Page 172 - DCOM205_ACCOUNTING_FOR_COMPANIES_II

Unit 8: Accounting for Insurance Companies

l z No risk transfer. notes
l z Timing risk transfer only, but no transfer of amount risk – i.e., where the amount to be paid
until the contract is considered fixed or subject to minimal uncertainty, but uncertainty
exists as to the timing of the payment.

l z Retroactive reinsurance, subject to exceptions.

Notes Whether a particular accounting paradigm requires deposit accounting under
these conditions can vary significantly from one accounting paradigm to another.

Three general forms of deposit accounting currently observable are bank deposit approaches,
prospective approaches and 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. The defining characteristic is that the ending
deposit for a reporting period is dependent solely on the beginning balance, the credited rate for
the period, and any deposits or withdrawals during the period. The credited rate may be fixed or
variable, dependent on market rates or based on non-market events or rates, but the method of
its calculation is generally set in advance.
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. (Conceptually, it
is also possible for a prospective method to use a market rate that is updated for each reporting
period.)

Under this approach, the deposit value will change with the amortisation of interest, and with a
change in projected future losses (and with a change in the discount rate, if the rate is not locked-
in by the accounting paradigm).
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. This method could also conceivably
generate a negative rate if applied to a contract where the projected outflows no longer exceed
the initial inflows. Whereas the prospective approach only cares about future (except possibly for
an interest rate locked-in in the past), the retrospective approach cares about all the flows since
inception, past and future.
Under this approach, the deposit value and discount rate are subject to change whenever the
projected cash flows since inception are changed.

self assessment

State whether the following statements are true or false:

11. The defining characteristic of prospective approach is that the current value of the deposit
is not equal to the present value of future payments, irrespective of the initial deposit or
past payments.

lovely professional university 167