1. Insurance Accounting Overview
WAMIC Director Seminar
November 16, 2016

2. Goals Understand key concepts in insurance accounting
Obtain a better understanding of financial statements
Use ratios to assess your Company’s overall financial condition

3. What makes insurance accounting unique?
Premiums = Income
Losses = Cost of goods sold
Surplus = Equity
…it’s just different terminology!

4. Key concepts-Premiums
Written premium
Earned premium
Unearned premium
Deferred premium
Premiums received in advance
Cancellations

5. Premiums

6. Key concepts-Premiums
Written premium
The total premium charged to the policyholder for the effective period of the contract
Recorded as of the effective date of the contract
When written premium is recorded, a liability for unearned premium is established to reflect the amount of premium for the portion of the insurance coverage that has not yet expired

7. Key concepts-Premiums
Earned premium
The portion of written premium that has been fully earned as of a date.
Example: Insurance policy written December 1st for a one year term. Premium is $1,250, of which $50 in policy fees is fully earned when the policy is written.
Remaining $1,200 will be earned (and recognized as income) equally throughout the year.
How much of the $1,200 is earned through December 31st?
How much total is earned through December 31st?

8. Key concepts-Premiums
Unearned premium
A liability or future obligation representing the portion of premium that will be earned in future periods.
Example: Insurance policy written December 1st for a one year term. Premium is $1,250, of which $50 in policy fees is fully earned when the policy is written.
How much of the $1,200 is unearned through December 31st?

9. Key concepts-Premiums
Deferred premium
An asset or future benefit representing the portion of premium that will be received in future periods.
Example: $1,250 insurance policy written December 1st for a one year term, payable in quarterly installments. Policyholder paid $ in December 1st.
How much is deferred premium as of December 31st?
$1,250 - $ already paid = $ deferred – represents the remaining that will be collected.

10. Key concepts-Premiums
Premiums received in advance
A liability that represents cash that is received before the policy’s effective date.
Example: $1,250 insurance policy written December 1st for a one year term, paid amount in full on November 28th.
$1,250 would be treated as premiums received in advance (a liability) until its December 1 effective date.

11. Key concepts-Premiums
Cancellations
A complete termination of any existing policy before expiration, may be requested by the insured or occur by reason of nonpayment of premium.
If, at the time of cancellation, the insured has paid more premium than has been earned, the insured will receive a return of premium.
$1,250 premium paid in full November 28, and the policyholder cancels policy on January 31.
How much would be return premium?
$1,250 - $50 (fully earned) – $200 (earned in December and January) = $1,000

12. Reserves

13. Key concepts-Reserves
Reserves are the liability established for unpaid losses and loss adjustment expenses.
Reserves are recorded when insured events occur based on the estimated costs of settling the claims.

14. Key concepts-Reserves
Reserves are management’s best estimate of those amount incurred yet unpaid.
They are reduced for estimated salvage and subrogation recoveries.

15. Key concepts-Reserves
Claim Notification
Claim Estimation
Claim Settlement
Reinsurance Receivable
Salvage and Subrogation

16. Financial Statements

17. Balance sheet - Assets What your Company owns Cash and investments
Real estate
Deferred premium

18. Balance sheet - Liabilities
What your Company owes to others
Reserves
Commissions payable
Unearned premiums
Reinsurance payable

19. Balance sheet - Surplus
Assets – Liabilities = Surplus
Looked at by regulators to assess overall financial condition.
A Company’s surplus provides a cushion for absorbing above average losses.
Surplus will increase when you have underwriting profit/net income.
Surplus is also affected by changes in unrealized gains/losses in investments.

20. Illustrative Balance Sheet

21. Income Statement
Underwriting profit is the measurement of how well a company is doing from its insurance operations.
Net income includes underwriting profit, investment income, other income and income taxes.
From an analysis standpoint, use historical trend of underwriting income to determine if Company is doing well.

22. Illustrative Income Statement

23. Financial Ratios

24. Financial Ratios
Compile historical data and calculate financial ratios to assess a Company’s financial condition and evaluate trends
Obtain your Company’s Annual Statement which shows many of the key financial ratios

25. Financial Ratios Gross premiums written to surplus ratio
Measures how strong of a cushion a Company has for above-average losses
The higher the ratio, the more risk (and weaker) a Company bears
Gross premium/policyholders’ surplus
Example: Gross written premium $2,275,000; Policyholders’ surplus $3,943,500
Gross premiums written to surplus ratio 57.7%
Flip it: for every $1 in premium written, there is $1.73 in surplus.

26. Financial Ratios Change in net writings Example:
Major increases or decreases in net premiums written indicate a lack of stability.
Moderate change between 1-5%.
Don’t want too much growth too fast.
Example:
Net premium written previous year: $2,200,000
Net premium written current year: $2,275,000
Change in net writings$75,000
$75,000/$2,200,000 = 3.4%

27. Financial Ratios Change in policyholders’ surplus Example:
The ultimate measure of the improvement or deterioration of the Company’s financial condition during the year
Measured as the change in policyholders’ surplus divided by beginning surplus.
Prefer not to see greater than 10% decline.
Example:
Policyholders’ surplus prior year: $3,501,500
Policyholders’ surplus current year: $3,943,500
Change in policyholders’ surplus $442,000
$442,000/$3,501,500 = 12.6%

28. Financial Ratios Reinsurance ratio Example:
Measures reinsurance costs as a percentage of premiums written.
The lower the number, the less reinsurance you’re paying proportionately.
Town mutual range of 25-45%.
Example:
Reinsurance ceded $900,000
Gross premiums written $2,275,000
Reinsurance ratio 39.56% (900,000/2,275,000)

29. Financial Ratios LOOK at the trends
Ask your Manager to compile 10 year historical data showing financial ratios and underwriting profit
Trend data may help identify needs to evaluate underwriting, raise rates

30. Questions? Margo Rosen, CPA Partner Carlson Highland & Co., LLP