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Unit 13: Audit of Banking and Insurance Company

IRDA set out to change this. In the first set of Regulations that came out in 2000, it was required Notes
that the companies recognized the Premium income over the contract period or the period of
risk, which, simply meant, proportionately.

Example: If `3,650/- is collected for a vehicle insurance policy that commenced on 18th
th
Sept, 2003 to expire on 17 Sept, 2004, the revenue recognizable is ` 1,950/- for the financial year
ending 31st Mar, 2004, as the policy runs its course for 195 days out of 365 days in the current
financial year. The balance of ` 1,700/- is to be kept as unearned premium, as it is attributable
and allocable to the succeeding accounting period.
Perhaps, the idea germinated from the perception that in the days of high-end computers and
sophisticated methods of accounting, any percentage adhocism in provisioning was not necessary
and that the revenue accounting could be almost realistic.

IRDA’s fresh set of regulations of 2002, possibly realizing that the earlier Regulations on this
score were found ‘complicated’ by the existing and the new insurers alike, sought to grant an
escape route by bringing back the ‘adhoc regime’, by saying that though the premium recognition
should still to be on ‘accrual’ basis, the minimum of URR should be at percentages prescribed.
However, the problem is far from over. First of all, there is an all important point that has been
missed by the rule-framers and not also queried by rule-followers. The URR provision, basically,
is on the “Net” basis. For this, only percentages, however adhoc they may seem, can work.
Pro-rata recognition of revenue is possible only on “Gross” premiums.

This is, essentially because, the Reinsurance programmes are not policy wise, except for very
major ones. They are, mostly, on treaty basis and the underwriting year for reinsurance markets
will be blatantly different from the financial year basis that we might be following.
The actual manner in which the whole premium accounting and RI cessions accounting works is
too mind boggling to be wished away with any simplistic solutions in the name of bringing in
any ‘seeming realism’. Many insurers, taking advantage of the situation that ‘actual accrual’ can
never be worked out correctly, simply continue adopting ad-hoc percentages, claiming that
they are the ‘minimum’.
Now, there are myriad practical problems that are encountered by the companies in recognizing
the revenue but, the responsibility of auditors is to see that the Regulation is followed
scrupulously or if not followed, reported accordingly. If one peruses the published annual
reports of the insurance companies for 2002-03, it can be seen that most of the auditors have
conveniently maintained silence on this. What is worse, some nationalized insurers have blatantly
changed the rules of the game to suit their convenience during 2001-02 and 2002-03, resulting in
huge difference to bottom lines, without eliciting any adverse comment from the auditors. This
is perhaps the only industry, where lower business volume in a year can actually result in
higher profits because of the ‘reserve release’ factor. Unless the auditors understand the tricks
that can be played by the managements in this, it will not be possible for them to be true and fair
to themselves let alone to the shareholders.
For the first time, a new concept called ‘Premium Deficiency’ was brought in by IRDA. Again a
measure for augmenting policyholders’ funds, it mandated that if the sum of expected claims
costs, related expenses etc. exceed the URR, the said excess is to be recognized as Premium
Deficiency. It is a fact that neither IRDA has attempted to explain the concept of this Premium
Deficiency or the methodology of providing the same nor any Insurance Company really appeared
to be unduly bothered on this. Some companies have opined that there was no premium deficiency
in their companies while some simply ‘disclosed’ certain sums, even though the regulatory
need was to recognize the same in accounts. However, the interesting aspect is that in most

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