Ethiopian Institute

of Financial Studies

Ethiopian Institue of
Fiancial Stdies
(EIFS)

Insurance Accounting

August , 2019

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of Financial Studies

Expectation
1.
2.
3.
4.etc…

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Outline of the Training

Day 1 Theoretical background for insurance accounting

Day 2 Balance sheet and valuation of assets and liabilities

Day 3 Revenue Account , Profit and Loss, and Change in

Equity
Day 4 Reinsurance transactions and insurance financial
statement analysis

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Objectives:
• To understand:
- the theoretical background, peculiar nature and principles of
insurance accounting
- Comparing the practice of insurance accounting with that of the
theories and principles and identifying the gap
• To construct insurance financial statements
• To pursue the why and how part of analyzing the insurance
financial statements
• To give way as to how the result of the analysis could be used in
decision making
- Policy formulation
- Strategy development
- Ensure safety, soundness and stability of the insurer (Increase
earnings per share)
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Agenda - Day 1:
Theoretical background for insurance accounting
1. Introduction – in brief
2. Conventional Accounting – in general
3. Insurance Accounting(SAP) and the difference
with that of conventional accounting
4. Recent developments in the field, taking
financial economic concepts into account.
5. Modifications of some of GAAP as applicable
to insurance
6. Summary

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1. General Framework for Insurance Accounting

Insurance
Accounting

Insurance

Risk
Management

Risk

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2. Background
i. Insurance:
- Expensive and prestigious field of study

ii. Insurance accounting:

- Impenetrable goo
- However, since we do not have complex
insurance operations, the accounting practice
is not that complex.

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iii. Types of Conventional Accounting

- Service accounting
- Merchandise accounting
- Cost accounting
- Financial accounting
- Management accounting
- Fund accounting

We add on this list

- Insurance accounting

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iv. What makes insurance accounting different

from conventional types of accounting
- Financial institutions are established at the mercy of the
general public
- Front end payment of premium and rear end collection
of claims
- Philosophy:
- Trust is from the side of the insured public and
- Promise is from the side of the insurer
- Creates gap in service delivery and revenue realization

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Discussion question
What if the public lose trust and confidence in
the financial institutions or an insurer fail to keep its
promises?
- No body will go to banks and insurance
companies
- No money/fund would not be mobilized
- No credit facility would be available
- No investment
- No employment
- Economic growth of the nation would be
retarded
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Concluding remark
- Financial institutions in general and
insurance in particularly are
highly regulated business all over the
world to:
- Protect the interests of
the Policy holders
- ensure trust and
confidence of the public in the
sector

-
Policyholders interest protection is
therefore, guided by law,
regulation and other related
secondary proclamation or directives 11
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- Then- Statutory Accounting Principles(SAP)

emerged

- Interest Protection – Demonstrate using Balance

sheet

Interest Protected by

Shareholders External auditors

Management Internal auditors

Policyholders Supervisors/Regulators

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v. Underlying Assumptions:
Insurance accounting presupposes
basic knowledge and skill on :
a) Insurance:
- principles, concepts and
practices(skills)
b) Conventional accounting:
- principles, concepts and
practices in general
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3. Insurance– in brief

Reaction!!!

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A) Theorem for Insurance:

Insurance depends on two things:
i. Risk
- It is impossible to know about insurance
without first having prior knowledge
about insurable risks
- If there is no risk, no need to talk about
insurance and Insurance accounting
- Like money is for Banking, risk is for
Insurance (M for B and R for I)

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ii. Economy
- The whole purpose of the
financial system,
including insurance, is to
support the economy
- No economy means, no
insurance
- Spiral effect/ reverse effect

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B) Definition
i. Shareholders:
- Business
- Business model (primary, secondary, tertiary)
- Objectives:- maximize EPS or ROE
- Shareholders should not maximize their profit at the
cost of the policyholders as this would create conflicting
interest
– Therefore, the need to properly account
transactions to ensure equitability
and fairness

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ii. Policyholders:
- Peace of mind
- Insured buys peace of mind and they always expect
insurers to discharge their promises
- Therefore, adequate reserve (premium and claims)
should be maintained
- Construction of policy holders
statement

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iii. Insurance technicians/professionals:

-
Risk transferring mechanism
-
When one buys insurance,
premium would be paid that
triggers accounting for Premium
- Front end collection of
premium but the service
rendered on going
basis until the agreed
period come to and end.

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iv. Lawyers:
- Contract:
- Solitary vs Allitairy
- Contract of adhesion
- Contra preferentum rule (The doubt of
the interpretation goes in favor of the
insured person)
- Consensus ad idem (meeting of mind,
intention)
- Claims in dispute should be
maintained 100%

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V. Scholars/ Academicians:
- The process of dealing in risk and risk management
- Financial intermediary (Contractual) like:
- Depository
- Contractual
- Investment Companies
- mobilize fund from
- money markets
(open
market) -
Mutual companies-
(in a group)
- invest it (not loan)

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- Therefore, insurers are public money

administrators
- Need arises to fulfill there promises to the
public

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Sector Profile

Observation
- Very small market =
USD$300million.
- The market is steadily growing and
average growth in premium 15%

- Endowed with big Potential to grow

- No real challenges, crises or
systemic risks

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- Growing but not developed well

i) Infrastructure:
- Branch, Agent, Mobile technology, online sales

ii) Products and services:

- Underwriting, Claims, risk management ,
investment, Actuarial services, Los
adjustor services, reinsurance etc..

iii) Capability
- Low level of awareness about insurance
- Community people tend more to traditional risk
coping mechanism such as Idir
Iv) Trust and confidence
- People do not trust insurance as they suppose
to pay premium in advance
- Consumer protection mechanism is necessary
(Insurance regulation)
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2. Accounting in General:
2.1Definition:
Accounting is "the art of recording, classifying, and
summarizing in a significant manner and in terms of money,
transactions and events which are, in part at least, of
financial character, and interpreting the results thereof”
Source: AICPA
Accounting is “ the language of a business”.

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Summary of the definition – signifies the accounting cycle

The process/art of:
- Identifying transaction
- source document/objectivity
- Classifying
- A, L, C, R,E
- Recording,
- journals
- Summarizing,
- ledgers (subsidiary and
controlling), Pre closing Trial
balance
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- Adjusting
- Assets with revenue – Earned
premium and unearned premium
- liabilities with expenses
(Reserves for outstanding
claims), and
- their ultimate effect on profit or
loss and on capital
- Closing
- All temporary accounts. i.e.
revenue and expenses
- Reporting
- Financial statements ( B/S, P or L,
Capital statement, cash flow and
revenue account)

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Remark:
Take real accounts (balance sheet) or post closing
trail balance to begin the new year operation. The
cycle continues.

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2.2 Basic Principles (GAAP)

a) Accounting Entity:
- Independent and separate from its
owners
- What does the practice looks in our case?
b) Going Concern:
- will be in operation indefinitely
- A single claim may affect the going
concern of an insurer
c) Monetary Unit :
- stable currency is going to be the unit
of record

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d) Time-period :
- Financial year (July 01 – June 30)
- Interim periods
- economic activities of an enterprise
can be divided into artificial time
periods
e) Historical cost :
- report based on acquisition costs
rather than fair market value
- Favored for objective evidence
f) Revenue recognition :
- Accrual basis of accounting.
- Any difference between recognition
and realization? 30
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g) Matching principles:
- Expenses have to be matched with revenue
- How do you consider commission particularly
on life insurance and long term agreement
insurances?

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h) Full disclosure :
- Information is presented in the
main body of financial statements, in
the notes to statements or as
supplementary information
- Transparency to:
- Shareholders and
Potential investor
- Tax authority
- Regulators
to support informed decision
- Part Seven of the IBP 746/2012
- Disclosure of information and
examination of insurers

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i) Objectivity :
- based on objective evidence
Example:
- The recognition of revenue should be based on verifiable
evidence such as the delivery of goods or the issue of
invoices
- How does insurers make cat. reserve?
j) Materiality :
- Significance of an item should be
considered when it is reported

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k) Consistency :
- uses the same accounting principles
and methods from year to year.
L) Conservatism :
- when choosing between two solutions,
the one that will be least likely to
overstate assets and income should
be picked
- Is insurance need to be more
conservative? discuss

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3. Insurance Accounting
3.1 SAP vs. GAAP
i) Going concern vs. Liquidation
- a single claim can destruct an insurer
- A single claim can wipe out the entire
resources of an insurer

- If an insurer liquidates to day, is the

resource( asset) enough to
accommodate the obligation (claims).

ii) Conservatism Vs. Prudence

IBNR, cat. Reserve, equalization
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iii) Accrual Vs. Fund/Cash – with modification

modified cash basis and accrual basis
iv) Matching -
- with modification Commission
to intermediaries
- income earned as received in
the case of life insurance
v) Objectivity for some reserves such as Cat.
risks

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- Statutory requirements
For certain accounts (Pro’n. No. 746/2012)
- Art. 2(2)- Admitted assets
- Art. 2(3)- Admitted liability
- Art. 19 -25 -Different
prescription
- Art. 48- NPNC
- Art. 54- Manner of
transacting reinsurance
transaction
- etc..
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Remark
-
Conventional Accounting
Principles alone are not enough
to construct insurance
financial statements.
- SAP Specification
- Insurance accounting has its own
peculiar characteristics and
principles

- That is why it stands as a

discipline like any other
profession
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3.2 Basis of accounting

i. Cash basis

ii. Accrual basis

- Choice of the accounting basis for insurers:

Guided by the philosophy to ensuring the
insurers ability to pay its obligation from its
resources i.e. solvency.

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i. Cash Basis
- Cash accounting is simply looking at cash on hand
- Meaning: All Receipt less all payments
- It focuses on physical movement of cash
- This can be very misleading – Considering
issues of
i. Solvency:
- Cash on hand does not mean
individual or company is solvent
ii. Payables:
- Bills/payables/claims exceed cash in
hand and may come due in the next
day/period
iii. Receivables:
- On the other hand income may be
expected/receivable/premium but not
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• Therefore, due to at least these reasons, we can

not directly apply only cash basis accounting for
insurance transaction

• Options:
Hence we need to modify cash basis
accounting in to accrual basis accounting

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ii. Accrual accounting:

a. Focus:
- logical movement of cash (not physical)
b. Meaning:
- Take adjustment to cash position
taking into consideration of all
outstanding:
- Receivables, and
- Payables
- This gives a more accurate picture of
financial position

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Exercise:
• As at June 30, 2015, an insurer has reported a cash
balance of around Birr 3 billion. On the same date
claims that has already admitted and in process is
estimated around Birr 4 billion. The insurer has also
reported premium receivable of around Birr 2 billion.

• Required:
1. Assuming the insurer has no receivable, what is
the solvency position ?

2. What is the overall solvency position of the

insurer?

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Cont’d
For example: June 30, 2015
- Cash on hand 3 billion
- Payables 4 billion
- Balance (deficit) 1 billion
- Receivable 2 billion
- Final Balance-surplus 1 billion

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a. Interpretation:
- Positive cash balance is not always
mean that the Co. is solvent
- Physical movement of cash alone
cannot determine the solvency
position
- the combination of both physical
movement and logical movement of
cash determines the solvency position

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b. Advantage:
i. Accrual accounting permits
matching of earned income to
incurred costs and
expenses(outgo)
ii. The balance sheet will
show:
- Actual cash balance
- assets (in the form of receivable)
- liabilities (in the form of payables)
- If logical assets exceed
logical liabilities, the
company is solvent
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iii. Revenue account

will show:
-
income,
-
outgo and
-
changes in non-cash items

throughout the year

-
If logical income exceed
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Discuss

i. An insurer can be profitable but may

be insolvent
ii. An insurer can be in loss but solvent
iii. An insurer can be solvent and
profitable as well

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iv. Reconciles:
Balance sheet with revenue account
i) Receivable with income,

Account receivable Dr.

Income Cr.
ii) Liability with expenses

Expense Dr.
Accounts payable Cr.

.
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4. Recent developments in the field

a) Nomenclature of statements
Old IFRS
Nomenclature Nomenclature
Balance sheet Statement of financial position

Profit or loss Statement of comprehensive

income
Capital statement Statement of changes in equity

Cash flow Statement of cash flow

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b) GAAP to IAS - IFRS

i. GAAP (National standard)- Historical

- UK
- American,
- Russian,
- Chinese
- All countries influenced by
British or under the colony of
British use British GAAP and so
on.

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ii. Criticism on GAAP

- Comparison among countries
becoming difficult
- Does not support the Globalization
theory of free flow of capital and labor
- Deters FDI
- Do not facilitate accession to WTO
- Therefore, IAS emerged to minimize
the misalignment
- FASB: Professionals from more than 100
countries came together and developed IAS
and IFRS

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iii. International Accounting Standard - IAS:

a. Have been replacing national
accounting standards i.e. National GAAPs
b. National GAAP shifted to International
standards (IAS)
c. Underlying premises:
- Globalization: Free flow of
- Capital (FDI)
- Labor
- Comparison of statements
becoming essential to make the
free flow decision (labor,
Capital, asset, etc)
- New standard becomes so essential
i.e. IAS
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iv. Criticism on IAS

- the standards are not only about
accounting
- it is about financial reporting,
which is broader than reporting
- “Accounting” in IAS has been changed
to FR “Financial Reporting” of IFRS

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Q. What is the difference between “Accounting”

and “Financial Reporting”
• Accounting:
- An art, book keeping/recording of transactions on A, L, C, E and R and
reporting .
- Therefore, produces information

• Finance:
- Analyzing accounting statements (historical performance and future
inclinations) and make decision
- Satisfy certain legal duties and responsibilities (Tax)

- Formulate strategy, managing and controlling

• Link/Connection
- Accounting is an essential part of finance. It is a sub-function of finance.

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c. IAS and IFRS

Note:
- IFRS does not replace IAS nor says that IAS is
irrelevant
- Those issues still not addressed by IAS are
covered by IFRS as well.
- IFRS make the international accounting
standards more comprehensive
- It is still in the process of developments

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d.Basic shifts brought by IAS and IFRS:

From Book value to market value, which is
believed to fairly represent the
entity’s value

Q. Discussion
Is it book value or market value that explains the
companies real value?

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e. Challenges of IFRS
- Agreement quite difficult to reach
- GAAP is still in effect in some
countries
- The need to harmonize laws
- Accounting practices
- Matured factor for valuation

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f. Ethiopian development:
- Banks, Insurance companies, MFIs
shall adopt IFRS by June 30, 2018
Art. 26 (746/2012): Financial reports
The National Bank may direct insurers to prepare
financial reports in accordance with international
financial reporting standards, regardless of the
changes in their designations or their replacement,
from time to time.
 Proclamation 847/2014: Financial Reporting
-Established Accounting and Auditing Board of Ethiopia (AABE)

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Q. Discussion Questions:
Why SAP focuses on prudence and liquidation
principle instead of directly following going
concern and conservatism?

- A single claim may wipe out the entire

resources and may cause insolvency

- More reserve is essential to ensure going

concern and to deliver the promise to ph.

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vi. Emphasis by IFRS:

a. Shift from revenue account to
balance sheet
- Earlier, what matters was the
bottom line of P&L
statement
- Challenge:
balance sheet items can swing
dramatically, so more volatility
likely

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b. Shift from Book Value to Market

values
- Greater emphasis on market
values of:
- assets, and
- liabilities

Q. What does this mean for our market?

discuss

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5. Accounting application to insurance

i. Insurance accounting:
- follows same principles as
accounting in general
- Follows accrual accounting
- Matching income to
outgo
- But, SAP plus
ii. Key feature is that increase in reserves is
taken as expense in the year

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iii. “Inverse product cycle”

- is what makes insurance different
from other business (service,
merchandising, cost etc..)
- Premium - Front end collection
- Trust is the philosophy
from the side of the PH
- Claims (Value of service) - rear end
- Promise is the philosophy
from the side of the
insurer

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iv. Life insurance,

- increase in actuarial reserve is
accounted for as expense

- Actuarial reserve may be as

much as 95% of total
liabilities

- Premiums are taken into income

as paid

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Discussion Questions:
a. No concept of “earned” or
“unearned” premium in life
insurance. Comment
b. What is the source of technical
provision for life insurance?
c. What is life fund?

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v. Non-life insurance,
- Earned premiums enter into
revenue account
- Unearned premiums are
liability on balance sheet
- Other liabilities include claims
processed but not yet paid and
Incurred by Not Reported
(IBNR) claims
- Again, increase in liabilities is
expensed

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vi. Three sets of books

a. Background:
- Ideally, should be one set
of books for all users
- But, could be different
depending on different
users
Q. Who are the major user of financial
statements?
- Shareholders/Investors/
General users
- Employees
- Tax authority
- Regulator/NBE
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b) Different users require different books of

accounts that gives rise to
separate :
- Balance sheet,
- Profit or loss accounts, and
- Reconciliations become necessary
when preparing these
different books of accounts.

Q. From what perspective do we need to

look into these three books?

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i For investors and general users

a. Assumptions
- “Best estimate”/ Conservatism but
generally margins for
adverse deviations
permitted
b. Consideration:
- All assets and liabilities at face
value
c. Objective
- to give fair picture of company’s
financial situation without
undue conservatism or optimism

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ii. For prudential regulators

a. Assumptions
- Prudence (Conservatism
plus)
b. Consideration
- Only “admitted assets”, “admitted
liabilities” are considered in the
calculation of solvency margin.
For example, assets which can be
used for claims, intangibles,
goodwill etc.
- Our experience- Directive
No. ISD 25/2004

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- Catastrophe and
equalization reserves
permitted
c. Objective:
- Ensure Stability (safety
and soundness) and
solvency continued
viability of entity and
future ability of payment of
claims

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iii. For Tax authorities

a. Assumptions
- No hidden conservatism
b. Consideration
- Discounting with interest
for life IBNR reserves
- Limitations of initial
expense amortization for
life insurance
C. Objective:
- maximize tax take

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• Take aways for the theoretical background for

insurance accounting
• Understand:
- Risk as basis for insurance
- Insurance as one of a risk management mechanism
- Some of the definition of insurance that gives way to construct
insurance financial statements
- Insurance principles and practices
- Conventional accounting principles and practices
- The difference between GAAP, IAS and IFRS
- GAAP application/modification for insurance accounting
- The legal prescription for insurance accounting(SAP)
- Solvency that need to be maintained on going basis
- Why three sets of books
- Insurance accounting= Conventional Accounting + SAP
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Agenda of Day 2
1. Balance sheet
2. Valuation
2.1 Assets valuation
2.2 Liability valuation

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1. The balance sheet

i. Basic equation:
A = L + C and Surplus
ii. Assets classification:
- Current and fixed
- Marketable and depreciable
- Earning and non-earning

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iii. Liability:
- Main items should be
a) For life insurance:
- Actuarial liabilities
- First calculate the risk (R)
R = fXs
f = number of death
S = average cost of the
death
- Discount the value
b) For non-life insurance:
- UPP
- method 1/12, 1/8, 1/24, 1/365 or flat rate
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Q. How can we be sure that UPP is adequate

enough to accommodate future claims?

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- IBNR

- Claims admitted but not yet paid (o/s)

How is the practice?

“Go through again” version
- If this item is excessive, shows
company is not paying claims
rapidly, could indicate liquidity
problem

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iv. Capital and surplus consists of

- Paid in capital
- share premium/PIEP
- Surplus/Retained earnings
a) Free reserve: 10% of net
income
b) Retained earning:
-100% from profit

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-Most of the surplus generated each year

should belong to with profits policyholders

-Articles of Association should fix formula

-Proportion can go to shareholders, subject

to maximum permitted

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2. Valuation -
a) Definition:
- Determination of the economic value of
an asset or liability
- Specifies the value of assets, liabilities
and net worth on the balance sheet date
b) How are they valued?
- Valuation depends on the method the
company adopted, Book value or market
value
- In any case the method applied should
be applied consistently (consistency
principle)
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- Traditionally
- based on book value,
- assumptions- value do not change
from year to year
- Current practice
- move towards change assumptions
based on market conditions at each
valuation

- This can give rise to very volatile

balance sheets

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2.1 Asset valuation

2.1.1 Characteristics of assets
Before valuation of the assets, it should be essential to
know the type and characteristics of the assets itself:
A) Financial assets,
a. Why Financial – because it can
easily flows in and flows out of
the organization very easily
b. Why asset - because it has value (any
thing that has value is asset)

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c. Types:
i. Money
-Definition:
Commonly accepted as
medium of exchange
-Example:
- Coins,
- Currency notes,
- Bank deposits
- Stamps
- Checking account

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ii. Investment in Equity

Definition:
- Claims against profit or from sells
proceeds upon liquidation
Example:
- Common stock,
- Preferred stock

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iii. All debt security instruments

Definition:
Debt = credit or loan
Security = guarantee
Example:
- Treasury bill
- Bond
- Promissory notes
- Commercial papers
- CDs,etc..
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Characteristics:
- Do not provide a continuous stream of
services to the owners as does fixed assets
- They serve as a store of value (purchasing
power)
- They can not be depreciated physically (do
not wear out)
- Their physical condition (form) is not
generally relevant in determining their
market value (price)

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- They are fungible (can be easily changed in

form and interchanged with or substituted
for other assets).
- Low cost of transport & storage.

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B) Fixed/ Tangible assets

i. Definition:
- Assets that have a physical
characteristic/location
- Example:
- Buildings, inventories,
vehicle, computers and
equipment, etc.

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C) Receivables
- Agents’ balances:
- Arise due to pre-payment of
commission, to permit agents’
incomes to be smoothed out
- These balances are
unrecoverable if
agent leaves
- These balances should be
written off if unpaid
after about 3 months

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D. Premium receivable:
- In insurance, coverage is
contingent of payment of premium,
i.e.
- paid in cash, not on credit
- If premiums remain unpaid, policy
remains in force during
“grace period” (usually 30 days),
with a possibility of
- reinstatement within
say 3 months if still unpaid

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- If premiums remain unpaid beyond

this date, they should not count as
an asset or receivable,
- Policy should lapse, generally
without value for non-life,
as paid-up policy in some cases for
life insurance
- Surrender value
- Whole paid up but reduced
sum insured
- Whole paid up but extended
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Market definition for assets

Asset Market
Money
TB and promissory Money market
note
Receivables Factoring or asset
management market

Equity investments Share market

Debt securities/bond Bond market
Fixed asset/property Property/ estate market 94
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2.1.2 Valuation method

i. Book value method

a. Book Value:
- Traditionally assets were
held at book value
- meaning:-
Book value is cost price
of asset, with some
adjustments

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b. Fall in Book value:

Reason: when impairment to value
considered “permanent”,
Effect: Book values could be written
down

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c. Rise in book value:

Reason:
- like inflationary situation

- Book value of assets that

has risen in value could be
increased artificially by
selling it and rebuying it at
higher price

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d. To avoid capital gain issues and then not to

consider the unrealized value as an income
the rise in value goes into “Investment
Reserve Account” (IRA)

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- For example:
- Case 1:
- The book value of the net asset of the insurer
rise by Birr 1 billion :
- Required:
1. Pass the entry
2. Rationalize the effect

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Solution 1:
- Asset increased by same amount
- Revenue recognized but not realized raised
by same amount
Asset Dr.
IRA Cr.

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Solution 2:

- Impact:
- EPS increase
- The value of the company in the
quoted market rises
- dd for share of the company rises
- Value for the company increase

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Case 2:
- The book value of assets of a company fall by
Birr 500million

- Required:
1. Pass the entry
2. Rationalize the effect

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Solution 1:
- Value of asset fall
- IRA fall by the same size

IRA Dr.
Asset Cr.

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Solution 2:

- Impact:
- EPS decrease
- The value of the company in the
quoted market falls
- dd for share of the company falls
- Value for the company falls
- Insolvency threat

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e. Transfers from IRA permitted, which

allows recognition of realized, but
not unrealized, capital gains
Example:
Book value = 100m
Sold = 120m
Realized gain = 20m

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• Pass entry:
Cash 120m
Asset 100m
Gain 20m
Effect:
Asset increased by 20million
Tax paid on capital gain

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ii. Market Value Method Market value:

a) definition
the price given to certain asset on
the market
b) market value

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Asset Value
Money Face value
Receivables NBE Directive on provision for
doubtful debts
Equity - Quoted on market or traded on
investments without much lose of their values
- NBE Directive
Debt Bond market
securities/bond Kept at maturity ( at amortized value)
Fixed Property values
- Professionals who valued
asset/property the property of a given
company
- professionally liable for wrong
doings 108
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Concluding remark:
- Book value method may not represent the
true picture of the company’s net worth.

-Fall in book value

- May cause reluctance to recognize
assets that has lost value, because loss
is hidden if security continues to be held
(could give rise to negative IRA)
For example;
While actual market price of the total share of the Company
is 30million, the Company may continue to hold the share
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 IFRS Requirement:
- Generally requires market accounting
for assets
- Obligatory for:
i. Assets held for trading
ii. Equities held for trading
iii. Fixed income assets can be
designated as “to be held to
maturity” and held at
amortized value
- Purpose:
- Eliminates artificiality of book value, but still leaves
some discretion.

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2.2 Liability valuation

- Leading Questions:
- What is the value of liability on
the balance sheet date?
- First see types of liability

2.2.1 Types of liability (See Balance sheet)

i. Technical provisions
- Claims
- Premium
- Actuarial liability/life fund
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i. Claim cycle:
Accident
happens

Reported Not
reported

Claim
processed IBNR

Claim
approved

Claim Claim IBNER

paid outstanding

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Claims (or loss) reserves, based on

claims cycle are:

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i. Incurred but not reported (IBNR)

- What is the value of IBNR on the
balance sheet day?
-
Most uncertain reserve
-
Most difficult to calculate
-
Simple IBNR calculation
- Number of claims per day
times average
claims size times
average delay in
reporting
- Or calculate as 114
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Demonstration:
a) Statistical Method
- Number of claims per day (f) = 3
- Average claim size (S) = 100,000
- Average delay (d) = 5 days

IBNR = 3 X 100,000 x 5= Birr1.5million

Note:
Risk = F X S
IBNR risk = f X s x d

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- Suitability of the formula:

- the formula works well if claims
report quickly (e.g. automobile
collision, travel insurance) and
settlement process does
not go beyond year
- If this is not the case, more
complex methods, such as
triangular methods or
Ferguson-Bornhuetter
methods should
be employed

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b) Triangulation;

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c) Statutory Requirement
Ethiopian Experience:- IBNR
- 10 % of net earned premium or
Triangulation results, which ever is
higher

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Discussion Questions:
Q. What if an insurer ignores IBNR?

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Case 1:
- Claims has already been incurred
- However, It has not been reported to the
company, however,
- If the company ignores:
a. Provision for IBNR is not maintained
in the given period,
b. Expense understated,
c. Profit inflated,
d. Profit tax charged,
e. Dividend will be paid out.

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Case 2:
- Latter on:
- The claim appears,
- No reserve was made against
IBNR claims,
- The company has no source of income
to pay out such losses
- mismatch between income and
expenses
- And yet the claim has to be paid
- incase of shortage of liquidity the
company losses its credibility and
reputation,
- Loss of customers,
- Killer risk to the company could likely
occur
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ii. IBNER
 Development of loss reserves
 Initially the loss reported and little about the
ultimate loss was known
 Some amount paid and some are still remains
outstanding during the year and at the end
 The loss development continues over the year in
the same pattern
 It takes many years to develop d losses are for
any year
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Therefore, IBNER, requires critical accounting consideration:

- Claims in process will normally be estimated as case
reserve
- If paid claims turn out to be close to case reserves,
no need for additional action
- If case reserves consistently underestimated,
then additional statistical reserve required to
correct this

Q. How do you evaluate the practice in your company

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iii. Case reserve

- Alternatively, only large claims
can be assessed by case
reserve (Case by case method)
- Loss adjustor role
- Smaller claims can be treated
statistically by looking at past
pattern of claims payment and
adjusting for trends in claims
reporting.
- The method reduces cost as
compared
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Cont’d
iv.Outstanding claims:
- Claims approved but not yet
paid
- Add up approved claims
- If this reserve unusually
high could indicate
liquidity problems or
inefficiency in claims
handling
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v. Incurred claims
a. Incident occurring period
- Accidents which actually
happened during
the accounting
period
- When to pay is not an
issue but when
incidents occur

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Incurred  Paid claims

claims =  Minus claim brought forward (O/s
beginning)
 Plus:
- Claims carried forward
(O/s-ending)
- Change in IBNR
- Change in IBNER

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Allocating losses to years in which they occurred –

2008 loss year
2014 2015 2016

- Total paid during the year = 100

- Losses paid in 2015 for:-
- losses in 2014 – B = 60
- losses in 2015 – C=40
- Losses outstanding in 2015 – D = 80
- Losses incurred in 2015 – C + D = 120

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• Exercise:
In 2015 an insurance company reported net earned
premium of Birr 300m. In the same year the company
paid 100m that contains claims brought forward of Birr
60million from 2014. Moreover, the claims incurred but
not been paid in 2015 was reported Birr 80m.
Regulatory requirements set out that IBNR shall be
15% of the net earned premium. To make deficiencies
in outstanding claims the company held provision of
15% of the outstanding claims (assume o/s claims
amounting to Birr 200 million for 2015).

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• Required.
1. Calculate the claims incurred for 2015
2. Calculate the claims ratio

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a) What does large volume of outstanding claims

indicate
- Liquidity problem, which leads cash
flow underwriting but not risk underwriting
- Inefficiency in claims settlement which leads
to loss of customers
- In the worst case both are killer risks

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• See the claims Schedule

- Lesson: Constructed to reach Incurred claims

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Final Remark on Claims

- Depends on Claims cycle:
• Paid
• IBNR
- Remember how to determine it (formula or 10% of net earned
premium)
- IBNER
- To make up deficiency in claims reserve, case by case method
or statistical method
- Outstanding claims
- Case by case method or statistical method (remember the use of
professionals LA, actuaries)
- Incurred claims =
- Paid – beginning outstanding + ending outstanding + IBNR +
IBNER
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2. Reserve on premium

a. Gross premium equals sales result of

company
b. Net premium = Gross premium - Cession
(premium to reinsurance)
- Important to put net premium in
appropriate year for accrual
accounting

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 Net premium account divided in

to two:
- Part of the premium would be
earned and reported in the
revenue account
- Part of the premium would be
unearned and
reported in the balance
sheet as liability
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 Unearned premiums provision (UPP):

How it occurs?
- Mismatch between accounting period and
policy period
- policy could be sold in any one moment during the
year.
- Accounts, however, should be closed at June 30
(Legal requirement)
- A policy sold on January 1, should be closed at
June 30 for the services rendered and the
premium earned
- Unearned part of the premium transferred to the
next accounting period to cover claims that might
arise for the unexpired risks
- This would drive the calculation of actual income
earned during the accounting period
- Presupposes the application for matching of
expenses (incurred claims mainly) with that of
income (earned premium mainly)
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Allocating premium to appropriate year

2014 2015 2016

A B
C D

UPP in 2014= B = BF into 2015

UPP in 2015= D = CF into 2016

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 What does it indicates?

- Annual premiums paid in 2014
and 2015
- 2014 premium covers
accidents happening in 2014
and 2015 (A + B)
- 2015 premium covers
accidents happening in 2015
and 2016 (C + D)

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Demonstration of 1/24th method

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 Net earned premium (NEP)

NEP = NP + UPPbf – UPPcf

See Premium Schedule

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Exercise:
In 2015 and 2016, an insurance company
reported gross written premium of Birr 380m
and Birr 400m respectively. The average cession
is equal to 25%. 40% of the net written premium
of the preceding year was carried forward to the
current period. From the current period net
written premium an amount equal to Birr
120million (as calculated using 1/24th method)
has been carried forwarded to 2017. In the year
2016, the company incurred claims amounting to
Birr 260m.
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Required:
1. Calculate the net premium
2. Calculate UPP brought forward
and carried forward
3. Calculate the retention ratio
4. Calculate earned premium
5. Comment on the method used to
calculate UPP in 2015
6. Calculate loss ratio and comment.

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No. Item 2016 Disclosure

(in mil’s
Birr)
1 Gross premium 400
2 Cession 100 25% of 400
3 Net premium 300 (1 -2)
4 UPPbf 114 (380 – 95)*40%=114
5 UPPcf 120 Given - as calculated using 1/24th
method

6 Earned premium 294 (3 + 4) – 5

7 Incurred claims 260
8 Loss ratio 88.4% (7/6) loss making business

Comment:
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• Premium schedule

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A. PREMIUM
SCHEDUAL- Ethiopian Institute
GIDB A1 of Financial Studies Page 11
Insurer:
Year:
Quarter: In '000 Birr
1 2 3 4 5
Accident
ITEM Employer's
Aviation Burglary and Engineering
liability***
(GPA and PA)
1. PREMIUM
1.1 Gross written from - public 0
- insurers
- reinsurers
Total Gross premium 0 0 0 0 0
1.2 Cession
1.3 Net (1.1-1.2) 0 0 0 0 0
2. UNEARNED PREMIUM PROVISION (BF)
2.1 Gross
2.2 Cession
2.3 Net (2.1-2.2) 0 0 0 0 0
3. UNEARNED PREMIUM PROVISION (CF)
3.1 Gross
3.2 Cession
3.3 Net (3.1-3.2) 0 0 0 0 0
4. OTHER- PREMIUM PROVSIONS(BF)*
4.1 Gross
4.2 Cession
4.3 Net (4.1-4.2) 0 0 0 0 0
5. OTHER- PREMIUM PROVISIONS (CF)*
5.1 Gross
5.2 Cession
5.3 Net (5.1-5.2) 0 0 0 0 0
6. EARNED PREMIUM
6.1 Gross (1.1+2.1-3.1+4.1-5.1) 0 0 0 0 0
6.2 Cession (1.2+2.2-3.2+4.2-5.2) 0 0 0 0 0
6.3 Net (1.3+2.3-3.3+4.3-5.3) 0 0 0 0 0
7. NUMBER OF POLICIES
8. SUM INSURED- ALL POLICIES
9. NUMBER OF LAPSED POLICIES
10.SUM INSURED- LAPSED POLICIES
11. NUMBER OF POLICYHOLDERS
Note: See notes to the statement.
* Specify the type of other premium provisions 145
** Inward premium from domestic insurers in the case of private insurers and includes inward premium from foreign companies in the case of EIC
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Claims Schedule

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B. CLAIMS SCHEDUAL-GIDB:B1 Page 14
Insurer:
Year Ethiopian Institute
Quarter: of Financial Studies In 000' BIRR
1 2 3 4 5
ITEM Bur. & house
Accident Aviation Engineering Employer's liability
breaking
1. PAID
1.1
Gross
1.2 Cession
1.3 Net (1.1-1.2) 0 0 0 0 0
2. OUTSTANDING CLAIMS:BF
2.1 Gross
2.2 Cession
2.3 Net (2.1-2.2) 0 0 0 0 0
3. OUTSTANDING CLAIMS:CF
3.1 Gross
3.2 Cession
3.3 Net (3.1-3.2) 0 0 0 0 0
4. IBNR:BF
4.1 Gross
4.2 Cession
4.3 Net (4.1-4.2) 0 0 0 0 0
5. IBNR:CF
5.1 Gross
3.2 Cession
3.3 Net (5.1-5.2) 0 0 0 0 0
6. OTHER CLAIM PROVISIONS: BF
6.1 Gross
6.2 Cession
6.3 Net (6.1-6.2) 0 0 0 0 0
7. OTHER CLAIM PROVISIONS:CF
7.1 Gross
7.2 Cession
7.3 Net (7.1-7.2) 0 0 0 0 0

8. INCURRED CLAIMS
8.1 Gross (1.1-2.1+3.1-4.1+5.1-6.1+7.1) 0 0 0 0 0

8.2 Cession (1.2-2.2+3.2-4.2+5.2-6.2+7.2) 0 0 0 0 0

8.3 Net (1.3-2.3+3.3-4.3+5.3-6.3+7.3) 0 0 0 0 0
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2. Life Insurance Reserve

a) Same as accounting for general

insurance in general
- Asset
- Liability
Except for deduction of increase in
actuarial liabilities.reserves when
calculating profit

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b) Life Fund
Case 1: Increase in Life Fund
- Life fund 2015 = 4,500,000
- Life fund 2016:
- Number of death = 100
- Average cost of claims =
50,000
- Actuarial reserve =
5,000,000
• Increase in life fund 50,000 (5,000,000-4,500,000) is
accounted as an expense for the period
• How is the management of the life fund? 149
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Case 2: Decrease in Life Fund

- Life fund 2015 = 4,500,000
- Life fund 2016:
- Number of death = 80
- Average cost of claims =
50,000
- Actuarial reserve =
4,000,000
• Decrease in life fund (500,000) transferred and
accounted to revenue account provided actuarial
attestation is secured.
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 In some jurisdictions (eg Ethiopia), insurers

sets up life fund in which the reserves and
corresponding assets held.

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c) Premiums enter income when due and

paid
d) Investment income enters when due
- Unit linked products – investment linked
- Index linked products – inflation linked
- no splitting between earned and
unearned premiums (Do you agree?)
- Bulk of reserve is actuarial liability,
which requires complex actuarial calculation

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e) Claims
i) Outstanding
- should be small, as admitted
claims should be paid
quickly
- Complex underwriting but
simple in claims handling and
settlement
ii) IBNR and other reserves
- Should also be small, based on
past experience in delay
in reporting

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3) Revenue account
- The premium story and the claims
story all about the construction
of revenue account
- Premium account represents all
revenue from operation and
ends up with earned premium
- Claims account represents all out
go from operation and ends
up with incurred claims
- The difference between total revenue
and total out go is underwriting result
(surplus or deficit)
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- Management expenses
- Commission net ( paid to
brokers and agents
and received from
reinsurers)
- Ultimately ends up with u/w
surplus or deficit

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Net Revenue Account (policy holders account)
of Financial Studies

No. Item All class of

Business

1. NET EARNED PREMIUM (Income) 294

2. NET CLAIMS INCURRED (outgo) 260
3. MANAGEMENT EXPENSE* 10
4. COMMISSION:
4.1 INSURANCE: Incurred 6
4.2 REINSURANCE- Earned :
4.2.1 Premium 1.2
4.2.2 Profit 0.8
4.3 NET COMMISSION [4.1 - (4.2.1 + 4.2.2) ] 4
5. UNDERWRITING RESULT (1-2-3+4.3) 20

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Agenda of Day 3
1. The Profit and loss statement–
2. Capital and surplus – components
3. How the balance sheet and revenue account are
linked – profit and loss account, retained earnings
etc
4. Reinsurance transaction

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- Profit and loss statement

- Starts by taking the bottom line of
revenue account- Underwriting
surplus(Loss) plus
- Investment income, plus
- Other miscellaneous income
- Underwriting account and
investment account generally
reported separately

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- To see income from operation and

income from other sources
separately
- Losses on underwriting account made up
for by gains on investment account
- see the statement for details of the
expenses

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• Profit or loss statement

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F. STATEMENT OF
Ethiopian Institute
of Financial
COMPREHENSIVE Studies
INCOME-
GIDB:F
Insurer
Year
Quarter In 000'Birr
Current Preceding
No. ITEM Quarter/year Quarter/year Remark
1Income:
1.1 Underwriting result 0
` 1.2 Income from Investment:
1.2.1 Dividend income*
1.2.2 Interest Income
1.2.3 Rent Income

1.2.4 Others (specify)

1.3 Total Investment Income(1.2.1 to 1.2.4)

1.4 Other non-investment income

1.5 Capital gains or loses(specify)

1.6 Total Income(1.1+1.3+1.4+1.5)

2Expenses:

i) General and administrative:

2.1 Salaries and employee benefits (non-management)
2.2 Administrative and general (attach schedule)
2.3 Office Rent
2.4 Ordinary general meeting expense
2.5 Interest expense
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Change in equity
 Description:
 The term describes value of the business after
the total claims of creditors are subtracted from
the asset
 Purpose:
 To reconcile the owner equity at the beginning
of the year with equity at the end of the year
 Capital and surplus is composed of
 Paid-up share capital and
 Retained earnings
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• Components include:
1. Beginning owners equity
2. Plus net income
3. Minus dividend
4. plus contribution received by business
5. Minus contribution distributed to others
6. Equals change in retained earnings/contributed
to capital
7. Ending owners capital (Cost value method)
8. Adjustment for change in asset values
(Ending market value – Cost value) – (Beginning
market value – Cost value)
9.Ending owner equity (Market value basis 163
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Change in equity
1 Balance at beginning of the quarter/year Current Q/Y Preceding Q/Y

2 Add:
2.1 Paid up capital
2.2 Share premium
3 Sub Total
4 Net income (loss) for the quarter/year
less:
4.1 Dividends declared to shareholders
4.2 Legal reserve
4.3 General reserve(Specify)
5 Sub Total
6 Retained profit for the quarter/year(4-5)
7 Balance at the end of the Quarter/year (1+3+6)
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• Link
- between revenue account, profit
and loss, balance sheet and change
in equity

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• Revenue account
- Begins with - net earned premium
- Ends with Underwriting result(Surplus/Deficit)
• Profit and loss statements
- Begins with - Underwriting result
- Net income or net loss
• Retained earning statement
- Begins with - Beginning capital
- Ends with - Retained earning that includes net income
or loss, to ending capital
• Balance Sheet
• Ending capital

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Net Revenue Account (Policy holders account)

No. Item All class
1. Net earned premium 18.2
2. Net claims incurred 12.4
3. Management expense 0.6
4. Commission 2.8
5. Under writing result (1-2-3+4.3) 2.4

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Profit or loss statements

Underwriting result 2.4
Investment income 6.7
Other income 2.3 11.4
Expenses 6.3
Profit before tax 5.1
Tax 0.9
Profit after tax 4.2
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Change in Equity
1 Equity at the beginning of the year 19.6
2 Net income for the year 4.2
Less: Dividend 2.5
3 Retained earning 1.7
4 Equity end of the year (1+3) 21.3

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Balance Sheet
2016 2015
Asset:
Cash 4.9
Financial asset 105.0
Others 25.6 135.5 117.8
Liabilities:
Current liability 10.0
Technical reserves 104.2 114.2 98.2
Capital and surplus:
shareholders 8.8
Retained earnings 12.5 21.3 19.6

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Segmentation
 Life and non-life
- Assets and liabilities for life and non-life
insurance business need to be
separated(Proclamation No.746/2012)
- Class of business
- Revenue account for all classes of
business should be worked
out separately and
independently.
• See Premium schedule
Q. Why Segmentation?

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Reinsurance (Cession) transaction

 RI defined
 It is a risk transferring mechanism from an insurance
company to another insurer/reinsurer
 Is insurance of insurance
 An insurance company pays premium to a reinsurer for
the risk transferred
 The reinsurer pays claims when occurred
 All these transactions are in a pre decided
proportion/treaty agreement.

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Purpose:
- Capacity
- Spreading
- Catastrophe cover
- Solvency (capital maintenance)
- Technical assistance (underwriting new business,
withdrawal, pricing, training and capacity building
etc.)

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• Why do we need a reinsurance accounting?

- U/w and accounting are inextricably/inseparably
related
- They are two sides of the same coin
- Together they determine the financial
performance of the reinsured and the
reinsurer

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For insurers:
- A statement of account is summary of
ceding companies transaction of:
- Premium and claims
- For class of business
- For a period of time
- They are the records of transactions
between the parties to a RI contract

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For Reinsurers:
- Information contained in the RI account is
required by the reinsurer to enable it
prepare:
- A/c for its own retrocession
- Financial statements (profit and loss,
Balance sheet etc..)
- To file returns to regulators
- Provide data for assessment of technical
reserves and for preparation of underwriting
statistics and evaluation of each treaty
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Reinsurance allocation

Forms of reinsurance
a) Treaty
- Proportional

- Surplus treaty
- Quota share treaty
- Non proportional

- Excess of loss (Exl)

- Stop loss

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b) Facultative
- Proportional
- Surplus treaty
- Quota share treaty
- Non proportional
- Excess of loss (Exl)
- Stop loss

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• Reinsurance accounting started from the point

of allocating premium and loss

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- Example of Surplus treaty:

- Reinsurance treaty- Effective January
1st 2015:
- An Insurance Company
concluded a surplus treaty
agreement with Africa Re, Swiss-
Re and Arig-Re with 2lines,
3lines and 4lines respectively.
The Company has capital and
free reserves of Birr 10million
that allows it to retain per risk to
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• January 10:
- The insurer has accepted a building
with a sum insured of Birr 5million.
The premium was agreed 10 per mill.
Subsequently, a fire occurred and
destructed 80% of the building.

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Instruction:
- Allocate:
- the sum insured,
- the premium, and
- the loss between the R/Is and the
direct insurer
- Pass the entry in the books of the
insurer

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Surplus treaty:
• SI = 5million
• Retention = 500,000
• Premium = 10 per mill
• Loss = 80%
• R/I arrangement:
- 1st surplus= Africa Re = 2lines
- 2nd surplus = Swiss Re = 3lines
- 3rd Surplus= Arig Re = 4lines
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Solution

Reinsurance allocation
treaty lines SI Proportion Premium= Loss=
50k 4m
3rd 4lines 2.0m 2/5= 40% 20k 1.6m
surplus

2nd 3lines 1.5m 1.5/5 =30% 15k 1.2m

surplus

1st surplus 2lines 1.0m 1/5=20% 10k 0.8m

retention Retention 0.5m 0.5/5=10% 5k 0.4m

5,000,000 100% 50k 4m
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• Entry Premium:

Ceded premium Birr 45

Due to Africa RE Birr10
Due to Swiss Re Birr15
Due to Arig Re Birr20

- Entry Claims:
Due from Africa RE Birr0.8
Due from Swiss Re Birr1.2
Due from Arig Re Birr1.6
Ceded claim Birr 3.6

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Exercise – 1
1. EIC issued a fire and lightening policy for a
building with a sum insured of Birr40million
and charged a premium of 1/mill on the sum
insured. The Company has arranged a
reinsurance program of 1st , 2nd and 3rd surplus
treaty with reinsurers X, Y, and Z for 5 lines, 4
lines and 6 lines respectively. EIC’s retention
capacity from this risk was Birr3million (One
Line) only. During the policy period, a fire
accident (insured peril) damaged 80% of the
building.
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Required:
1.Allocate the share of the exposure (sum
insured) to the direct insurer and the reinsures.

2.Allocate the premium share to the direct insurer

and the reinsures.

3.Allocate the share of the loss to each of the

rinsurers and the direct insurer.

4. Pass the entry

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Premium Loss
Treaty Lines Sum insured (40,000 or (32mil or
Sum proportion 1/1000 * 80% of
insured 40mil) 40mil)
3rd sur. (Z) 6 lines 10mil 10/40= 25% 10,000 8,000,000

2nd Sur. (Y) 4lines 12mil 12/40= 30% 12,000 9,600,000

1st sur. (x) 5lines 15mil 15/40 = 37.5% 15,000 12,000,000

Retention 1line(3million) 3mil 3/40= 7.5% 3,000 2,400,000

Total 40,000,000 100% 40,000 32,000,000

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Entry Premium:

Ceded premium Birr 37

Due to x Birr15
Due to Y Birr12
Due to Z Birr10

Entry Claims:
Due from X Birr12m
Due from Y Birr9.6m
Due from Z Birr8m
Ceded claim Birr29.6

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Excess of loss – Demonstration

R/I program:
• RI A – 1st EXL= 100,000 in excess of 10,000
• RI B – 2nd EXL= 90,000 in excess of 110,000
• Loss reported = 300,000

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EXL Loss sharing

nd
2 EXL 90,000
st
1 EXL 100,000
Retention 10,000
Total 200,000

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Comment:
1.How about the remaining 100,000 loss?
- Will be borne by the direct insurer

2. Effect: Burden on solvency margin

3. Cause: Inadequate R/I program

arrangement

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• Exercise 2:
An Insurance Company in Ethiopia arranged excess of
loss treaty with Reinsurers A, B and C for the risk it
accepted under its Aviation Hull Insurance as follows.
- Reinsurer A: 1st excess of loss, Birr3million in excess
of Birr2miliion
- Reinsurer B: 2nd excess of loss, Birr5million in
excess of Birr5million
- Reinsurer C: 3rd excess of loss, Birr7million in excess
of Birr10million
The Company issued Aviation Hull Insurance Policy to
its client for a plane with the sum inured of
Birr20million. Unfortunately, the plane crashed and
total loss was reported to the Company.

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REQUIRED:
1. Determine the loss distribution between the
direct insurer and the reinsurers.

2. How much of the loss is born by the direct

insurer? Comment on the Company’s
reinsurance arrangement.

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Loss sharing
EXL
rd
3 EXL 7,000,000
2nd EXL 5,000,000
1st EXL 3,000,000
Retention 2,000,000
Total 17,000,000

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• Comment:
- How much of the loss borne by the
direct insurer
- 2mill retention plus 3million not
reinsured value ( in total
5million)
- However, the retention capacity is
only 2million
- The company failed to arrange
adequate reinsurance
program.
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Premium Bordereaux
• Purpose:
• To record each cession of premium to the
reinsurance treaties so that:
• Premium can be allocated easily to
reinsurance
• There is a convenient list of cessions that can be
used as the basis for allocating claims
• Statistics may be compiled easily
• Reinsurers are aware of the type of business
that they are accepting
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Claims bordereaux:
• Purpose:
• To record each claim to be recovered from the
reinsurance treaties so that:
- Claims can be recorded correctly from
reinsurers
- Statistics may be compiled easily
- Reinsurers are aware of the losses they are
being asked to pay and can establish
adequate reserves.

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Summary
Insurer Cedes Business to Reinsurer

Premiums

Claims

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Reinsurance accounting

Insurer Cedes Business to Reinsurer

• Initial Premium of Reserve transfer
• Annual Premium
• Investment Income
• Risk Charge
• Commission Allowance
• Expense Allowance
• Claims
• Reserve Increase

• Profit Commission or
Experience Rating Refund

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Final result:
Due to reinsurer
Due from reinsurer
Reinsurance account

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E. REINSURANCE ACCOUNT SUMMARY-GIDB:E3

Insurer Page 24

Year

Quarter In 000' BIRR

11 12 13 14 15
Motor Pecuniary Others* Total
ITEM Own D. Liability Sub total Proceeding Quarter
1. INCOME:
1.1 Claims Paid(B3-1.2) 0
1.2 Outstanding claims BF(B3-3.2) 0
1.3 Outstanding claims CF(B3-3.2) 0
1.4 IBNR BF (B3 -4.2) 0

1.5 IBNR CF (B3-5.2) 0

1.6 Other claims provision BF(B3. 5.2) 0
1.7 Other claims provision CF(B3 -6.2) 0

1.8 Amount earned (1.1+1.3+1.5+1.7-1.2-1.4-1.6)=(B3-8.2) 0 0 0 0 0 0

2. OUTGO:

2.1 Premium paid(A3-1.2) 0

2.2 Unearned premium BF(A3 - 2.2) 0
2.3 Unearned premium CF (A3 -3.2) 0
2.4 Other premium Provision BF(A3 -4.2) 0
2.5 Other premium Provision CF(A3-5.2) 0
2.6 Amount incurred(2.1+2.2+2.4-2.3-2.5)=(A3 - 6.2) 0 0 0 0 0 0

3. COMMISSION FROM REINSURERS (D3: 4.2.3+ 4.3.4) 0

4. NET REINSURANCE ACCOUNT (1.8+3-2.6) 0 0 0 0 0 0
Note: 1. See notes to the statement.
4=underwriting surplus for cession account
2.6 = Incurred costs to the reinsurers(Outgo)
1.8= Earned income from the reinsurer
2.6/1.8 = Loss ratio for cession account
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K. REINSURANCE - Placement Summary - GIDB:K Page 32

Insurer
Year

Quarter

In 000'Birr

Insurance Retention Treaty placement Facultative placement Exposures not reinsured

No. Class of Business

Sum insured Premium Sum insured Premium Sum insured Premium Sum insured Premium Sum insured Premium

1 Accident
2 Aviation
3 Burglary and hose breaking
4 Engineering
5 Employer's liability
6 Fire
7 Goods in transit
8 Liability
9 Marine
10 Medical expense
11 Motor
12 Pecuniary
13 Others

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Agenda of Day 4
1. Insurance financial
statement analysis

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Insurance Financial statement analysis

1. What is that something we need to analyze?

- Financial statements, but on what
perspective?

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Perspective 1: Governance and finance

i. Stress on finance
 sound operation and financial well being
of an insurer is subject to close and
intensive scrutiny by the board,
 staffing of a company and selection of
management is considered as secondary
matter,

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ii) Stress on management

 governed by “fit and proper” standard, which presupposes
prior approval of the management and other controlling
persons, and subsequent changes in management
compositions
 According to IAIS, “fit and proper” management focuses on:
 Experience
 Honesty, and
 integrity
 financial strength of directors, officers and controllers
of the company

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• In general, the Board needs to ensure that

adequate management, from business and
technical perspectives, is in place before
commencing operation and ongoing basis

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• Which one do you go for?

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IAIS Recommendation:
- Hybrid regulatory form derived from
the combination of the two
basic forms particularly for
emerging insurance markets
like Ethiopia is essential

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• Remark:
Therefore, the analysis should focus on both
Governance issues and operational and
financial matters

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Perspective 2: Principles : SAP vs. GAAP

No GAAP SAP
1 Matching Immediate recognition
of some expenses
2 Going concern Liquidation
3 Conservatism Prudence
4 Accruals Cash basis for
acquisition costs
5 Objective evidence Prudent reserving

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Perspective 3: Compliance to law

 Governing law- Insurance Business Proclamation No.

746/2012
Article Provision
Art. 19 Maintenance of Required Capital
. Art. 23. Margin of Solvency
Art. 24. Technical Provisions, Depreciation and Amortization.
Art. 25. Overall Investment Policy
Art. 26. Financial Reports
Art. 27. Separation of Accounts
Art. 31. Audit Reports

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Art.33. Disclosure of Information

The directors of an insurer shall immediately, jointly or severally,
report in writing, to the National Bank where it appears probable
that the insurer:
a) cannot meet its obligations to its
policyholders or other creditors;

Art. 37 Grounds for Suspension or Revocation of License and

Receivership
The National Bank may suspend a license and put an insurer
under receivership if the insurer has become insolvent;
m) the insurer invests its funds or assets or any part
thereof in investments prohibited by law
or by directives;

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Art. 46. Restrictions on Loans and

Financial Guarantees by an
Insurer
Art. 48 No Premium No Cover

Different NBE Directives on Around 45

Insurance Supervision

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• Final Remark:
- Risk Based supervision rules out that compliance to laws,
regulation and directives alone can not ensure stability or
safety and soundness of an insurer.

- And yet RBS doesn't say that rule based supervision is

irrelevant

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2. Financial Statements :
- Financial performance of any business
organization is summarized in the
financial statements
- Focus on end result

i. Revenue account (policyholders account) summarizes:

• All premium (incomes)
• All claims (out go)
• Underwriting surplus/deficit for a given period
• Condition statement

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ii.Profit or loss summarizes

• All incomes from operations and investment

• All expenses
• Net income/loss for a given period
• Condition statement

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iii. Balance sheet summarizes

• Asset
• Liability
• Net worth /Capital/Equity on a specific date
• Position statement

iv. Equity statement summarizes

- Beginning capital
- Change in capital
- Ending capital on a specific date
- Condition statement

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v. Cash flow statement summarizes

• All receipts
• All payments
• Cash surplus/deficit
• Condition statement

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3. Why analysis?
i.To measure or assess:
a. financial performance
- Capital adequacy/solvency
- Asset quality
- Reinsurance
- Adequacy of technical
reserves
- Management efficiency
- Earning
- Liquidity

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b. Risk of the company

- Credit risk
- market risk
- liquidity risk
- Technical provision risk
- underwriting and liability risk
- operational risk
- Reinsurance risk
- contagion and related party risk

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c. SWOT
- Strength
- Weakness
- Opportunities
- Threats
d. Market forces (Porter’s Model)
- Supplier :- existing and new entrants,
- Customers : - bargain power of customers- low price,
- Product:- substitute -self insurance or move to another
insurer,
- Competitive rivalry

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ii. To make decision as to:

a. how to control risk

b. how to improve finical performance

c. formulate policies and strategies to

enhance strength and opportunities
and minimize likely effect of the
weakness and threats

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5. How to analyze (Method of analysis)

i. Trend analysis:
Own past performances with the current
(Comparative B/S, P&L, etc)
- IS IT IMPROVING?
- Take lesson on it
- IS IT DETERIORATING?
- What are the reasons
- IS IT STABLE?
- Where is the company heading?
Put big “WHY” all the way through

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ii. Comparison:
a) Compare Plan with performance
(variance analysis)
For example: Premium production

b) With peer groups

(Company A with Company B)

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iii. Ratio analysis:

a) Definition:
- Measures the relatively between
two variables
Q1. first is there any relativity
between the two variables?

Q2. If the answer is yes, what is the

degree of relationship?
Is it strong, remote or no relationship?

For example:
Current ratio= CA/CL
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b. What is the primary and main objective of a

share company?
- Increase earnings per share (EPS)
- how can we express it? In the
form of ROE

c. ROE is a model
- R = profit
- E = Capital
- why model?
- It represents the bottom
line of B/S and P&L
statements,

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iv. Demonstration of ROE model and theorems

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TR TA
5 2 3
TE TL
NI TC
1

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Case 1: ROE = ROA X EM

NI/TC = NI/TA X TA/TC
Case 2: ROA = PM X AU
NI/TA = NI/TR X TR/TA
Case 3: ROE = PM X AU X EM
NI/TC = NI/TR X TR/TA x TA/TE

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• What do they measures?

ratios measures
ROE How the company efficiently uses its capital to generate net
profit
ROA How the company efficiently uses its asset to generate net
profit

EM How money times equity multiplied during the given period

(wealth creation)
AU How efficiently and effectively the company utilizes its assets to
generate total revenue
PM How much of the total revenue accounted for net income.
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Case 4: Other ratios or Early warning ratios

Explain

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V. Early warning tests

a. General
- what do they mean?
- Tests have shown to be
important
- values outside range
correlated with
developing financial problems

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 ratios are flags that warrant further investigation

 few ratios outside normal range does not

necessarily signal a problem

 on the other hand, deterioration of ratios, even

within normal range, may be worrying sign

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 indicators are probably poorer in developing

countries than in developed ones

 need to calibrate/standardize ratios for this market

 gives companies benchmarks to work towards to

ensure financial health

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b. 13 tests
- Tests 1 to 7 are for all types of
insurance company
- Test 8 is for life insurance
companies only
- Tests 9 to 13 are for non-life
companies only

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Financial ratios

Test Name of test Definition Usual

number range
1a Net Net premiums Up to 3X
insurance written/(capital + surplus)
ratio
1b Gross Gross premiums Up to 7X
insurance written/(capital + surplus)
ratio
2 Change in Change in net premiums -33% to
net premium written +33%
3 Change in Increase/decrease in -10% to
surplus capital + surplus +50%

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Financial ratios
Test Name of Definition Usual
number test range
4 Earnings Net income/capital and -3 to 20%
ratio surplus
5 Surplus Commission and Up to
relief allowances from 20%
reinsurers/capital and
surplus
6 Solvency (capital + surplus)/(total Minimum
ratio liabilities) life –
4.5%
Non-life –
15%

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Financial ratios
Test Name of test Definition Usual
number range
7 Investment Investment in real Up to
in real estate estate and subs /(capital 100%
and subs + surplus) (life)
Up to 60%
(non-life)
8 Default ratio Mortgages in Up to 6%
on default/(capital +
mortgages surplus)
9 Loss ratio Losses incurred/earned 50 – 80%
premiums
10 Expense Expenses/earned 20 – 35%
ratio premiums
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Financial ratios

Test Name of test Definition Usual

number range
11 Combined Loss ratio + expense 80 –
ratio ratio 100%
12 Net trade Amount due/capital and Up to 50%
debtors surplus
13 Liquidity Liquid Assets/Claims Around
reserves plus unearned 150%
premium reserves

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Given:

CS = Capital & Surplus (Equity)

NPW = Net Premiums Written
ROE = Return on Equity
Underwriting Income + Investment Income =
Net Income Before Tax = NI

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NI/CS = ROE
NI/NPW = Return on Sales
NPW/CS = Risk Ratio
And therefore:

Why Net Premiums ÷ Capital

NI X NP = NI and Surplus, or "Risk Ratio“,
GP CS CS is an especially important
indicator
or

Return on Sales X Risk Ratio = ROE

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Case 5: Remark
- Take the ratio indicators that fall
outside the standard range for further
analysis
- See integration effect of ratios
- Look in to the components of the ratio,
For example,
- ROE= NI/Total capital
- If ROE is falling, it could be
attributable either to the fall in
NI or the rise in adjusted equity.
Therefore, clearly identify the
cause.
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Case 6: See and evaluate stress on:

– Premium
– Claims
– Reinsurance
– net income
– Capital
– wealth creation
– BOD and management
– OVER All financial stress
– Failure of the company

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- Risk measure of insurance - CARAMELS

- Capital Adequacy
- Asset quality
- Reinsurance
- Adequacy of reserve
- Management (Governance)
- Earning
- Liquidity
- Subsidiary

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Remark:
Formulate the appropriate policy, strategy
and follow-up the excusion process

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Regulatory and supervisory perspective

• Why?
– To protect the interests of policy holders
– To ensure trust and confidence of the general
public
– What if the interests of the general public is not
protected
– No body would go to the insurers and no money
would be available for credit and interment
– Economic growth of the nation remain reared
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• The market is an emerging market

• Small market, but having great potential to be
exploited
• We need to have clear:
– Vision/mission
– Policy
– Strategies
• Success is all about risk management
• Risk measurement is essential to control risks
• Final performance is among the major risk
measurement modalities
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• The sector faced no real challenge and walks at random

• The market is growing
• Sooner or latter foreign insurers may join the market after
WTO accession
• The demand side is growing
• The supply side has to be strengthened
• Merger and liquidation is a head of the sector
• We need to build internal efficiency for international
competitiveness
• RMP – provides the solution

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Capital requirements

- Capital is required for a number of reasons

- Finance new business (new business
strain), especially for life insurance
- Grow business
- Ensure future survival, under adverse
conditions
- Regulatory capital concentrates on latter
issue

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Supervision

 Meaning
overlooking the entire operation of an insurer
Protection of the policy calls for no restriction
 Method : RBS
Off-site surveillance
on-site examination
 Instruments
Laws and directives
principles(Insurance, accounting, IAIS)
good practices(Benchmarked experences
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Objective
- Protection of policy holders interest
 Pillars: - regulation
 both prudential and administrative (policy, frameworks, circulars,
guidelines, directives etc. enforcement)
- Licensing
Company, Brach, brokers, agents, loss assessors, loss adjustors,
actuary

- Supervision
on-site, off-site, regular, surprise, full scale, special

- intervention
Stop writing certain classes
Increase in technical provision
stop dividend declaration
removal of management and board
license suspension
receivership
licese revocation

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• Questions
• Comments
• Final remark

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