Page 170 - DCOM205_ACCOUNTING_FOR_COMPANIES_II

Unit 8: Accounting for Insurance Companies

Ceded reinsurance accounting: There are two general approaches to ceded reinsurance accounting notes
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.
These approaches may sometimes be combined in a single accounting system.

Example 3: U.S. GAAP treats ceded reinsurance premiums and losses as negative
premiums and negative losses for income statement purposes, but ceded loss reserves as an asset
rather than as an offset to a liability for balance sheet purposes.

The following example assumes that the relative entries in an account are added together to get a
total. For example, if a company writes $100 in direct premium and then cedes $10 in premium,
it assumes that the premium entries are + ` 100 and – ` 10. These values are then aDDeD to get
the net of ` 90. There are some accounting systems that record ceded entries as positive values,
and that always subtract ceded values in calculating totals for an account. In such a system the
premium entries would be + ` 100 and + ` 10, and the user of the information would have to
know to suBtract ceded amounts from direct and assumed amounts.

Example 4: Ceded reinsurance impact on income statement, assuming treatment as
negative insurance.
Assume the company has (and has historically maintained) a 20% quota share ceded reinsurance
contract for all direct insurance, with a ceding commission of 30%.
Assume the loss ratio on direct business is 65%, and the only direct expense is a 30% commission.
Assume the direct earned premium for the year is $100 and the direct loss reserve at year-end is
$200.
income statement
Direct Earned Premium $100
Ceded Earned Premium -20
Net Earned Premium 80
Direct Incurred Losses $ 65

Ceded Incurred Losses -13
Net Incurred Losses $ 52

Direct Commissions $ 30
Ceded Commissions -6
Net Commissions 24
Net underwriting income $ 4
Balance sheet
Direct Loss Reserve $200

Ceded Loss Reserve -40
Net Loss Reserve 160

If the accounting instead required segregated reporting of the impact of ceded reinsurance, it
may require that it be treated as a net expense in the calculation of underwriting income. In the
above example, the net cost of ceded reinsurance would be ` 1 (equal to an earned premium cost
of ` 20, less recoveries of ` 13 for losses and ` 6 for expenses).

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