What is Unexpired Risks Reserve?

In most cases policies are renewed annually except in some cases where policies are issued for a shorter period. Since insurers close their accounts on a particular date, not all risks under policies expire on that date. Many policies extend into the following year during which the risk continues.

Therefore on the closing date, there is unexpired liability under various policies which may occur during the remaining term of the policy beyond the year and therefore, a provision for unexpired risks is made at normally 50% in case of Fire Insurance and 100% of in case of Marine Insurance. 

This reserve is based on the net premium income earned by the insurance company during the year

Reserve for unexpired Risk:

For Marine Business = 100% of net premium income
For others = 40% of net premium income
(Income tax authorities allow even a provision of 50% of net premium income from other sources)

What is Re-insurance?

If an insurer does not wish to bear the whole risk of policy written by him, he may re-insure a part of the risk with some other insurer. In such a case the insurer is said to have ceded a part of his business to other insurer. The reinsurance transaction may thus be defined as an agreement between a ‘ceding company’ and ‘reinsurer’ whereby the former agreed to ‘cede’ and the latter agrees to accept a certain specified share of risk or liability upon terms as set out in the agreement. 

A ‘ceding company’ is the original insurance company which has accepted the risk and has agreed to ‘cede’ or pass on that risk to another insurance company or a reinsurance company. It may however be emphasised that the original insured does not acquire any right under a reinsurance contract against the reinsurer. In the event of loss, therefore, the insured’s claim for full amount is against the original insurer. The original insurer has to claim the proportionate amount from the re-insurer.

There are two types of reinsurance contracts, namely, facultative reinsurance and treaty reinsurance. Under facultative reinsurance each transaction has to be negotiated individually and each party to the transaction has a free choice, i.e., for the ceding company to offer and the reinsurer to accept. Under treaty reinsurance a treaty agreement is entered into between ceding company and the reinsurer whereby the volume of the reinsurance transactions remain within the limits of the treaty.

Journal entries relating to re-insurance business ceded to and by an insurance company

A re-insurance business transaction may be defined as an agreement between a ceding company and re-insurer, whereby the former agrees to cede and the latter agrees to accept a certain specified share of risk or liability upon terms as set out in the agreement. The accounting entries pertaining to re-insurance business ceded to and by an insurance company may be explained with the help of an example given below:

(X insurance company cedes re-insurance business to Y insurance company and Z insurance company cedes re-insurance business to X insurance company.) Accounting entries pertaining to re-insurance business ceded to and by X insurance company in the above example may be given as follows :

1. Re-insurance Premium (on re-insurance ceded) Account Dr.
To Y Insurance Company
(Being premium on re-insurance business ceded to Y insurance company recorded)

2. Z Insurance Company Dr.
To Re-insurance Premium (on re-insurance accepted) Account
(Being premium on business ceded by Z insurance company recorded)

3. Y Insurance Company Dr.
To Claims (on re-insurance ceded) Account
(Being claims receivable from Y Co. for part of insurance business ceded)

4. Claims (on re-insurance accepted) Account Dr.
To Z Insurance Company
(Being claims on re-insurance business accepted from Z Company recorded

5. Y Insurance Company Dr.
To Commission (on re-insurance ceded) Account
(Being commission due on re-insurance business ceded to Y insurance company recorded)

6. Commission (on re-insurance accepted) Account Dr.
To Z Insurance Company
(Being commission due on re-insurance business ceded to Z Company debited)

How compute premium income, claims expense and commission expense?

Premium income : The payment made by the insured as consideration for the grant of insurance is known as premium. The amount of premium income to be credited to revenue account for a year may be computed as:

Premium received on risks undertaken during the year (direct & re-insurance accepted)-
Add : Receivable at the end of year (direct & re-insurance accepted)-

Less : Receivable at the beginning of year (direct & re-insurance accepted) -

Less : Premium on re-insurance ceded: –
    Paid during the year –
    Add : Payable at the end of year –
    Less : Payable at the beginning of year –
=Total Premium income –

Claims expenses: A claim occurs when a policy falls due for payment. In the case of a life insurance business, it will arise either on death or maturity of policy that is, on the expiry of the specified term of years. In the case of general insurance business, a claim arises only when the loss occurs or the liability arises.
The amount of claim to be charged to revenue account may be worked out as under : 

Claims settled during the year—direct & re-insurance accepted –
(including legal fees, survey charges etc.)
Add : Payments to co-insurers

Less : Received from co-insurers and re-insurers –
=Net payment –
Add : Estimated liability at the end of the year –
(After deducting recoverable from co-insurers and re-insurers)
Less : Estimated liability at the beginning of the year –
(after deducting recoverable from co-insurers and re-insurers)
=Claims expense –

Commission expenses: Insurance Regulatory and Development Authority Act, 1999 regulates the commission payable on policies to agents. Commission expense to be charged to revenue account is computed as follows:

Commission paid (direct & re-insurance accepted) –
Add : Commission payable at the end of the year –
(direct & re-insurance accepted)
Less : Commission payable at the beginning of the year –
(direct & re-insurance accepted)
=Total Commission expense –