Insurance, system of insurance accounting

Sooraj.R

Introduction

• Insurance involves pooling funds from many insured entities (known as exposures) to pay for the losses that some may incur.

• The insured entities are therefore protected from risk for a fee.

• With the fee being dependent upon the frequency and severity of the event occurring.

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DEFINITION In financial sense• It is a social device in which

a group of individuals (insured) transfer risk to another party (insurer)

in order to combine loss experienced, which opermits statistical prediction of losses and oprovides for payment of losses from funds

contributed (premium) by all members who transferred risk

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Definition (Contd.)

In legal sense• It is a contract by which one party (Insurer) in consideration of price paid to him proportionate to risk provides security to the other party (Insured) that ohe shall not suffer loss, damage or prejudice by the

happening of certain specified events. • Insurance is meant to protect insured against

uncertain events which may cause disadvantage to him

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ELEMENTS IN INSURANCE • Insurance - combination of three elements1. Insurance as a Transfer System - transferring of risks

from Insured to IC which is financially sound and has capacity and willingness to take risks.

• A Loss exposure can give rise to three types of losses, namely:

a) Property loss (including net income loss),b) Liability loss, andc) Human and personnel loss.

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Elements in Insurance (Contd.)2. Insurance as a Business - insurance primarily attempts to

meet its costs and expenses from premium that it earns and also make a reasonable margin of profit for its own sustainability.

• Other benefits to society as a whole such as:a) Payments for the costs of covered lossesb) Reduction of the insured’s financial uncertainc) Efficient use of resourcesd) Support for credite) Satisfaction of legal requirementsf) Satisfaction of business requirementsg) Source of investment funds for infrastructure developmenth) Reduction of social burden

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Elements in Insurance (Contd.)

3. Insurance as a Contract - an insurance policy is a

legally enforceable contract. The contract is between

IC and the Insured.

• An insurance contract must meet these four

requirements:

i. Offer and acceptance

ii. Consideration

iii. Capacity

iv. Legal purpose

Insurers' business model

• Underwriting and investing - Insurers make money in two ways:1. Underwriting, the process by which insurers select the

risks to insure and decide how much in premiums to charge for accepting those risks

2. Investing the premiums they collect from insured parties.

• Claims - Claims and loss handling is the materialized utility of insurance

• Marketing -Insurers will often use insurance agents to initially market or underwrite their customers.

TYPE OF INSURANCE

INSURANCE

LIFE INSURANCE

GENERAL INSURANCE

LIFE INSURANCE

Life insurance is a written contract between the insured and the insurer, that provides for the payment of the insured sum on the date of the maturity of the contract or on the unfortunate death of the insured, whichever occurs earlier.

GENERAL INSURANCE

• General insurance or non-life insurance policies, including automobile and homeowners policies, provide payments depending on the loss from a particular financial event. General insurance typically comprises any insurance that is not determined to be life insurance.

TYPES OF GENERAL INSURANCE

Health insuranceBusiness insuranceAutomobile insurance Fire insurance etc.

HEALTH INSURANCE

Just like one looks to safeguard ones wealth, these policies ensure guarding the insurer's health against any calamities that may cause long term harm to ones life and even hamper ones earning ability for a lifetime. Some examples of this type of policy are mediclaim policy, personal accident, group accident, traffic accident, etc.

Business Insurance

Risks of loss of profits/business, goods, plant and machinery are most profound in case of business. Under this head they cover the most widely used policies that cover a business from any loss of the above kind. Some of these policies are burglary insurance, shopkeepers insurance, key-man insurance, marine insurance, public liability insurance, workmen compensation insurance, air transit insurance, fidelity guarantee insurance etc.

Automobile Insurance

Auto Policy is required to be taken to cover the risks that arise to the owner, vehicle and third party. This includes the Compulsory Vehicle Policy (In India, by the Motor Vehicles Act, every car owner is required to covered against Act risks) and the Comprehensive Vehicle Policy.

FIRE INSURANCE

This policy is required to be taken to prevent any loss of profits / property from incidental fire. Eg: fire insurance and fire consequential loss policy.

IRDA’S MISSION

To protect the interests of the policyholders, to regulate, promote and ensure orderly growth of the insurance industry and for matters connected therewith or incidental thereto.

Composition of Authority under IRDA Act, 1999As per the section 4 of IRDA Act' 1999, Insurance Regulatory and

Development Authority (IRDA, which was constituted by an act of parliament) specify the composition of Authority.

The Authority is a ten member team consisting of a. a Chairman;b. five whole-time members;c. four part-time members, (all appointed by the Government of India)

Duties, Powers and Functions of IRDASection 14 of IRDA Act, 1999 lays down the duties, powers and

functions of IRDA.1. Subject to the provisions of this Act and any other law for

the time being in force, the Authority shall have the duty to regulate, promote and ensure orderly growth of the insurance business and re-insurance business.

2. Without prejudice to the generality of the provisions contained in sub-section (1), the powers and functions of the Authority shall include:

a. issue to the applicant a certificate of registration, renew, modify, withdraw, suspend or cancel such registration;

Duties, Powers and Functions of IRDA contd…

b. protection of the interests of the policy holders in matters concerning assigning of policy, nomination by policy holders, insurable interest, settlement of insurance claim, surrender value of policy and other terms and conditions of contracts of insurance;

c. specifying requisite qualifications, code of conduct and practical training for intermediary or insurance intermediaries and agents;

d. specifying the code of conduct for surveyors and loss assessors;

e. promoting efficiency in the conduct of insurance business;

Duties, Powers and Functions of IRDA contd…

f. specifying the form and manner in which books of account shall be maintained and statement of accounts shall be rendered by insurers and other insurance intermediaries;

g. regulating investment of funds by insurance companies;

h. regulating maintenance of margin of solvency;

i. adjudication of disputes between insurers and intermediaries or insurance intermediaries;

j. supervising the functioning of the Tariff Advisory Committee;

Basic Insurance Accounting

• Loss and loss adjustment expense accounting basics

• Reinsurance accounting basics• Deposit accounting basics

Loss and loss adjustment expense accounting

• The basic accounting transactions involving losses are

• Paying claims• Increasing or decreasing claim reserves• These two items affect the income statement

through incurred losses, which equals paid claims (or “losses”) plus the change in loss reserves, or

Incurred losses = paid losses + (ending loss reserves - beginning loss reserves)

Reinsurance Accounting Basics

• There are two general approaches to ceded reinsurance accounting currently in existence:

• 1) Treating the ceded reinsurance entries as negatives of the direct or assumed reinsurance entries, or

• 2) Treating the purchase of reinsurance as the purchase of an asset.

Deposit accounting for a contract generally observes the following rules

• The accounting is done on an individual contract-by-contract basis, and not on a portfolio basis, even if the resulting contract-by-contract amounts are reported on a summary basis in financial reports.

• The amount(s) received for a contract is recorded as a deposit liability, with no revenue or expense impact (and therefore no impact on income).

• The deposit liability is increased due to additional receipts, and usually investment income credits of some sort, and decreased due to payments.

• As such, the deposit generally represents a present value of future payment obligations.

Different forms

• Three general forms of deposit accounting currently observable are

1. bank deposit approaches, 2. prospective approaches and 3. retrospective approaches

Bank deposit approach

• This is the simplest of the three deposit accounting approaches to be discussed. Under this approach, the initial deposit grows with credited interest at a rate whose calculation is determined in advance (and with possible additional deposits depending on the contract terms) and declines with withdrawals.

Prospective approach

• The defining characteristic of this approach is that the current value of the deposit is set equal to the present value of future payments, irrespective of the initial deposit or past payments

• The interest rate is generally a market rate, which may be based on risk-free rates and may be locked-in at inception such that it does not change over time.

Retrospective approach

• The defining characteristic of this approach is that the deposit is a function of the initial deposit, all past payments, and the current estimate of all future payments. Under this method the interest rate is the rate for which the discounted value of past payments and estimated future payments would equal the initial deposit. The interest rate can change whenever the estimated cash flows under the contract change.