company secretarial practice

MFRS 4 insurance contracts

MFRS 111
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insurance Industry
MFRS 4 insurance contracts

1. Introduction
2 main parties in the insurance business:
1- the insured and 2) the insurer.
The insured is the individual or organization, which had agreed to contribute an amount of money and been relieved from the risks
The insurer is usually an organization, which manages the money and undertakes the risks.

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Introduction
• The insurance business can be broadly categorized into two classes, the general insurance and the life insurance.
• life insurance business is involved in life insurance policies.
• general insurance business is involved in policies other than life insurance policies such as marine, motor vehicles, fire and theft.
• Takaful -Islamic insurance, which also offers life and general insurance, but is managed according to the syariah laws. MFRS 111
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2. Definitions
• Several terms used in General Insurance Business.
• Acquisitions cost are commissions and agency related expenses incurred in securing premium on general insurance policies.
• Claims are demand by any party for payment by the insurer of a policy benefit on account of an alleged loss resulting from an event or events alleged to be covered by a policy of insurance.

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2. Definitions
• Premium is the amount payable to an insurer under a policy as consideration for the obligations assumed by the insurer. •
• Reinsurance is an arrangement whereby the re-insurer in consideration of a premium, agrees to indemnify the principal ceding insurer against the loss, or part of the loss, which the latter may sustain under the policy or policies that the insurer has written.
•
• Re-insurer is an insurer who accepts part of a risk from a ceding insurer by way of insurance.
•
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Acts, Standards and Guidelines
• The Insurance Act 1996 (the Act) regulates the operation of insurance business in Malaysia.
Section 3 of the Act, the administration and enforcement of the Act is the responsibility of
Bank Negara Malaysia (the Bank).
• BNM to make such regulations and rulings that are considered necessary for the prudential supervision of insurance licensees. The Act also influences the accounting procedures of enterprises conducting insurance business.
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Acts, Standards and Guidelines
• The Bank also issues regulations and guidelines from time to time to complement the Insurance
Act.
• GPI 3 – Guidelines of Director General of
Insurance (the Guidelines), which helps to ensure that the bank’s rules and regulations are adhered. • GPI 15, which gives an example on how the report and annual accounts are prepared.
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Acts, Standards…
• Persatuan Insurans Am Malaysia (PIAM), formed in May 1979- constitutes the statutory association recognised by the Government of
Malaysia for all registered insurers who transact general insurance business in this country. MFRS 111 9

Acts, Standards…
• MAS 3 - Accounting for General Insurance Business and
MAS 4 - Accounting for Life Insurance Business were initially established and made effective on January 1,
1992.
• With the establishment of the Malaysian Accounting
Standards Board, MASB 17 - General Insurance
Business and MASB 18 -Life Insurance Business were later produced and made effective on July 1, 2001, superseding both MAS 3 and MAS 4 respectively.

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accounting for general insurance business • The primary issues - the recognition and allocation of insurance or reinsurance contract premium, acquisition costs and claims to the accounting periods in relation to the risks.
• The Nature of Business
• General insurance is a form of insurance that gives protection of risks towards: • destruction or losses of properties caused by events such as flood, fire, theft, and accidents,
• losses of income caused by destruction of properties, and
• losses arising from compensation claims caused by injuries resulting from professional incompetence or personal liability.
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general insurance
• The types of insurance classified under the general insurance include insurance for motor vehicles, fire, marine, sea and air cargo, oil and gas, and theft.
• Insurance involves a contract between two parties, the insured and the insurer. The insurance policy exists with the contract.
• In Malaysia, the insurer must be a registered company and granted a license by the Central Bank. The contract in the policy will explain types of risks undertaken, determine events that enable claims to be made and the insurer’s obligations. The insurer does not have any obligation for events other than those determined in the contract. MFRS 111 - 12

general insurance
• The insurer will only issue insurance policy if the insured has an insurable interest and there exist an insurable risk. An insurable interest is an interest that will cause losses to the insured if a certain or specified event happens.
• As an example, a shop house insured from fire is an insurable interest to its owner, not to the general public. However, several insurable interests can exist in one property. An example may be property bought on loan. Both the owner and the lender can claim insurable interest on the property. This means that if any event stated in the policy happened and caused losses to both parties, then both parties can claim their respective losses.

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general insurance
• not all risks can be insured. In order to determine whether a risk can be considered as an insurable risk or not, several things need to be considered:
• -the possibility of loss can be estimated,
• -the amount of loss can be calculated and
• - the risk must be spread to sufficient similar cases.
• In some cases, insurance are compulsory. For example, all motor vehicles in Malaysia must have an insurance policy. When properties are bought on loan, both the properties and the buyer must have insurance policies.

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general insurance
• In some situations, the insurers may reinsure part or all of the risks to another party known as the reinsurer - reinsurance.
• Reinsurance is a contract between the primary insurance company, which originally issues a policy to a party, and the reinsurer who agrees to accept part or all of the future liabilities towards the policy issued by the primary insurer.
• As an example, assume that an insurance company issues a general insurance policy. To spread the risk, the insurance company enters into an agreement with another insurance company to transfer part of the risk. The ratio for the risk transfer depends on the agreement between both parties. One of the reasons why reinsurance is made is to spread the risk further.

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Insurers Activities
• From the accounting aspect, there are two main activities of the insurance companies; underwriting and investment.
• The underwriting process begins with determining the probability of an identified event happening, followed by collection of premium and ends with payment of claims or maturity of policies.
• In general, premium collection is done throughout the period while the claims cannot be predetermined. We also face situations where claims had been made but the payment has not been delivered.
Payment of claims usually takes some time.
• A business is considered a ‘short-tail’ business when the time needed to settle its claim is short. Usually, property damages that are easily quantified and relatively quick in settlement are considered ‘shorttail’.
• On the other hand, a ‘long-tail’ business is when the time taken to settle a claim is long due to the court’s involvement in deciding the amount of claims to be paid.
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Insurers Activities
• Personal or bodily injuries situations where estimation of awards are difficult, and property damages where the amount is not easily agreed on are typically ‘long-tail’.
• Investment -important activity for insurance companies where part of the cash obtained from premium is invested first.
• An investment manager must be efficient is managing the company’s investment so that the company can balance its liquidity and ability to pay claims while making enough profit from investment. Revenue from investment - just as important as revenue from the underwriting activities.
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Insurers Activities

underwriting

premium

investment

properties

claims financial assets acquisition costs

reinsurance

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Accounting for the Underwriting
Activities

• Underwriting activities basically involve premium collection and payment of claims.
• other factors need to be considered too, such as the acquisition costs involved, reinsurance and co-insurers.
• Accounting for Premium
• Premium is the primary source of revenue for a general insurer. • premium - the amount payable to an insurer under a policy as consideration for the obligations assumed by the insurer.
When an individual or organization buys an insurance policy, the policy holder transfers the contracted risks to the insurer. What do the insurer get in return?
MFRS 4 - 19

Accounting for Premium
• The premium - the consideration received by the insurer for undertaking the risks. It comprises premium received and receivable on insurance policies written by the insurer.
• The amount of premium is determined by an insurer so as to cover anticipated claims, administrative, acquisition and other costs, a profit component, and charges by enforcement bodies such as license and stamp duties. MFRS 111 - 20

Accounting for Premium
• The premiums collected to cover these components are revenue of an insurer on the basis that they are collected in consideration for the insurer rendering services by indemnifying those insured against specific losses. MFRS 111 - 21

Accounting for Premium
• Gross premium is the amount receivable on an insurance policy written by an insurer, adjusted for additional or return premium, but before deducting commissions, brokerage or other expenses. • Net premium is the premium receivable on an insurance policy less any premium for reinsurance ceded. Earned premium is the net premium after adjusting for movements in the unearned premium reserve.
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Accounting for Premium
• A few issues arise in accounting for premiums:
• Should all payments received be recorded as premium revenue? This is because certain payments collected are to be paid to other parties such as the brokers, agents and government. In this case, except for stamp duties, all other collections are revenue because the stamp duty is collected for the government (charged to the policy holders).
• Other charges, such as commissions, brokers fees, etc are operational costs charged to the insurer. Therefore, collections to recover the charges should be recognized as revenue. MFRS 111 23

Premium Recognition
• This problem arises because the risk coverage period is usually not the same as the accounting period. For example, the accounting period for a general insurer is from January 1 to December 31 each year. But the coverage period for the insurers clients does not necessarily be the same. Furthermore, a general insurer would have many clients with different coverage periods. In this case, premiums should be recognized in the risk coverage period, not the accounting period.
• An important assumption here - the probability of risk is spread evenly over the period although in reality this may not be true. For example, there may be higher probability of flood or fire occurring in certain seasons of the year.

MFRS 111 24

Premium Recognition
• Premium should be recognized in a financial period in respect of risks assumed during that particular period.
Practically, a date that approximates the date of risks assumed is often used. In real life, premiums are received everyday. To simplify calculation, many insurers use, for example, the middle of the month in which the policies are written as the date of the assumption of risk.
• If the premium is subject to later adjustment or if there is insufficient information available at the end of a financial period to enable accurate identification of premium, a provisional premium must be used as the base and the amount should be adjusted for any other relevant information as soon as it is available.
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Premium Recognition
• At year-end, premiums can be earned and unearned. As risk is assumed to spread evenly over the period, premium should be recognized as earned evenly over the period of risk coverage. Hence, the full amount of the premium received or receivable at the beginning of the policy period is not completely earned until the end of the policy period.
• At the end of the financial year, the portion of the premium which represents coverage of risks for the expired period of the policy is recognized as premium revenue, while the portion of the premium which represents coverage of risks for the unexpired period of the policy is considered as unearned at that date and is taken to the unearned premium reserve (UPR) account.
• The UPR is a liability account because it represents the obligation of the insurer towards the policy holder.
MFRS 111 26

Premium Recognition
• In cases where the primary insurer spreads the risks by ceding out a portion of the risks assumed under a policy to a reinsurer, a specified portion of the premium would also be ceded to the reinsurer as a consideration. • The portion ceded to the reinsurer is to be excluded from the computation of the unearned premium reserve. However, the Central Bank may require an additional provision to be included in the calculation of the UPR if the premiums are ceded to an overseas reinsurer. •
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Example
• An insurer’s financial year begins and ends on
January 1 and December 31 each year. The insurer collects RM360 from a policy holder as an annual premium payment on Jun 1 of the current year. On 31 December of that year, the insurer only earned RM210 while the balance
RM150 is taken to the Unearned Premium
Reserves (UPR) account, and will be completely earned when the policy matures on May 31 next year.
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Example
• In the above example, UPR is calculated using time passage. However, in the real world, insurers received premiums from many policy holders everyday. It would be difficult and time consuming to calculate the UPR based on the above method. Therefore, the standard and the guidelines have provided several methods that can be used by the insurers to calculate the UPR.
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Unearned Premium Reserves (UPR)
• UPR is to be computed using the method that reflects the actual liability at the balance sheet date. There are primarily two methods of computing the UPR:
• fixed percentage method
• time apportionment method

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Fixed percentage method
• The UPR is computed by applying a specific percentage to the premium (less reinsurance premiums ceded). This method assumes that policies are written evenly during the financial period. The percentages used are 25% for marine and aviation cargos, and inland transit, and 40% for other types of general insurance.

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Time apportionment method
• This method basically uses the passage of time to recognize premium revenue. There are several time apportionment methods that may be applied depending on the circumstances of the policies. The main methods:
• -the 1/365th (daily),
• -the 1/8th (quarterly) and
• -the 1/24th (monthly) methods.
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Time apportionment method
• The 1/365th method is the most accurate method where the UPR is the aggregate of the unearned premiums, calculated on a pro-rate basis, in respect of the premiums relating to the unexpired periods of the respective insurance policies at the end of the financial year. MFRS 111 - 33

Time apportionment method
• The 1/8th method - based on the general assumption that the premiums are spread uniformly over the quarter while the 1/24th method is based on the general assumption that the premiums are spread uniformly over the month and assumes that the average date of issues of all policies is the middle of that month. MFRS 111 - 34

Time apportionment method
• Time apportionment method may also be used for non-annual policies, where the coverage period may be more or less than a year. • For these policies, the time apportionment method is adjusted consistently. Once the basis is adopted, it should be applied consistently. MFRS 111 - 35

Example:
• The followings are the premiums received by a general insurer for fire insurance policy for the year 2011. The financial year of the insurer is from 1 January to 31 December each year. The premiums received are for annual coverage. MFRS 111 - 36

Date

Amount (RM)

January 3

15,480

March 24

22,350

June 20

18,900

October 11

28,230

December 30

30,860

Total

115,820

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• Required:
• Determine the Unearned Premium Reserves
(UPR) for that company using the fixed percentage method, the 1/365th method and the 1/24th method.

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Solution
The UPR based on the fixed percentage method:
UPR
= 40% x 115,820
= RM46,328
The UPR based on the 1/365th method:
UPR
= (2/365 x 15,480) + (82/365 x 22,350) + (170/365 x 18,900) +
(283/365 x 28,230) + (363/265 x 30,860)
= 84.82 + 5,021.10 + 8,802.74 + 21,887.92 + 30,690.90
= RM66,487.48
The UPR based on the 1/24th method:
UPR
= (1/24 x 15,480) + (5/24 x 22,350) + (11/24 x 18,900) + (19/24 x
28,230) +
(23/24 x 30,860)
= 645 + 4,656.25 + 8,662.50 + 22,348.75 + 29,574.17
= RM65,886.67
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Explanation
• The 365 in the 1/365th method represents the 365 days in a year. The premium earned and the UPR is calculated on a daily basis. For example, the premiums received on January 3, this year will expire on January
2, next year. Therefore, until December 31, this year, the premium has not been completely earned; the policy has another 2 days (January 1 and January 2 next year) to mature. The premium for the 2 days should not be recognized as premium revenue but as
UPR. The following time lines illustrated two premium receipt dates from the example.
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For premium received on January 3:

Earned (premium revenue)

1/1/x1

3/1/x1

31/12/x1

2/1/x2

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For premium received on October 11:
Earned (prem. rev)
UPR (283 days)

31/12/x1

1/1/x1
11/10/x1

10/10/02

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Explanation
• Under the 1/24th method, each month is divided into 2 parts; the first part is from the 1st until the 15th of each month and the second part is from the 16th until the last day of the month.
• Therefore, there are 24 parts in one year. To simplify calculations, all premiums received during the month are assumed to have been received on the 15th of that month. Thus, the premium received on January 3rd is assumed to have been received on January 15th. Until
December 31 that year, 23 parts have expired (1 in
January and 2 for each month from February until
December) while another one has not (1/1/x2 until
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15/1/x2).

For premium received on January 3:

Earned (23 parts)

UPR
1/1/x1

15/1/x1

31/12/x1

15/1/x2

Similarly, premium received on March 24 is assumed to have been received on
March 15.
Therefore, until December 31 that year, 19 parts have expired (the portion will be recognized as premium revenue) and another 5 have not (the portion will have to be recognized as UPR).
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Explanation
• As illustrated by the example, there is not much difference in the amount of UPR calculated using the 1/365th and the 1/24th method. Although the fixed percentage method is the simplest method, it usually produces a materially different amount of
UPR. The Guidelines suggest the following:

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Explanation
Business
Malaysia:

Overseas business:

in fixed percentage method (25%) for cargos and transit 1/24th method minus 20% for other policies fixed percentage method (25%) for cargos and transit
1/8th method minus 20% for other business

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