ACCOUNTING

Is a system or set of rules and methods for collecting, recording, analyzing, summarizing, and reporting financial information? It is essential for planning an insurer’s solvency and profitability goals and for determining whether the company is meeting these goals.

Financial reporting is one of the most important aspects of accounting for insurers which is the process of presenting financial data about a company’s financial position, the company’s operating performance, and its flow of funds during a specified period of time.

Users of Accounting Information

Internal Users company officers and members of board of directors who conduct strategic planning and financial management, to managers in all functional areas, who use accounting information to set departmental or team guidelines & procedures.

External Users are outside the insurance companies who have a need for information contained in the company’s financial statements. They include

• National, state & provincial regulatory bodies.
• Insurance companies rating agencies.
• Current & potential policy owners of the company.
• Current & potential investors in the company
• Government Taxing authorities
• Creditors of the company

Organization & Responsibilities of the Accounting Department

• Establishing a system of accounts, which are basic tools that a company uses to record, group, and summarize similar types of financial transactions.
• Maintaining the company’s accounting records and investigating any discrepancies.
• Recording receipts & disbursements of money.
• Preparing & analyzing financial statements.
• Assisting managers with the interpretation of financial results.
• Analyzing the company’s operating costs
• Assisting financial managers with the development of long-term financial plans for the entire organization.
• Compiling budgets and preparing reports on performance that deviates from budgets.

The person in charge of the accounting department holds the title controller (or comptroller), reflecting the fact that the accounting area is responsible for controlling the company’s operations and protecting its resources. Reporting to the controller are a number of assistant controllers each overseeing a different unit of the accounting department? Typical units include line of business accounting, financial reporting, tax accounting, and internal auditing. Depending on the insurer, internal auditing may be considered a part of accounting, a part of compliance, or an independent department.

Financial Accounting

Focuses primarily on reporting a company’s financial information to meet the needs of company’s external users. Management Accounting is the process of identifying, measuring, analyzing, and communicating financial information so that a company’s internal managers can decide how best to use the company’s resources. It also helps to identify areas or functions that are not performing as planned.

Accounting Standards

These standards advise, among other things, how and when accountants recognize revenues and expenses and how they value assets & liabilities. In accounting recognition is the process of [1] classifying items in a financial transaction as assets, liabilities, capital, and surplus, revenue or expenses, and [2] recording the transaction in the company’s accounting records.

In an attempt to promote consistency, comparability, and more complete disclosure of information included in corporation’s financial reports, the International Accounting Standards Board{IASB}-an organization founded in 2001 as the successor to the ?International Accounting Standards Committee- has developed a set of International Financial Reporting Standards[IFRS].The European Union has decided that the financial statements of all publicly held companies in EU countries must comply with IFRS by 2005.However the IASB has no authority to mandate the adoption of IFRS by any jurisdiction. In the US, two important accounting standards for life insurers are US generally accepted accounting principles and statutory accounting practices.

U.S Generally Accepted Accounting Principles

 Are a set of financial accounting standards, conventions, and rules that U.S. stock insurers follow when summarizing transactions and preparing their financial statements? Mutual & Fraternal insurers must comply with GAAP if they sell variable life insurance or variable annuities.

Financial statements prepared according to GAAP provide users with financial information that is based on standardized definitions, valuation methods, and formats. The underlying premise of financial statements prepared in accordance with GAAP is the going-concern concept. Under this concept, accounting processes are based on the assumption that a company will continue to operate for an indefinite period of time.

The Financial Accounting Standards Board [FASB], a private organization funded by the accounting profession and companies with an interest in accounting practices, established U.S. GAAP requirements.

Statutory Accounting Practices in the U.S.

In addition to complying with GAAP requirements, insurance companies in the US must comply with statutory accounting practices, which are the accounting standards that all life insurers in the US must follow when preparing the Annual Statement and specified other financial reports that are submitted to state regulators. In contrast to GAAP, which are oriented toward demonstrating an insurer’s profitability, statutory accounting practices are designed to provide insurance regulators with information about an insurer’s solvency.

Insurance companies must satisfy the statutory accounting requirements for each state in which they conduct business. To minimize the differences in statutory accounting practices among the states the NAIC approved the Codification of Statutory Accounting Principles, which creates a single, basic written standards for statutory accounting.

Statutory accounting is perceived as a more conservative approach than that of the going-concern concept used by GAAP. Accounting Conservatism is the choice of a financial reporting method that results in the projection of lower values for a company’s assets, higher values for its liabilities and expenses, and a lower level of net income than would be the case if the company used a less conservative reporting method.

Financial Accounting Operations

Can be classified into

Premium Accounting

Also called policy accounting, is the accounting operation that is responsible for maintaining detailed accounting records of all financial transactions related to the policies an insurer has issued, including premiums, commissions, claim payments, policy loans, and policy dividends.

• It ensures that policy owners are properly billed, premium payments from policy owners are properly accounted for, and premium income is recorded by appropriate categories so that the company can use data to compute premium taxes.
• The basic policy record is used for premium accounting usually identifies the producer who is to receive the commission and the amount of commission.
• When a life insurance claim payment is authorized, the accounting area records the transaction and sends the payment to appropriate person.
• Accounting for life insurance policy loans requires recording the principal-the initial amount borrowed
• Accounting for policy dividends involves recording the amount of each policy dividend and applying the dividend according to the dividend option that each policy owner has chosen.

Investment accounting

Is responsible for recording all accounting entries related to the assets in an insurer’s investment portfolios. It includes tracking and recording the following amounts:

• The cash inflows (investment income and sales of securities) & outflows (purchase of securities and investment expenses such as brokerage commissions) associated with the insurer’s investments.
• Investment valuations that will be used in the company’s financial statements.
• Realized and unrealized capital gains and losses from investments. When an investment matures or is sold, any gain or loss on the investment becomes a realized gain (loss).An unrealized gain (loss) occurs when the value of a currently held asset changes.

Accountants usually establish an investment account – a segment – for each product line within the general account.

General Accounting

As business entities, life insurance companies perform some of the same basic accounting operations like payroll accounting that all businesses undertake. Another type of general accounting that all businesses conduct is disbursement accounting. Large expenditures must usually be supported by a voucher, which is a payment request signed by someone with the authority to disburse the amount involved.

Tax Accounting

Keeps records related to all the company’s taxes, and prepare tax returns and filings. Insurance companies also pay premium taxes, which are taxes on the premium income an insurer earns within a particular jurisdiction. Premium taxes are calculated as a percentage of premium income. The definition of premium income for premium tax purposes varies from one jurisdiction to another. For Example in the US, some states impose a tax on gross premiums, whereas other states allow an insurer to deduct the amount of policy dividends from gross premiums before calculating the amount of premium taxes owed.

Financial Reporting

Is the preparation and filing of required financial statements that communicate summaries of a company’s numerous financial transactions? Important financial statements are

• Balance sheet.
• Income statement.
• Cash Flow Statement provides information about the company’s cash receipts, cash disbursements, and net change in cash during a specified period.
• Statements of owner’s equity which shows the changes that occurred in an insurer’s stockholders’ or policy owners’ equity during a specified period.

The Annual Statement

Each year, every life insurer operating in the US – whether domiciled in the US or in another country – must file an Annual Statement with the NAIC and with the insurance department of every state in which the company conducts business. An insurer’s senior officers must attest to the accuracy of the information contained in the annual statement. It includes the following reports and other information:

• A balance sheet in the form of an Assets page and Liabilities, Surplus, and other Funds page.
• An income statement in the form of a Summary Of Operations page.
• A Capital and Surplus Account page.
• A Cash Flow statement.
• Other exhibits, schedules, and supplemental reports that support the totals shown in the primary financial statements.

Statutory accounting practices prescribe specific rules for asset valuation, which is the process of setting reported values for invested assets. Admitted assets are assets whose full value can be reported on the Assets page of the Annual Statement. They are considered to support the insurer’s policy reserves. Some typical admitted assets are    

• Cash
• Investment-grade securities
• Computer equipment
• Accounts receivable due in less than 90 days

Partially admitted assets are assets for which only a portion of their monetary value is reported on the Assets page of the Annual statement. It includes invested assets reduced by any amount that exceeds statutory investment limitations.

Nonadmitted assets are assets that are accorded no value on the Assets page of the Annual Statement. Examples are

• Furniture, machines, and equipment.
• Office supplies
• Advances to agents.
• Speculative or low-quality securities
• Accounts receivable due in 90 days or more

Requiring the omission of certain non-liquid assets from the Annual Statement is one way insurance regulators ensure conservatism in insurer’s accounting operations.

The Annual Report

In the US, an annual report is a GAAP-based publication that a company’s management sends to its owners and other interested parties to report on the company’s financial performance during the past year. Because it conforms to GAAP, the annual report is less conservative than the Annual Statement.

The SEC requires all publicly traded companies – including stock life insurers but not required for mutual insurers – and companies that sell variable life insurance or variable annuity products to prepare an annual report so that stockholders and other investors can compare the relative merits of alternative investments.

Management Accounting

Focuses on providing financial information solely for a company’s managers. Management accounting systems use the accounting information captured by the company’s financial accounting system and then present the information in ways that are useful for company mergers.

Financial Accounting	Management Accounting
Provides data for external users	Provides data for internal users
Is required by law	Not Required
Is subject to specific accounting principles	Not specific
Emphasizes precision of data	Emphasizes flexibility & relevance of data
Has a historical focus	Forward-looking focus
Reports on the business as a whole	Reports on Whole or individual parts
Culminates in the presentation of financial statements and so is an end in itself	Helps managers make decisions, and so is a means to an end.

Two Aspects of Management Accounting are

Budgeting

Is a management accounting process that includes creating a financial plan of action that an organization believes will help it achieve its goals? A budget is a financial plan of action expressed in monetary terms that covers a specified term period. During the budgeting process, life insurance company managers and other staff make forecasts about the following values:

• Number of policies the company will sell during the budget period.
• Amount of income the company expects to earn during the budget period.
• Cost of the work that must be done to sell and administer the desired number of products.
• Cost of anticipated capital expenditures.
• Amount of benefits expected to be paid.

Three types of budgets are

Operational Budgets covers part or all of a company’s core business operations are referred to as an operational budget. The first type of operational budget that a company prepares is a revenue budget, which indicates the amount of income from operations. After preparing the revenue budget, budget planners prepare an expense budget, which is a schedule of expenses expected during the given period.

Cash Budgets projects a company’s beginning cash balance, cash inflows, cash outflows, and ending cash balance for a particular period. It provides information the insurer needs to develop its investment strategy and to conduct effective asset /liability management.

Capital Budgets shows a company’s plans for the financial management of its long-term, high cost investment proposals. Financial managers use capital budgets to analyze decisions about investing in such long-term projects and to help monitor the financial status of the company’s capital investments.

The difference between actual results and budgeted results budget variance.Management accountants prepare regular reports showing budget variances for the company, for individual departments, and for each product line.

Cost Accounting

Is a system for accumulating and categorizing expense data that is used to facilitate effective cost control and to generate accurate estimates of future costs for use in the pricing of a company’s products?

Comparative analysis is the process of comparing an expense in one period to the same expense in a different period. It can help the insurer spot cost trends, fluctuations, peaks, and valleys, but it does not explain the reasons for changes.

Functional cost analysis is the process of accumulating the costs that are involved in each activity within a function.

Activity based costing (ABC) is a method by which an insurer links its costs to its products based on the activities required to produce each product.

Auditing

Is the process of examining and evaluating company records and procedures to ensure that [1] the company’s accounting records and financial statements are presented fairly and reasonably, [2] quality assurance is maintained, and [3] operational procedures and policies are effective?

The most common type is financial audit which is an evaluation of whether a company’s financial information, financial statements, and source documents comply with accounting standards and are a fair and consistent depiction of the company’s financial condition and performance.

An insurer’s required financial statements must undergo an external audit, which is an evaluation by an auditor who is employed by a public accounting firm and who is not associated with the insurance company. The purpose of an external audit is to [1] issue an independent opinion as to whether those financial statements present fairly the company’s operations through adherence to a given set of accounting principles, [2] recommend changes to the company’s system of internal control and [3] prepare reports of audit findings.

At the conclusion of an external audit, the auditor issues and signs an auditor’s opinion, which is a statement, prepared by an independent public accounting company, that [1] expresses the auditor’s opinion as to whether the information contained in insurer’s financial statements fairly represents the operations of the company, and [2] attests that the audit was conducted in accordance with generally accepted standards.

Related to an external audit is a financial condition examination, which is a formal investigation of an insurer that is carried out by insurance regulators and is designed to identify and monitor any threats to an insurer’s solvency. During financial condition examination, examiners from the applicable regulatory agency

• Examine the insurer’s accounting records and evaluate whether the insurer is operating on a sound and lawful basis.
• Investigate the insurer’s financial and business activities to assure that they do not contain any hazards to the insurer’s solvency.

Upon completion of the examination, examiners file an examination report with the appropriate regulatory authority, which sends a copy of the report to the insurer under study. The report may suggest causes for any problems and recommend solutions to the problems. The insurer has a specified time after receiving the report, usually 30 days in US within which to respond. If the report indicates that the insurer is financially impaired, the IRA takes any necessary action to protect policy owners.