Accounting & Reporting in Insurance Business
Hi everyone, I am business consultant with about 11 years of experience in business analytics, business requirements gathering, process flow and process modeling, accounting and financial reporting.
Today almost everyone understands Insurance, that is what Insurance means, what are the benefits & limitations of having insurance cover and various other terms used in this industry. There are numerous articles available on internet about such questions. But what lacks for any accounting student or someone looking to join an Insurance company, is how the accounting is done in these Insurance Companies and how it is different from other industries such as – Banking, Manufacturing, Retail, etc. So this article focuses more on the aspects of accounting and various terms that are used within Finance domain of an Insurance company.
To start with let’s have a look at this definition of Insurance,
A contract (policy) in which an individual or entity receives financial protection or reimbursement against losses from an insurance company. The company pools clients’ risks to make payments more affordable for the insured.
As mentioned in Investopedia.com along with a wonderful video on their site. You can see that using this URL: http://www.investopedia.com/terms/i/insurance.asp
In simple words, insurance is a risk management technique, wherein as per the terms of contract one party (insured) indemnify or guarantee insurable risk to another party (Insurer) in exchange of monetary payments (called premium)
- Risk Management Technique – Process to minimize the adverse effects of accidental losses on an organization
- Contract – Written agreement enforceable by law
- Insured – A person or organization covered by insurance
- Insurer – A person or company that gives insurance cover to insured or who underwrites an insurance risk (also called ‘Underwriter’)
- Indemnify – Compensate (someone) for harm or loss
- Insurable Risk (or Pure Risk) – Chance of Loss or No Loss, but no chance of gain
- Premium – an amount paid in exchange of insurance cover
I am sure, many of you must have read this definition or the terms that I used so far. Now let’s look from accounting point of view, any commercial business activity involves recognition of revenue and expenses in the income statement. Many of us might think that it’s very straight forward, whatever the company has received in the form of premium is company’s revenue and broker commission, employees’ salary and claims paid are the expenses.
At this point I would like to refer some basics of accounting which all of us studied and I assume most of us still remember those, otherwise to brush it up with a bit of can search over internet.
- Matching Concept – revenues are reported along with the expenses that brought them in the same period
- Accrual Concept – expenses and revenues are recorded in the period they occur, whether or not cash is involved.
So now let’s understand some important terms and basic accounting entries involved with a simple example. (For this example I have not used big numbers in thousands or millions just small numbers and simple calculations.
- Peter is looking for an insurance cover for his home, he approached a nearby insurance broker ‘AON’.
- The broker gave him quotes from three different Insurance Companies.
- Finally, Peter decided to take insurance cover from AIG, with following terms of policy: –
- Premium – $120
- Broker Commission – 10%
- Policy Start Date – 1st July XX01
- Duration of Policy – 1 year
In most companies all the above business activities are tracked in their underwriting systems, so to begin the accounting journey relevant data moves from Underwriting systems to Accounting system based on policy terms and conditions – such as,
- Premium Amount
- Commission % or amount
- Revenue Recognition Methodology, such as – Proportionate, based on event, etc.
- Policy Start & End Date
Will continue further with this example along with nuts and bolts of the accounting and reporting in my next blog, that is I will have basic journal entries used to record the information mentioned above along with how it is placed in Income Statement and Balance Sheet.