’s Equity
Revenue

If an account shows opposite of its normal balance, that account is subject to manager review.
For example, if Cash account which has a normal debit balance, shows credit balance i.e. the
cash balance is below zero, it needs investigation.

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 Accounting Principles and Concepts
Two Financial Statement Concepts:
Entity Concept states that a company must account separately for the business
activities of each entity, business unit or economic unit. An entity is the basic
business unit for which a company keeps separate business records and prepare
Financial Accounting in Insurance Companies

reports, e.g. a person, a partnership, a corporation , an organization, a business or a

portion of a business.
The Going Concern concept states that a company should maintain its accounting
records with the assumption that the company would continue to operate
indefinitely i.e. it is not facing liquidation. Liquidation is the process of selling all
company assets for cash and using that cash to pay the company’s debts; any
remaining funds are distributed to the company’s owners.

Insurers should disclose all material or significant information in the financial statements. The
accounting information should be :
Relevant i.e. useful and timely to affect an user’s decision about the company
Reliable i.e. accurate, objective and free from bias and misrepresentation
Comparable i.e. statements for different accounting periods and different companies can be compared
Consistent i.e. company follows same accounting principles in different periods (unless there is a sound
reason to change)
Conservative i.e. prudent reaction; understating asset and revenue, overstating liabilities and expenses

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 Realization and Matching principle

Realization principle states that a company should recognize revenue when it is

Financial Accounting in Insurance Companies

earned, regardless of when the company receives the actual payment (insurance
premium or annuity consideration for example), so long as a legal and reasonable
expectation exists that the customer will remit payment in full.

Recognition refers to the process of classifying an item in a financial statement as an asset,

liability, owner’s equity, revenue or expense.

Matching Principle states that a company should recognize expenses as the

company earns the revenue related to those expenses, regardless of when the
company receives payment for the revenues earned and regardless of when the
company actually paid the expenses.

Realization Principle and Matching Principle work in tandem.

Prepared by Avik Saha

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 Account Bases – Accrual and
Cash basis
Accrual basis Accounting is an accounting system under which a company records
revenues when they are earned and expenses when they are incurred, even if the
Financial Accounting in Insurance Companies

company has not yet received the revenues or paid the expenses.

Cash basis Accounting is an accounting system under which a company records

revenues and expenses only when it receives cash or disburses cash.

Only accrual basis accounting follows realization and matching principles.

Example: On 31st Dec, 2010, Insurance company ABC bought $5000 of furniture on account from XYZ. XYZ delivered it
same day. ABC remits the payment in full on Jan 10, 2011.

Cash Basis Accrual Basis

Furniture…….$5000 Dr.
December 31, 2010 No Accounting entry Accounts Payable…......$5000 Cr.

January 10, 2010 Furniture…….$5000 Dr.

Cash…......$5000 Cr. Accounts Payable …….$5000 Dr.
Cash…......$5000 Cr.
Note: All subsequent examples follow accrual basis accounting.

Prepared by Avik Saha

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 Asset Accounting
Some definitions

Valuation is the process of calculating monetary value of an asset

Financial Accounting in Insurance Companies

Historical Cost is the original price paid for the asset

Book value is the value at which the company records the asset in its accounting records and reports the asset
on the balance sheet. On date of purchase, asset’s historical cost equals book value.
Amortization is the periodic and systematic increase or decrease of the original cost of an investment to its
ultimate value at maturity
Depreciation is the allocation (spreading) of the cost of an asset over the asset’s estimated useful life. Total
amount of depreciation allocated to an asset as of a specified date is called Accumulated Depreciation.
Fair value is the price that an asset would obtain if the seller sells the asset to the buyer in the absence of a
required liquidation (in case of bankruptcy) or other condition that would force the asset’s sale by the seller.
Fair value accounting is reporting a company’s assets on the balance sheet at fair value.
Bond, Stock, Mortgages are some of the investment vehicles of insurance companies. These are invested assets.

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 Asset Accounting…Cont.
Accounting for asset (A) purchase
Financial Accounting in Insurance Companies

Purchase on Cash
Asset A ……. $$$ Dr. (Asset)
Cash….$$$ Cr. (Asset)

Purchase on Account
Asset A ……. $$$ Dr. (Asset)
Accounts Payable ….. $$$ Cr. (Liability)

Purchase on Account with a cash down payment

Asset A ……. $$$ Dr. (Asset)
Cash….$ Cr. (Asset)
Accounts Payable ….. $$ Cr. (Liability)

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 Asset Accounting…Cont.
Accounting for asset (A) Sale
Financial Accounting in Insurance Companies

Sale for Cash

Cash….$$$ Dr. (Asset)
Asset A ……. $$$ Cr. (Asset)

Sale on Account
Accounts Receivable - Asset A ….$$$ Dr. (Asset)
Asset A ……. $$$ Cr. (Asset)

Sale on Account with a cash down payment

Accounts Receivable - Asset A ….$$ Dr. (Asset)
Cash…………………………………$ Dr. (Asset)
Asset A ……. $$$ Cr. (Asset)

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 Asset Accounting…Cont.
Some Complex Asset Accounting Entries
Financial Accounting in Insurance Companies

Bonds …………………………………...$1000 Dr.

Investment Income Due and Accrued …..$20 Dr.
Cash …………………………………$1020 Cr.
(To record the cash purchase of a bond with face value $1000 and accrued interest of $20)

Cash Dividend income due and accrued ………$200 Dr.

Dividend Income - Common Stock……….$200 Cr.
(To record (on ex-dividend date) the cash dividend income due and accrued on 200 held shares at the rate of
$1/share)

Note:
Ex-Dividend Date is the date used to determine whether a stockholder is eligible to receive a declared cash dividend.
Bonds pay interest (and return of capital). Stocks pay dividend (and capital gain or increase in stock price)

Prepared by Avik Saha

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 Asset Accounting…Cont.
Some Complex Asset Accounting Entries

AT&T stock ………..$9500 Dr.

Financial Accounting in Insurance Companies

Cash………………..$9500 Cr.
(To record purchase of 100 shares of AT&T at $95/share)

Cash……………………………….$8000 Dr.
Loss on sale of AT&T stock……..$1500 Dr.
AT&T stock…………………….$9500 Cr.
(To record sale of those 100 AT&T shares at $80/share (at a loss))

Cash……………………………….$12000 Dr.
AT&T stock…………………….$9500 Cr.
Gain on sale of AT&T stock…..$2500 Cr.
(To record sale of those 100 AT&T shares at $120/share (at a gain))

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 Asset Accounting…Cont.
Some Complex Asset Accounting Entries
Purchase and sale of real estate
Financial Accounting in Insurance Companies

Insurance company A purchases Axis Building for $1,000,000. Depreciation on the building is $10,000 per year. Accounting entry for recording
this depreciation is as follows:
Depreciation expense - Axis Building….$10,000 Dr.
Accumulated Depreciation – Axis Building….$10,000 Cr.
Accumulated Depreciation is a contra account . Contra Account accompanies a specified ‘companion’ account – typically an asset account, that has
a normal balance which is opposite of the companion account. The amount in contra account usually reduces the balance in its companion
account.
Insurer A sells Axis Building for $1,500,000 (gain). Depreciation on the building to date is $20,000.
Cash……………………………………………..$1,500,000 Dr.
Accumulated Depreciation - Axis Building…..$20,000 Dr.
Axis Building……………………………………….$1,000,000 Cr. (disposing the asset)
Gain on sale of Axis Building……………………..$70,000 Cr
If Insurer sells the building for $900,000 (loss), the following accounting entry is made:
Cash…………………………………………….$900,000 Dr.
Accumulated Depreciation - Axis Building….$20,000 Dr.
Loss on sale of Axis Building………………….$80,000 Dr.
Axis Building……………………………………….$1,000,000 Cr. (disposing the asset)

Prepared by Avik Saha

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 Asset Accounting…Cont.
Some Complex Asset Accounting Entries
Reinsurance Transactions
Financial Accounting in Insurance Companies

Life Insurance company XYZ issued an individual life insurance policy with a $300, 000 death benefit. XYZ reinsured $50,000
of the risk. While policy was in force, claim was made for the policy and XYZ determined that the beneficiary would receive the
full amount i.e. $300,000. The following accounting entry is made:

Death Claims Paid…………………$300,000 Dr. (Expense account)

Cash……………………………….$300,000 Cr.
(to record payment to beneficiary)

Amount recoverable from reinsurer……..$50,000 Dr. (Asset account)

Death Claims Paid……………………..$50,000 Cr.
(to record amount recoverable from reinsurer)

Cash…………………….$50,000 Dr.
Amount recoverable from reinsurer……..$50,000 Cr.
(when the amount received from insurer)

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 Reserve (Liabilities) Accounting
Reserve are estimates of the amount of money an insurer needs to pay future contract obligations. Reserve
make up significant portion of insurer’s liabilities
Financial Accounting in Insurance Companies

Cash…XX Dr. Invested Assets …XX Dr. Change in reserves…XX Dr.

Premium Income…XX Cr. Cash…XX Cr. Contractual reserves…XX Cr.

To record premium income To record purchase of invested To record the establishment of

received from sales of new life assets to generate income and reserves for the new life insurance
insurance products dividends product

Cash…XX Dr.
Death Claim paid…XX Dr.
Invested Assets…XX Cr.
Cash…XX Cr. Claims are incurred and reported
against the new block of policies
To record sale of invested
To record payment of and are approved for payment
assets to provide cash for the
approved life policy claims
payment of policy claims

Contractual reserves…XX Dr.

Actuaries provide an updated Change in reserves…XX Cr.
reserve amount for the
product on the valuation date To record the reserves released
from the settlement of claim

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 Reserve (Liabilities) Accounting…cont.
Recording and paying policy owner dividends (for different payment options)

Board approves dividend and sets the date

for policy owner dividend payment
Financial Accounting in Insurance Companies

Actuaries determine and recommend

dividend to board of directors
Policy owner dividend…..XX Dr.
Policy owner dividend payable…..XX Cr.

Insurers update policy owner dividend

record for policy owner dividend
payment option

CASH PURCHASE ADDITIONAL INSURANCE

Policy owner dividend paid….XX Dr. Dividends to purchase Paid-Up Addition…..XX Dr.
Cash…………………………….XX Cr. Single premiums for Paid-Up Addition ……………XX Cr.

Or
REDUCE PRIMIUM
Policy owner dividend applied to Dividends to purchase one year term insurance…….XX Dr.
premium……….XX Dr. Single premium for one year term insurance ……………….XX Cr.
Premium Income…….XX Cr.
ACCUMULATE AT INTEREST
Policy owner dividend applied to dividend
accumulations……….XX Dr.
Dividend Accumulations..…….XX Cr.
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 Reserve (Liabilities) Accounting…cont.
Waiver of premium accounting

Waiver of premium contract provision provides premium payments to keep a life insurance policy in force if the
insured suffers a qualifying disability.
Financial Accounting in Insurance Companies

Waiver of premium benefits – ordinary……XX Dr.

Premium Income……………………..XX Cr.
(to record the payment of a waived premium)

Premium Suspense Account

Suspense account is an account that is used to record transactions that can not be posted immediately to a specified
account. Premium Suspense is the liability account used to record transactions that are intended as premiums, but that
the insurer cannot accept as income until a particular event occurs. Insurers typically use premium suspense
accounts for premium payment amounts that are a) renewal premiums b) different from the amounts in the insurer’s
records or c) lacking critical information such as policy number.

Cash…………………XXX Dr.
Premium Suspense …………..XXX Cr.
(to record receipt of premium payment that cannot be immediately recorded to a premium income account)

Premium Suspense …………..XXX Dr.

Premium Income……………..XXX Cr.
(To record the application of a suspended premium as an actual premium – after the particular event occurs)

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 Capital and Surplus Accounting
Preferred Stock
Preferred stock is a type of equity security that represents ownership in a corporation and usually provides for the payment of
fixed periodic dividend which is paid before any dividends can be paid on the corporation’s common stocks.
Financial Accounting in Insurance Companies

Cash………………..XXX Dr.
Insurer’s Preferred Stock……………….XXX Cr.
(to record issue and sale of Insurer preferred stock at par value)

Additional Paid-In Capital

Cash………………..XXX Dr.
Insurer’s Preferred Stock…………………XX Cr.
Additional Paid-in capital………………….X Cr.
(to record the sale of Insurer preferred stock at greater than par value)

Unrealized gains and losses

Unrealized Loss on Bonds…………..XXX Dr.
Market Value adjustment – Bonds………….XXX Cr.
(to decrease the value of a bond temporarily as the bond’s current value is less than the value recorded in the accounting records )

Realized Loss on Bonds…………..XXX Dr.

Bonds……………...………….XXX Cr.
(to write down the value of a permanently impaired bond)

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 Revenue and Expense Accounting
Premium Income

Cash…………………XXX Dr.
Premium Income………..XXX Cr.
(to record premium income on policy sale)
Financial Accounting in Insurance Companies

Investment Income

Cash…………………XXX Dr.
Interest Income - Bonds………..XXX Cr.
(to record interest income received on bonds owned by the insurer)

Cash…………………XXX Dr.
Interest Income - Mortgages………..XXX Cr.
(to record interest income received on mortgages owned by the insurer)

Cash…………………XXX Dr.
Rental Income - Real Estate………..XXX Cr.
(to record rental income received on real estate owned by the insurer)

Cash…………………XXX Dr.
Dividend Income – Common Stock………..XXX Cr.
(to record dividend income received for the common stock owned by the insurer)

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 Revenue and Expense Accounting…cont.
Producer Commission
Commission expense…………….XXX Dr.
Producers Ledger Control…………XXX Cr.
(to record incurred producer commission expense)
Financial Accounting in Insurance Companies

Producer Ledger Control………..XXX Dr.

Cash…………………………………XXX Cr.
(to record the payment of producer commissions)

Producer Salaries
Salaries Expense……………………………$1000 Dr.
Federal Income Taxes Payable………………...$100 Cr.
Social Security and Medicare Taxes Payable…..$80 Cr.
State Income taxes payable……………………...$20 Cr.
Salaries Payable………………………………...$800 Cr.
(to record the establishment of a liability for a producer’s salary and appropriate tax withholdings)

Salaries Payable…………………………….$800 Dr.

Cash……………………………………$800 Cr.
(to record the payment of a producer’s salary)

State Income taxes payable…………………$20 Dr.

Cash…………………………………….$20 Cr.
(to record payment of state income taxes withheld from a producer’s salary)

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 Revenue and Expense Accounting…cont.
Reinsurance Allowances and Premiums
Ceding Company is the insurer which purchases reinsurance
Assuming Company is the reinsurer

Ceding company pays periodic premiums to assuming company

Reinsurance Allowance is the commission that reinsurer pays to the ceding company (like the insurer pays commission to producers)
Financial Accounting in Insurance Companies

E.g. For a reinsurance contract reinsurance premium is $800, reinsurance allowance is $600. Following is the accounting entry
made by the insurer for reinsurance premium payment:
Reinsurance ceded – first year premium expense…………………$800 Dr.
Reinsurance Allowance – ceded……………………………..$600 Cr.
Cash……………………………………………………………$200 Cr.
(to record payment of reinsurance premium; the insurer basically pays $200 to the reinsurer)

The accounting entry made by the reinsurer is as follows:

Reinsurance Allowance – assumed……………………$600 Dr. (Expense account)

Cash…………………………………………………….$200 Dr. (Asset account)
Reinsurance assumed – first year premium income……$800 Cr. (Income account)

Premium Taxes
Premium taxes are taxes on the paid premium income an insurer receives within a particular jurisdiction.

Premium Tax expense………………..XXX Dr.

Premium Taxes Payable…………….XXX Cr.
(to record incurred premium taxes)

Premium Taxes Payable……………...XXX Dr.

Cash…………………………………..XXX Cr.
(to record payment of premium taxes)
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 Responsibility Accounting
The area, function or organizational unit that a specified manager controls is called a
Responsibility Center. The said manager is called the Responsibility Manager.
Financial Accounting in Insurance Companies

Cost Center is a department or division to which costs (expenses) can be traced. E.g. accounting
department, legal department and the claims department of an insurance company.

Profit Center is a department or other business segments to which both costs (expenses) and
revenues can be traced. E.g. companies’ lines of businesses – individual life insurance, annuities,
health insurance, and group life insurance.

Investment Center is a department or other business segments to which both costs (expenses),
revenues and capital or investment funds can be traced. E.g. lines of businesses, investment
division.

Responsibility Accounting is a management accounting (i.e. for internal use as against financial
accounting which is particularly prepared for external users) system of policies and procedures
that allow for revenues, expenses and investments to be assigned to the specific employee or
organizational level that is accountable for those revenues, expenses and investments.

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 Insurance company responsibility
centers organization
Investment Centers Profit Centers Cost Centers

Claims Administration

Life Insurance Line Underwriting

Financial Accounting in Insurance Companies

Policy Owner Service

Individual Insurance
Division

Claims Administration

Health Insurance Line Underwriting

Policy Owner Service

Insurance Company
Home Office
Claims Administration

Life Insurance Line Underwriting

Policy Owner Service

Group Insurance
Division

Claims Administration

Health Insurance Line Underwriting

Policy Owner Service

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 Cost Accounting
Cost Classification by description

Cost Classification Definition Example

Financial Accounting in Insurance Companies

Direct cost A cost that is identified with a specific cost To the group life line of business, the salary of
object the division manager of group life insurance
Indirect Cost A cost that is not identified specifically with a To the group life line of business, the salary of
single cost object the vice president in charge of all group
insurance
Controllable cost A cost over which a responsibility manager has To a line of business, the cost of its supplies,
decision making authority travel and employee overtime
Non-controllable cost A cost over which a responsibility manager has To a line of business, home office rent and
no decision making authority depreciation on equipment
Differential Cost The difference in cost between two alternative To the group insurance division, the difference in
choices costs if a new line of business is added, and if
the line is not added, to the division
Marginal Cost The additional cost of producing an additional To a life insurer, the additional cost of processing
unit of an existing product or service one more policy application per hour
Sunk cost A cost that is already incurred and does not To a line of business, existing salary cost that
change as a result of a future decision will not change as a result of the decision to
undertake a specified project
Unit cost A cost attributable to a single measured amount To a life insurer, the cost per $1000 of insurance
of work underwritten
Discretionary Cost A cost that result from periodic management To a life insurer, the costs of product advertising,
decision that changes as conditions change promotional campaigns, and employee training

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 Cost Accounting…cont.
Cost Classification by behavior

A fixed cost is a cost that remains constant for all levels of production or operating
Financial Accounting in Insurance Companies

activity, e.g., fire insurance for home office facility, which remains same
notwithstanding sales volume.

A variable cost is a cost that changes in amount in direct proportion to changes in

the level of operating activity, e.g. agent commission, which increases with sales
volume.

A semi variable cost has a fixed cost component and a variable cost component, e.g.
cost of electricity which involves a basic monthly service charge and the rest
depending on usage.

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 Cost Accounting…cont.
Cost Classification by measurement

An opportunity cost is the benefit forfeited as a result of choosing one decision

Financial Accounting in Insurance Companies

alternative over other, e.g., if an insurer is considering introduction of a new

universal life product requiring an out-of-pocket cost of $1 million, the opportunity
cost in this case will be what other things the insurer could have done with $1
million like purchasing asset that would have generated investment income.

Marginal cost and Unit cost, which are described under cost classification by
description also fall under classification by measurement.

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 Cost Accounting…cont.
Cost Accumulation

Cost accumulation is the process of capturing all company costs and categorizing
Financial Accounting in Insurance Companies

them in meaningful ways.

Four methods of accumulating cost data:

1)  Type of cost – e.g. cost relating to salary
2)  Line of business – e.g. cost attributable to/allocated to a line of business
3)  Department or cost center – e.g. accumulating all claim cost under claims dept.
4)  Function – e.g. cost of policy maintenance function of insurer

Cost Allocation Base

Allocation base is used to ensure equitable allocation of indirect costs to cost centers,
e.g. amount of square footage, number of employees, percentage of direct costs etc

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 Auditing
An audit is the examination and evaluation of company accounting records and
procedures to ensure that 1) the financial information, financial statements and
source documents comply with accounting standards and are fair and consistent
depiction of the company’s financial condition and performance 2) quality
Financial Accounting in Insurance Companies

assurance is maintained and 3) operation procedures and policies are effective.

Internal audit is a financial audit performed by company employees.

External audit is a financial audit performed by external auditors, who are

employees of public accounting firms, insurance regulators or reinsurers.

Audit trail is a chronological, sequential set of accounting records and reports from
the beginning to the end of a business transaction.

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 Accounting Regulation (US)
Generally Accepted Accounting Principles (GAAP) is followed by stock insurers.
Mutual and Fraternal insurers those sell variable products comply with US GAAP.
Financial Statement is prepared based on GAAP
Financial Accounting in Insurance Companies

Statutory Accounting is followed by all life insurers in US when preparing Annual

Statement that they submit to insurance regulators.

US Regulatory Agencies and Organizations

•  Securities and Exchange commission (SEC)

•  Financial Industry Regulatory Authority (FINRA)
•  Financial Accounting Standards Board (FASB)
•  National Association of Insurance Commissioners (NAIC)
•  Internal Revenue Service (IRS)

Countries are moving to International Financial Reporting Standards (IFRS)

for accounting and financial reporting.

Prepared by Avik Saha

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