Accounting Basis/Cession Basis

The flow of insurance business requires a current account system reflecting all the cessions to
reinsurance. But is it really possible to administer the day to day or policy by policy transactions ?

In order to resolve this problem and to save time and save on adminisration cost, a frequency
for preparing the accounts is established, this makes it simple to the cedant and the reinsurer.

Once the accounts are received, which periods will such received accounts be attributed to ?

Depending on the nature of treaty / business any of the 3 accounting / cession basis can be
applied by the insurer and the reinsurer.

1. Accounting or Balance Year (Clean Cut)

2. Occurrance or Accident Year
3. Underwriting Year

This is the most widely-used way of accounting insurance and

Accounting or reinsurance premiums and claims in the industry, employed
Balance Year particularly in mass –type-homogenous branches such as fire,
motor and accident. Premiums and claims regardless of their
original source date, and booked into the year of account it is open
and the time of actually entering the figures in the book.

Outstanding losses are estimated – known, reported and incurred

but not reported (IBNR) ones are as at end of the year – and
entered as a negative item. The corresponding estimate made at
the end of the previous year is brought forward as a positive item.
Also a certain portion of the premiums booked is transferred to the
next year a unearned premiums for the risks that have not yet
expired
1.1. – 31.12.2012

In Out
Premiums 2012 Claims 2012
Unearned premiums 2011 Unearned premiums 2012
Outstanding losses 2011 Outstanding claims 2012
Loss Profit

1.1. – 31.12.2013

In Out
Premiums 2013 Claims 2013
Unearned premiums 2012 Unearned premiums 2013
Outstanding losses 2012 Outstanding claims 2013
Loss Profit

The estimated entries (unearned premiums and outstanding losses)

would then also be the amounts one would receive as portfolio
entry or be asked to pay as portfolio withdrawal when and account
is distributed at the end of the balance year

In other words, when you come onto a new account that has been
running previously, you will be credited with a portfolio entry, but at
the same time you will also acquire the full liability for those risks
and losses not yet expired or paid, and which originated from
policies issued before you became a party to the account. The
same thing applies in reverse if you withdraw your support and pay
the portfolio withdrawal, extinguishing your responsibility for the
"tail" end of the business.
It goes without saying that this usually irrevocable transfer of
responsibilities, attaches great importance to the accuracy with
which the respective estimates are "guesstimated"
When the received premiums cannot be back tracked to their
Accident or source year, but the claims which are usually larger have no such
Occurrence Year difficulties, we apply occurrence year system. Here premiums are
booked as in an accounting year system, with a provision for
premium reserve for unexpired risks, often followed by
corresponding premium portfolio entries and withdrawals

The losses are allocated to the accident year (the year in which
they happened) regardless of actual date of payment. Reserves for
outstanding losses will thus also attach to the accident year and
neither will be subject to transfer to the next year, nor will there be a
loss portfolio entry or withdrawal

This method is quite common among non-proportional reinsurance

contracts. The entire statistical emphasis is placed on the contract
year and the loss actually occurring during that particular period. All
late loss payments will thus be allocated back to the contract year
in which the loss happened

The XL premium is although allocated back to the contract year

where it belongs, even though the actual adjustment may be made
quite some years later
Underwriting Year As the name says, the year in which the business was written is the
focal point for all accounting transactions referring to all and every
consequence of that particular act, no matter how far distant in time
they may manifest themselves. In this system, the claims are
effectively compared with those premiums that were paid for their
specific coverage

All that remains to be done at the end of the underwriting year is to

assess outstanding losses (reported and IBNR), deduct the
expected positive/negative premium run-off (additional or
cancellation premiums, late adjustments, cover surcharges, no
claim bonuses, profit commissions, etc.). If the reserves are
correctly estimated, should carry the contract through the entire run-
off period of the underwriting year, regardless of how long this may
take

In some cases when an underwriting year is nearly run-off, i.e.,

when enough is known that the estimates are virtually certain, it is
accepted practice to close the underwriting year by debiting the
reserve as if it were paid at the same time crediting the same
amount ti the following open underwriting year, which would then
also take on the run-off of the previous year

Other systems? There are possibilities to have a combination of any or all of the 3
systems. You can have premiums on accounting year basis with
loss allocation back to the year where the majority of the premiums
for the specific policy were booked or an XOL business in
underwriting year basis
Story Time: The three Underwriters (simplistic)
Line of Business (LOB)

Classification or grouping of insurance coverage's which provide protection for similar risks.

The major divisions are property and casualty, but the actual lines are much smaller, including
such lines as liability, automobile, fire, inland marine, worker's compensation, surety, and the like.

Many advantages were realized by this division of underwriting into separate lines of insurance.
Specialization resulted in a high degree of proficiency.

Different Lines of Businesses are:

• Property

• Casualty

• Engineering

• Marine

• Credit & Surety

• Aviation

Property consists of

 Main LOB >> LOB >> Sub Line 1

 Property >> Fire Insurance >> Material Damage, Business Interruption

 Property >> Special Risk >> Fine Art, Burglary, Cash in Safe

 Property >> Natural Catastrophe >> Earthquake, Storm, Typhoon, Flood etc..

Follows “Accounting Year” system since it is usually short tail business.

Casualty consists of

 Main LOB >> LOB >> Sub Line 1

 Non-Life Accident >> Personal Accident, Workmen’s Compensation >> Travel Accident,
Motor Accident

 Liability >> Liability Gen, Professional Liab >> GTPL , D&O Liab

 Motor >> Motor TPL, Motor Hull

Follows “Occurrence Year” system since it is usually long tail for claims settlement.

Engineering consists of
  Main LOB >> LOB >> Sub Line 1

 Engineering >> Single Risks, Annual Risks, Miscellaneous >> Contractors All Risks,
Erection All Risks, Machinery Breakdown, Computer/Low Voltage

Follows “Underwriting Year” system since it is usually long tail business.

Marine consists of

 Main LOB >> LOB >> Sub Line 1

 Marine >> Cargo, Hull, Energy, Liability >> Cargo Containers, Bulk, Pleasure Craft,
Tankers, Goods in Transit, Fishing Vessels, Gen Liab

Follows “Underwriting Year” system since it is usually long tail business.

Credit & Surety consists of

 Main LOB >> LOB >> Sub Line 1

 Credit & Surety >> Commercial Credit, Surety, Financial Guarantee >> Contract Bonds,
Customs Bonds

Follows “Underwriting Year” system since it is usually long tail business.

Aviation consists of

 Main LOB >> LOB >>

 Aviation >> Liability, Hull, Miscellaneous

Follows “Underwriting Year” system since it is usually long tail business.

General overview of LOBs

1. Aviation Insurance:

Insurance of accident and liability risks, as well as hull damage, in connection with the operation
of aircraft.

2. Burglary, fidelity, allied LoBs:

Insurance against burglary, breaking and entering, robbery, embezzlement; also includes water
damage, glass breakage, damage to and loss of jewellery or damage or losses in connection
with the keeping of animals.

3. Business Interruption (BI) / Loss of profits:

Insurance against the financial effects of a loss on a company's income. The insurance covers
overhead costs (interest, salaries, etc) and lost profit. This business is mostly included in the
corresponding insurance class (Principally fire and engineering ins).

4. Casualty Insurance:

LoB mainly comprising accident and liability. In the US, this term is used for non-life insurance
other than fire, marine and surety.

5. Credit Ins:

Insurance against financial losses sustained through the failure, for commercial reasons, of
policyholders' clients to pay for goods or services supplied to them.

6. Directors and officers (D&O) liability ins:

Liability ins for directors and officers of an entity, covering their personal legal liability towards
shareholders, creditors, employees and others arising from wrongful acts such as errors and
omissions.

7. Disability Ins:

Insurance against the incapacity to exercise a profession as a result of sickness or other infirmity.

8. Employers liability Ins:

Insurance taken out by employers covering employees against injuries arising from their
employment.

9. Engineering Ins: Ins covering the construction and erection of objects, and the insurance of
machinery in operating plants.

10. Financial guaranty Ins:

Financial guaranty insurance indemnifies for losses whenever a borrower of issuer of a debt
instrument fails to fulfil his monetary obligation under a financial contract.

11. Fire Ins:

Insurance against fire, lightning or explosion; it can also include insurance against windstorm,
earthquake, flood, other natural hazards and political risks.

12. Liability Ins:

Ins for damages a policyholder is obliged to pay due to bodily injury or property damage caused
to another person or entity based on negligence, strict liability or contractual liability.

13. Marine Ins:

Line of ins which includes coverage for property in transit (Cargo), means of transportation
(except aircraft and motor vehicles), offshore installations and valuables as well as liabilities
associated with marine risks and professions.

14. Motor Ins:

Line of Ins which offers coverage for property, accident and liability losses involving motor
vehicles.

15. Personal accident Ins:

The Ins of persons against illness accident, invalidity and death, as well as against the resulting
financial loss. This area also includes annuity Ins.

16. Professional indemnity Ins:

Liability ins cover which protects professional specialists such as physicians, architects,
engineers, lawyers, accountants and others against third party claims arising from their
professional acclivities; policies and conditions vary according to profession.

17. Property Ins:

A collective term for fire and BI ins as well as burglary, fidelity and allied lines.

18. Surety Bonds:

Surety ship is a specialised line of loss protection where one party guarantees performance of
an obligation by another party.

19. Surety Ins:

Sureties and guarantees issued to third parties for the fulfilment of contractual liabilities.

Few Terms to know

1Q. Premium ?

The payment, or one of the periodical payments that the policyholder agrees to make for an
insurance policy for covering the risk or losses.
2Q. Reinsurance Premium?

The payment, or one of the periodical payments that the Insurance company agrees to make
for an Reinsurance policy for covering the risk or losses.

3Q. Treaty Period ?

The period where the reinsurance agreement comes in force till a stipulated time. Its usually
for 1year after which the tty period would be renewed or cancelled as per the new agreement.
Ex – Calendar year or deferred year (01.01.2007 – 31.12.2007 or 01.04.2007 – 31.03.2008)

4Q. Policy Period ?

Specified period during which an insurance policy is in force. The period where the policy
holder insures his property,etc., to the insurance company. Many insured leads to many and
different policy period. Ex – Vehicle insurance (many insured with insurance period starting from
different dates).

5Q. Written Premium ?

Premiums for all policies written/sold during a specific accounting period.

6Q. Paid Premium ?

The total amount of premium paid by the insurance company for the reinsurance
treaty.

7Q. Earned Premium ?

The Premiums which are earned for one particular treaty period year and not for the policy
period / Portion of the premium covering the period of time already used, i.e. if a one-year policy
has been in effect six months, half of the total premium has been earned.

8Q. Unearned Premium ?

It is that portion of the premium which has been collected, but has not yet been earned, since
it will be used to cover the risk until the expiry of the policy in the next business year.

9Q. Return Premium ?

Part of the deposit premium refunded to the insured if a policy is cancelled, if benefits are
reduced or if the adjustment indicates that the initial premium was too high.

10Q. Portfolio Withdrawal ?

The unearned premium and the unpaid losses (in form of reserves) that do not belong to one
accounting period have to be transferred from the books to know the actual position of the treaty
at the end of the accounting period. Such withdrawn premium and losses are known as portfolio
withdrawal.

11Q. Portfolio Entry ?

 The unearned premium and unpaid losses which were withdrawn has to be accounted for in
the next accounting period where they belong to at the beginning of the year.

12Q. Clean Cut ?

Practice of transferring premium and loss portfolios from one year to another. After making
all the necessary booking for one year. No bookings or entries must be made in that particular
year again (The accounts for that period has been cut after the necessary bookings). Here
each Accounting year is clearly distinguished from one another.

13Q. RunOff ?

Run-off is the opposite of clean cut. Here we keep making entries in one insured period, till
we have received all the premium and have settled all the losses completely for that particular
year.

14Q. Long Tail business ?

A type of business in which claims take a long period of time to occur or be settled.
Insurance business where claims stemming from injury or damage occurring years earlier can
be presented for coverage long after the policy has expired.

15Q. Short tail business ?

Insurance business in which claims are reported and settled in a relatively short period of
time. Note: A short tail is usually available for no longer than a year.

16Q. Profit Commission ?

It’s the agreed commission, based on the treaty result (profit / loss) paid by the reinsurer to
the cedant.

17Q. Accounting year?

Year in which a particular premium or claim is accounted for.

18Q. Underwriting year?

Treaty year in which a contract was written or renewed

Portfolio Entry & Withdrawal

 Portfolio Entry should always be accounted in the first month of the insured period (e.g.
2009, 1 of 12)

 If cedent provides the portfolio Entry in the quarter, then, the accounting period for the
portfolio Entry will be the same as the accounting period defined in the Administration
Condition for such quarter.
  The due date should be as per condition agreed between UW/CM and cedent.

 If this information is not available, a default number of 90 days from the beginning(in
case of portfolio entry) and end (in case of portfolio withdrawal) of the quarter/accounting
period should be the due date.

 Existing loss reserves should be nullified, when Portfolio Withdrawal is booked.

 Portfolio Withdrawal should always be accounted in the last month of the Insured Period
(e.g. 2009, 12 of 12)

 If cedent provides the portfolio withdrawal in the quarter, then, the accounting period for
the portfolio withdrawal will be the same as per the accounting period defined in the
Administration Condition for such quarter.

Loss Reserves

 Loss reserves are reserves for losses which have in fact occurred and been reported by
the policyholder by the closing of the books but have not yet been paid.

Unearned Premium

The unearned premium is that portion of the premium which has been collected by the closing of
the books but has not yet been earned, because it will be used to cover the risk until the expiry
of the policy in the next business year.

Example

Business Year 1.01.2005-31.12.2005

Cover period of policy X: 01.07.2005-30.06.2006

On 31.12.2005 only half of the period of the cover has elapsed. This means that 50% of the
premium has been earned at 31.12.2005 & 50% of the premium must be set aside for the period
of cover remaining (1.1.06-30.06.06).
Unearned Premium-Calculation Methods

1. Flat-rate method

2. Pro rata temporis method

3. Fractional methods

 The 24th system

 The eight system

Flat-rate method

 The flat rate method is based on assumption that the policy expires are evenly spread
over the business year, with certain percentage of the written premiums accordingly
being set aside at the end of business year.

 This method is often used in practice, although technically it is not absolutely perfect.

 Example: 40 % of the premium is set aside at the end of the Business year.

Pro rata temporis method

This is the most accurate method of calculating the unearned premium in a portfolio, since the

reserve is determined individually per policy. Since this method is laborious and generally
requires good IT infrastructure, it is not very commonly used.

Calculation Formula

Period of the policy in the next year (number of days) X Annual premium

Total policy period ( normally 360 days )

Fractional methods

 The 24th system : is based on a portfolio in which the expiry of policies each month is
fairly evenly spread. The assumption is thus that policies in the same month expire
halfway through that month. A business Year has 24 half-months.

 Example: A business has 24 half months. On 31 December (at the end of the business
year) 23/24ths of the premiums from January have been earned, i.e. 1/24th is regarded
as the reserve (unearned premium)

Fractional methods

 The 8th System: This method is based on the amounts of premium ceded quarterly. The
average maturity is fixed in the middle of the quarter and only that fraction of the
 premiums which corresponds to the period from the middle of the quarter to the end of
the accounting period is considered as earned.

 Average policy incepts in the middle of each quarterly period and expires in the middle of
each quarterly period of the next year.

 Therefore for the 1st quarter, ½ quarter of premium remains unearned at the end of the
treaty year i.e. 1/8th; for the 2nd Quarter 1 ½ quarter of premium remains unearned i.e.
3/8th.

 This method is also reasonably accurate & simple to calculate.

Depends on average policy period of 12 months.

Premium Reserve Deposits:

• The premium reserve deposit is only in case of Proportional treaties.

• It is an arrangement where the reinsured retains a percentage share (as agreed in treaty
slips) of the reinsurance premium & the same is released in the next accounting year
same quarter along with percentage of interest.
• This kind of deposit is not desirable from the reinsurer’s perspective & should be avoided
unless required by local regulations.

• Local regulations are the government bodies who imply on their domestic insurance
companies to set aside certain percentage of premium as premium reserve deposit,
when the domestic insurance company reinsure business with foreign reinsurers.

• As protection against the cancellation of original business to ensure the payment of

losses,

• The loss reserve deposit is common in case of Proportional & Non- Proportional treaties.

• The loss reserve deposits represent the amount required to meet liability for outstanding
losses.

• They are calculated as a percentage of the outstanding losses. erg., 90% or 100%