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4.0 ACCOUNTING PRINCIPLES AND PRACTICE

Every private or public insurance company needs to record, store and present its financial
information to internal (directors, managers) and external (policyholders, stockholders) users.
Two types of accounting principles greatly help to efficiently perform this tasks. These two
accounting principles are briefly described below:

4.1 GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP)

The Financial Accounting Standard Board (FASB) has developed a set of accounting rules,
named GAAP which is used in almost every industry to conduct the accounting processes for
many years. The principles of GAAP and how they’re practiced in insurance companies are
listed below:

1. Business Entity Principle:

The business entity principle states that the business itself will be regarded as a separate
entity than its owners and any other related entities. In an insurance company, revenues
and expenses are kept separate from personal expenses of the owners because of this
concept. Even if the insurance company has other subsidiary or affiliated businesses,
every entity will be considered distinct.
2. Going Concern Principle:
According to the going concern principle, the insurance company will continue to operate
in the unpredictable future to accomplish its existing obligations and missions. This
principle drives the company to calculate depreciation, amortization and asset
capitalization. Only the chance of liquidation of the insurance company disqualifies this
principle.
3. Conservatism Principle:
The conservatism principle emphasizes on proper verification and identification of all
transactions. Under this concept, insurance companies should record expenses and
liabilities whenever there’s uncertainty about the result, but record revenues and profits
when they’ve actually occurred. In the absence of this approach, accountants tend to
overestimate assets and underestimate liabilities and this tendency leads to financial
misinformation among all stakeholders.
4. Objectivity Principle:
 According to the objectivity principle, the financial statements of an organization should
be based upon objective evidence and also, free from biases. The investment decisions in
an insurance company are often taken using valuation approaches that have a chance of
providing subjective results (as interest of associated parties are involved). Therefore,
objectivity principle is essential for fair decision making.
5. Revenue recognition Principle:
Revenue recognition principle suggests that a company should record revenue as soon as
it is earned and not wait until cash is received. This principle actually complies with the
accrual-basis accounting. Insurers can register their revenue from short-term insurance
contracts when the contracts have been expired. Revenue from long-term contracts can be
recorded when the premiums are due, not when the cash is actually received.
6. Matching principle:
The matching principle states that expenses should be recognized in the same period in
which it contributed to earning revenue. In simpler terms, expenses should be offset
against revenues. Matching principle is noticed in calculating the commission paid to an
agent or broker on the sale of an insurance contract where he’s being paid commission
according to how many policies he sold. Although matching principle is sometimes
ignored in insurance business in some regimes.
7. Cost Principle:
The cost principle is a strategy that values assets at their original cost, rather than the fair
value. This principle complies with the conservatism principle stated above.
8. Consistency Principle:
According to the consistency principle, insurance and other companies should use the
same accounting procedures in its financial reporting period after period, so that the
reports can be compared with one another. If new rules are to be followed, it should be
mentioned in the notes section of the statements.
9. Materiality principle:
The materiality concept implies that, all financial information considered to be ‘material’
to the users must be included in financial reports. Different insurers might have different
assumptions of material and these assumptions can change too. This fact often affects
total earnings and profits.
10. Full disclosure principle:
As the name suggests, this principle requires full discloser of each and every information
about a company in its financial statements. This is a vital principle in insurance business,
 and a violation of this principle can cause the insurer to bear major defamation and severe
financial compensation.

4.2 STATUTORY ACCOUNTING PRINCIPLES (SAP)

Since, the activities of insurance companies are drastically different from other business
organizations, the Generally Accepted Accounting Principles (GAAP) isn’t always enough to
conduct or record business transactions. Therefore, the Statutory Accounting Principles
(SAP) has been introduced by NAIC for preparing an insurance firm's financial statements.
SAP delivers the similar type of information about an insurer’s financial performance as
GAAP. But, the central objective of SAP is providing information about an insurance
company’s solvency – the capability of paying out policyholders. The three core values of
Statutory Accounting Principles are stated as below:
1. Conservatism:
Under this principle, insurance companies conduct valuations in a conservative
manner. The objective is to give protection to policyholders against any negative
movements in a company's financial situation.
2. Recognition:
The recognition approach states that, insurance companies should only write the
liquid and readily marketable assets in the balance sheet and the illiquid assets (such
as equity) should be marked against surplus. Recognition assumption is essential
because only liquid assets can be used to meet the firm's obligations when they are
due.
3. Consistency:
This approach regards that Statutory Accounting Principles should be applied in a
consistent manner which enables comparability among different years of statements.

4.3 ACCOUNTING PRACTICE IN INSURANCE COMPANIES

The accounting department of an insurance company is engaged in carrying out various

accounting tasks on a daily basis. Accounting, also referred to as the “Language of Business”
can prove to be a powerful tool for insurance companies by helping them to calculate
premiums, keep financial records, prepare payroll, compute tax etc. Some major practices of
accounting are stated as below:

1. Payroll management:
 The most complex task of the insurance business is undoubtedly Payroll processing.
The accounting department routinely prepares the remunerations and payrolls of
internal employees. But the problem arises when paying agents. The agents and
brokers don’t earn the same amount of money, moreover, the commission they get is
subjected to income tax. Accountants are highly skilled to perform this types of
difficult tasks.
2. Claims Settlement:
We all know, Settling claims of the policyholders is the fundamental task of the
insurance companies. The accounting department is responsible for calculating
financial compensation and deductibles regarding payment of the policyholders.
3. Record Preservation:
The knowledge of accounting helps insurance companies to keep precise records of
each business transaction. By using powerful cloud-based insurance accounting
software to record information, insurance companies can prepare different financial
statements, which in turn, help to make various types of decisions regarding
underwriting fee, employable number of agents, reinsurance policies, new investment
opportunities etc.
4. Other uses of Accounting:
Other uses of accounting include tax preparation, auditing, asset valuation and so on.
Most of all, the practice of proper accounting methods can tremendously increase
accountability among internal users.