Accounting Question

Audit & Accounting Guide Property and
Liability Insurance Entities
AICPA
(AICPA)

Accounting, Auditing and Governance for
Takaful Operations
Sheila Nu Nu Htay; Mohamed Arif; Younes Soualhi;
Hanna Rabittah Zaharin; Ibrahim Shaugee
(AAGTO)

AICPA Chapter 1
Nature, Conduct, and Regulation of the
Business
AAGTO Chapter 2
Takaful Companies and Their Accounting
Environment

General Nature of the Business
Primary Purpose
 In the property and liability insurance business,
the purpose is to spread risks.
 In this use, risk generally has two meanings
 A peril insured against
 Fire is a risk to which most property is exposed

 A person or property protected
 A home or an automobile

 For a payment known as a premium, insurance
entities agree to relieve the policyholder of all or
part of a risk and to spread the total cost of
similar risks among large groups of policyholders

Types of Insurance
 Accident and health
 Covers loss by sickness or accidental bodily injury
 Includes insurance that provides lump-sum or periodic
payments in the event of loss by sickness or accident

 Automobile
 Covers personal injury or automobile damage sustained by
the insured
 Liability to third parties for losses caused by the insured

 Fidelity bonds
 Cover employers against dishonest acts by employees
 Blanket fidelity bonds cover groups of employees

Types of Insurance
 Fire and allied lines
 Covers
 Fire
 Windstorm
 Hail
 Water damage

 Does not cover flooding

 Home insurance
 Provides coverage for damage or destruction of the
policyholders home
 In some locations the policy may exclude certain types of
risks such as flood or earthquake
 These require additional coverage

Types of Insurance
 Inland marine
 Covers property being transported other than transocean
 Includes floaters: policies that cover movable property, such
as a tourist’s personal property

 Miscellaneous liability
 Covers most other physical and property damages not
included under workers’ compensation, automobile liability, or
multiple peril policies
 Damages include
 Death
 Cost of care
 Loss of services resulting from bodily injury
 Loss of use of property

Types of Insurance
 Multiple peril
 Package coverage
 Includes most property and liability coverage except
 Workers’ compensation
 Automobile insurance
 Surety bonds

 Ocean marine
 Coverage for ships and their
 Equipment
 Cargos
 Freight
 Liability to third parties for damages

Types of Insurance
 Professional liability
 Covers liability arising from error or misconduct in providing or
failing to provide professional service
 Physicians
 Surgeons
 Dentists
 Hospitals
 Engineers
 Architects
 Accountants
 Attorneys
 Other professionals from liability arising from error or
misconduct in providing or failing to provide professional service

Types of Insurance
 Surety bonds
 Provide for monetary compensation to third parties for failure
by the insured to perform specifically covered acts within a
stated period
 Most surety bonds are issued for persons doing contract
construction, persons connected with court actions and
persons seeking licenses and permits

 Workers’ compensation
 Compensates employees for injuries or illness sustained in
the course of their employment

Legal Forms of Organization
 Stock companies
 Mutual companies
 Reciprocal or interinsurance exchanges

 Public entity risk pools
 Risk-sharing pools
 Insurance-purchasing pools

Legal Forms of Organization
 Banking pools
 Claims-servicing
 Also known as account pools

 Private pools
 Risk retention groups
 Purchasing groups

Major Sales Outlets
 Agents (agency companies)
 Act as independent contractors who represent
 One insurance entity (exclusive agents)
 More than one entity (independent agents)

 Employee sales force (direct writing companies)
 Insurance brokers
 Represent the insured

 Direct writing
 Sell policies directly to the public
 Usually through salespeople or Internet sales

 A combination of methods

Major Transaction Cycles
 Underwriting of Risks
 Evaluating risks
 Setting premium rates, which may be established by
 Manual rating
 Judgment rating
 Merit rating

 Reinsurance
 Pooling, Captives, and Syndicates
 Underwriting pools, associations, and syndicates
 Captives

 Processing and Payment of Claims
 Investments

Accounting Practices
 State Insurance Regulation
 National Association of Insurance
Commissioners
 Federal Regulation
 Securities and Exchange Commission

 The Dodd-Frank Wall Street Reform and
Consumer Protection Act
 Industry Associations

 Statutory Accounting Practices
 Permitted Statutory Accounting Practices

The History of Western Insurance
 Chinese and Babylonian traders practised the early
methods of transferring or distributing risk
 The Greeks and Romans introduced the origins of health
and life insurance around 600 AD with guilds called
“benevolent societies”
 Cared for the families and paid funeral expenses of members
upon death

 “Friendly societies” existed in England prior to the 17th
century near Lombard Street in London called Lloyd’s
 Mutually share in the profits and losses of sea voyages
 Lloyd’s of London remains the leading market for marine and
other specialist types of insurance

The Development of Takaful Accounting
 Takaful is Islamic Insurance
 Derived from the Arabic word kafalah
 A pact that guarantees individuals in a group against loss or
damage sustained by anyone of them
 Also described as guaranteeing each other
 Encompasses the elements of
 Shared responsibility

 Joint indemnity
 Common interest
 Solidarity

The Development of Takaful Accounting
 Base of takaful system is tabarru
 Meaning donation, gift, or contribution
 Defined fund makes takaful free from
uncertainty and gambling
 The purpose of this system is not to generate
profits but to uphold the principle of “bear ye
one another’s burden.”

The Development of Takaful Accounting
 The principles of takaful are
 Members (certificate holders or participants) contribute a
certain sum of money to a common pool
 Certificate holder pays his subscription with the intention
of helping those who need assistance
 Losses are divided and liabilities spread according to the
community pooling system
 Uncertainty or gharar is eliminated in respect to
subscription and compensation

 It does not derive advantage at the expense of others.

The Development of Takaful Accounting
 Mutual insurance evolved under the ancient
system of aqila as practised by Arabs of Mecca
and Medina
 Doctrine of aqila approved by the Holy Prophet
 Development of takaful in modern times
 1979: Sudan
 1984: The Malaysian National Fatwa

The Development of Takaful Accounting
 Established in the early second century of the
Islamic era
 Muslim Arabs expanding trade into Asia agreed
to a fund to compensate anyone in the group
who suffered losses through robberies or
piracy


This became marine insurance

Takaful Guidelines
 Revelatory sources have provided the Shariah basis
for takaful.
 The principles can be deduced from the Qur’an, Sunnah,
and Islamic legal maxim

 The Prophet in a hadith encouraged people to mitigate
their risks before leaving it to God to protect their property.
 Takaful is viewed as an effort to remove damage or harm
arising from an unexpected harm or peril through
compensation or coverage, the Islamic legal maxim aldarer yuzal (which means damage or harm is removed) is
supportive of this practise.

Takaful Governance
 The Shariah Framework of Takaful
 Comprehensive Shariah framework to govern the
operation of takaful business
 Shariah framework combined with sound legal and
regulatory structure
 Effective self-governance carried out by
 Takaful companies
 The Shariah Governance Framework
 Issued by the Central Bank of Malaysia (CBM) in
2011
 Provides guidelines for banks and takaful operators
to fulfil Shariah compliance comprehensively from
product approval to product implementation

Takaful Governance
 Islamic financial Institutions directed to institute a
Shariah framework in their organisations

 An insurance business will not be valid should any of
its business operations, products, and activities
contravene any Shariah principle
 The Takaful Act (Malaysia) 1984 provided that
Shariah-based insurance is enforceable if its “aims
and operations do not involve any element which is
not approved by the Shariah

Takaful Governance
 Shariah compliance refers to compliance to Shariah
rulings and decisions issued by


The Shariah Advisory Council (SAC)



The Shariah Committee (SC) of the Islamic financial
institution (IFI)



As determined by other relevant bodies

Audit & Accounting Guide Property and
Liability Insurance Entities
AICPA
(AICPA)

Accounting, Auditing and Governance for
Takaful Operations
Sheila Nu Nu Htay; Mohamed Arif; Younes Soualhi;
Hanna Rabittah Zaharin; Ibrahim Shaugee
(AAGTO)

AICPA Chapter 3
Premiums

Types of Premium Adjustments
 Cancellation
 A complete termination of an existing policy
before expiration
 Generally be requested by the insured

 Can be due to nonpayment of premium

 Endorsements
 Changes in existing policies that may result in

 Additional premiums
 Return premiums




Increases or decreases in coverage limits
Additions or deletions of property or risks covered
Changes in location or status of insureds

Types of Premium Adjustments
 Audit premiums
 Premiums determined from data developed by
 Periodic audits of insureds’ records
 Periodic reports submitted by insureds

 Audit may result in additional premium or
return premium

 Retrospective premium adjustments
 Modifications of the premiums after expiration
of the policies
 Adjustment is based on the experience of an
individual risk during the term of the policy

 Generally subject to maximum and minimum
premium limits specified in the policy

Premium Transaction Flow
 Normally includes the following functions that
generate most premium-related transactions
 Evaluating and accepting risks including the
evaluation of reinsurance needs
 Issuing policies including coding and policy
maintenance
 Billing and collecting premiums

 Paying commissions and other costs of acquiring
business
 Financial and statistical reporting

Involuntary Markets
 Premiums assumed from an involuntary pool
 Example: NCCI
 Based on direct voluntary writings in the state

 Premiums written directly as a “takeout” in lieu
of an involuntary apportionment

Involuntary Markets
 Assessments charged by a state that are
recoupable as
 Part of the premium
 Incorporated into the approved premium rate
 May be based on voluntary premium writings

 May be based on losses incurred in a given
line(s) of business

Involuntary Markets
 Passthrough surcharges
 Imposed by a state or municipality issuing
policies including
 Coding
 Policy maintenance

 Such surcharges are usually specified as a
percentage of premiums


Insurer records functions solely as a collections
facility

Accounting for Premiums and
Acquisition Cost
 Generally accepted accounting principles
(GAAP)
 Many specialized industry accounting principles
for revenue recognition for property and liability
insurance enterprises are specified in
 Financial Accounting Standards Board (FASB)
 Accounting Standards Codification (ASC)

 Financial Services – Insurance

Accounting for Premiums and
Acquisition Cost
 Insurance contracts are classified as shortduration or long-duration
 Depending on how long the contracts are
expected to remain in force
 Factors that determine if a short-duration
contract can be expected to remain in force are:
 The contract provides insurance protection for a
fixed period of short duration
 The contract enables the insurer to cancel the
contract or adjust the provisions of the contract at
the end of any contract period

Accounting for Premiums
and Acquisition Cost
 Factors that determine if a long-duration contract
can be expected to remain in force are:
 The contract generally is not subject to unilateral
changes in its provisions, such as a
noncancellable or guaranteed renewable contract
 The contract requires the performance of various
functions and services including insurance
protection for an extended period

Disclosure Considerations
 Premiums are significant to the entity’s
operations
 Often result in significant balances and accounts
reported in the entity’s financial statements
 Consider these factors when evaluating
disclosures required under FASB ASC
235-10-50-1
 Requires disclosure of information about the
accounting policies adopted by an entity

 GAAP and SAP may specify disclosures that must
be made when relevant related to premium,
acquisition costs and premium receivable

Disclosure Considerations
 Premium Revenue and Premium Adjustments
 Information disclosure required by FASB ASC
944-20-50-7
 Information that enables financial statement users
to understand the factors affecting the present and
future recognition and measurement of financial
guarantee insurance contracts

Disclosure Considerations
 Entities should consider whether the following
disclosures are applicable
 Significant Accounting Policies as required in




FASB ASC 310-10-50-2
FASB ASC 310-10-50-45-2
FASB ASC 310-10-50-4

 Assets Serving as Collateral as required in FASB
ASC 860-30-50-IA
 Nonaccrual and Past Due Financing Receivables
as required in paragraphs 6, 7, and 7a of FASB
ASC 310-10-50

Disclosure Considerations
 Entities should consider whether the following
disclosures are applicable, continued
 Accounting Policies for Off Balance Sheet
Credit Exposures as required in



FASB ASC 310-10-50-9
FASB ASC 450-20

 Foreclosed and Repossessed Assets as
required in



FASB ASC 310-10-50-11
FASB ASC 310-10-454

Disclosure Considerations
 Entities should consider whether the following
disclosures are applicable, continued
 Accounting Policies for Credit Loss Related to
Financing Receivables as required in FASB
ASC 310-10-50-11B
 Impaired Loans as required in FASB ASC
310-10-50-14A

 Credit Quality Information as required by
paragraphs 28 and 29 of FASB ASC 310-1050
 Modifications as required by paragraphs 33
and 34 of FASB ASC 310-10-50

Audit & Accounting Guide Property and
Liability Insurance Entities
AICPA
(AICPA)

Accounting, Auditing and Governance for
Takaful Operations
Sheila Nu Nu Htay; Mohamed Arif; Younes Soualhi;
Hanna Rabittah Zaharin; Ibrahim Shaugee
(AAGTO)

AICPA Chapter 4
The Loss Reserving and Claims Cycle
Sections 4.01-4.66

Types of Businesses and Their
Effect on the Estimation Process
 Policy Duration
Short duration

 Insurance coverage for a short duration (one year or less)
 Insurer can either not renew the contract or adjust future
provisions at end of contract period
 Some policies are considered short duration even though
they have a duration of more than one year
 Most policies written by property and liability insurance
entities are short duration policies

Types of Businesses and Their
Effect on the Estimation Process
 Line of Business or Type of Risk
 Property

 Liability insurance
 Workers’ compensation
 Surety
 Fidelity

 Credit
 Accident
 Health and guaranty insurance

Types of Businesses and Their
Effect on the Estimation Process
 Can be further classified as primary coverage or
reinsurance assumed
 Primary coverage involves policies written between an insurer
and a customer directly
 Reinsurance coverage involves the transfer of the insurer’s risk
to a reinsurer
 Retrocession (sometimes also called reinsurance of
reinsurance) involves the further transfer of the reinsurer’s risk
to a retrocessionaire

Types of Businesses and Their
Effect on the Estimation Process
 Excess claims
 Another insurer or the insured pays a significant portion of the
clam amount before the insurance protection responds
 Called a retention or deductible
 Retentions can be thousands or millions of dollars

 Policies referred to as high deductibles
 Policyholder typically responsible for reimbursing the insurer
for claim payments made up to the deductible level

Transaction Cycle

Components of Loss Reserves
 Loss reserves are an insurer’s estimate of its liability for the
unpaid costs of insured events that have occurred
 Case-basis reserves
 Sum of the values assigned by claims adjusters to specific claims
that have been reported to and were recorded by, the insurance
entity but not yet paid at the financial statement date.

 Incurred but not reported (IBNR)
 The estimated cost to settle claims arising from insured events
that occurred but were not reported to the insurance entity as of
the financial statement date. Another insurer or the insured pays
a significant portion of the claim amount before the insurance
protection responds

Estimating Methods
 Analytical techniques are used in estimating
and evaluating the reasonableness of loss
reserves
 Techniques generally consist of statistical
analyses of historical Information and result in
estimates that may be referred to as loss
reserve estimates

Data for Projections
 Generally grouped by line of business
 May be further classified by other attributes

 Data arranged chronologically
 Chronology of the data determined by
 Policy date: The date on which the contract becomes effective

 Accident date: The date on which the accident (or loss) occurs
 Report date: The date on which the entity first receives notice
of the claim
 Record date: The date on which the entity records the claim in
its statistical system
 Closing date: The date on which the claim is closed

Data Analysis
 Types of commonly arrayed and analyzed data
 Losses paid
 Case-basis reserves

 Losses incurred

 Claim units paid

 Claim units closed

 Claim units outstanding

 Defense and cost
containment (DCC) paid

 OCC outstanding
 Salvage and subrogation
recovered

 Claim units reported

 Reinsurance recovered

LAE Reserves
 The costs that will be required to settle claims that have
been incurred as of the valuation date
 Under GAAP LAEs are separated as


Allocated LAEs
 Expenses assignable or allocable to specific clams such as
fees paid to outside attorneys, experts and investigators and
used to defend clams



Unallocated LAEs
 Expenses that consist of all external, internal, and
administrative clams-handling expenses including
determination of coverage that are not included in allocated
LAEs

Changes in the Environment
 Changes in variables in the loss reserving process can be
considered in the following ways
 Selection of the loss projection method(s): Loss projection
methods vary in their sensitivity to changes in the underlying
variables and the length of the clam emergence pattern.
 Adjustment of underlying historical loss data: In certain cases
the effect of changed variables can be isolated and
appropriately reflected in the historical loss data used in the
loss projection.

 Further segregation of historical loss data: Certain changes in
variables can be addressed by further differentiating and
segregating historical loss data.

Changes in the Environment
 Additional changes in variables include
 Separate calculation of the effect of variables: The effect of
certain changes in variables can be isolated and separately
computed as an adjustment to the results of other loss
projection methods.
 Qualitative assessments: In many instances the magnitude or
effect of a change in a variable will be uncertain. The
establishment of loss reserves in such situations requires
considerable judgment and knowledge of the entity’s
business.

Audit & Accounting Guide Property and
Liability Insurance Entities
AICPA
(AICPA)

Accounting, Auditing and Governance for
Takaful Operations
Sheila Nu Nu Htay; Mohamed Arif; Younes Soualhi;
Hanna Rabittah Zaharin; Ibrahim Shaugee
(AAGTO)

AICPA Chapter 5
Investments and Fair Value Considerations

Regulation
 Insurance entities have a fiduciary
responsibility to be able to meet their
obligations to policyholders
 State insurance statutes and regulations
prescribe standards and limitations on
investment holdings and activities
 State regulations may also set requirements
regarding matters such as the location and
safeguarding of assets

Financial Accounting Standards
FASB 820
 Defines fair value as “the price that would be received to
sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the
measurement date.“

FASB ASC 825
 Creates a fair value option under which an entity may
irrevocably elect fair value as the initial and subsequent
measure for many financial Instruments and certain other
terms with changes in fair value recognized in the
statement of activities

Accounting Practices
Topic

GAAP

Statutory

Cash and cash equivalents

FASB ASC 210
FASB ASC 230
FASB ASC 305

SSAP No. 2

Debt and equity securities

FASB ASC 220
FASB ASC 310
FASB ASC 320
FASB ASC 325
FASB ASC 940
FASB ASC 944

SSAP No. 26
SSAP No. 30
SSAP No. 32
SSAP No. 43R

Realized and unrealized gains and
losses on debt and equity securities

FASB ASC 320
FASB ASC 944

SSAP No. 30
SSAP No. 32
SSAP No. 43R

SEC

SAB No. 103

Accounting Practices
Topic

GAAP

Statutory

SEC

Mortgage loans

FASB ASC 310
FASB ASC 944
FASB ASC 948

SSAP No. 36
SSAP No. 37
SSAP No. 83

SAB No. 105

Real estate

FASB ASC 360
FASB ASC 944

SSAP No. 40
SSAP No. 90

Derivatives

FASB ASC 815

SSAP No. 86

Joint ventures and partnerships

FASB ASC 323
FASB ASC 810

SSAP No. 48
SSAP No. 93
SSAP No. 97

Investments in subsidiary, controlled, and
affiliated entities

FASB ASC 810

SSAP No. 97

Investment income due and accrued

FASB ASC 310

SSAP No. 34

SAB No. 103

Accounting Practices
Topic

GAAP

Statutory

Asset transfers and extinguishments of
liabilities

FASB ASC 860

SSAP No. 103

Repurchase agreements

FASB ASC 860

SSAP No. 103

Securities lending

FASB ASC 860

SSAP No. 103

Fair value measurements

FASB ASC 820

SSAP No. 100

Fair value and concentrations of credit
risk disclosure requirements

FASB ASC 825

SSAP No. 27

Fair value option

FASB ASC 825

~N/A~

SEC

Auditing Investments
Consideration of Fraud in a Financial Statement Audit
 Fraudulent acts may cause a material misstatement of
financial statements

 Because of the characteristics of fraud, the auditor’s
exercise of professional skepticism is important when
considering the risk of material misstatement due to fraud.

Auditing Investments
Audit risk
 When the auditor expresses an inappropriate audit opinion
because the financial statements are materially misstated
 Materiality and audit risk are considered throughout the audit, in
particular when
 Determining the nature and extent of risk assessment procedures to
be performed
 Identifying and assessing the risks of material misstatement
 Determining the nature timing, and extent of further audit procedures

 Evaluating the effect of uncorrected misstatements on the financial
statements and in forming the opinion in the auditor’s report.

Audit & Accounting Guide Property and
Liability Insurance Entities
AICPA
(AICPA)

Accounting, Auditing and Governance for
Takaful Operations
Sheila Nu Nu Htay; Mohamed Arif; Younes Soualhi;
Hanna Rabittah Zaharin; Ibrahim Shaugee
(AAGTO)

AICPA Chapter 4
The Loss Reserving and Claims Cycle
Sections 4.67-4.191

Critical Accounting Policies
and Estimates Disclosure
Managements Discussion and Analysis section of Form
10-K discusses the following
 The actuarial methodologies used to calculate the loss
reserve projections and the differences in these methods for
different lines of businesses
 The discussion on the method used to develop reserve
estimates might Include Information on the loss reserve
projection methods used (for example, loss- ratio method paidloss development method incurred-loss development method
and so on); the basis for selecting a certain method for different
lines of business- and the reasons for any changes In the loss
reserve methodology.

Critical Accounting Policies
and Estimates Disclosure
 The significant assumptions, judgment, and uncertainty used
in the estimation process and the potential impact of variability
in this estimate to the financial statements.
 Uncertainties to be discussed may include any products with
higher volatility or uncertainty that may affect the overall
estimate and any particular assumptions that are more difficult
than others to measure.

 If available a company should disclose the range of
reasonable estimates for the loss reserves.

Critical Accounting Policies
and Estimates Disclosure
 The significant changes in these assumptions and the
effect of that change on the estimates produced.
 Examples of changes include


The claims-handling process



Policy and exposure forms



Inflation



Legal trends



Environmental factors



Mix of claimants



Timeliness of claim reporting by claimants

 Any development in the estimates that was identified
after the fact

Use of Specialists by Management in
Determining Loss Reserves
 Criteria that can be considered in determining whether an
individual qualifies as a loss reserve specialist include:
 Knowledge of various projection techniques
 Knowledge of changes in the environment including


Regulatory developments



Social and legal trends



Court decisions



The effect the factors have on emergence and cost of claims

Guaranty Fund and Other Assessments
 State guaranty funds assess entities licensed to sell
insurance in the state
 Provide for the payment of covered claims
 Meet other insurance obligations, subject to prescribed limits
of insolvent insurance enterprises

 The assessments are generally based on premium volume
for certain covered lines of business

 The most prevalent uses for assessments
 To fund operating expenses of state Insurance regulatory
bodies and second-injury funds

Accounting Principles
 Under GAAP, liabilities for the cost of unpaid claims
including estimates of the cost of IBNR claims are accrued
when insured events occur.
 The liability for unpaid claims should be based on the
estimated ultimate cost of settling the claims and should
include the effects of inflation and other social and
economic factors.

 Some companies select their estimate of the ultimate cost
of settling clams from a selection of several different
reserve methods

Accounting Principles
 Estimated recoveries on unpaid claims should be evaluated
in terms of their estimated realizable value and deducted
from the liability for unpaid claims
 Liability for those adjustment expenses expected to be
incurred in the settlement of unpaid claims should be
accrued when the related liability for unpaid claims is
accrued

Disclosures of Certain Matters
in the Financial Statements of
Insurance Enterprises
 Applicability to statutory financial statements
 Auditors are required to apply the same disclosure evaluation
criteria for statutory financial statements as they do for
financial statements prepared in conformity with GAAP.

 Relationship to other pronouncements
 In some circumstances the disclosure requirements in FASB ASC
944 may be similar to or overlap with the disclosure requirements in
certain other authoritative accounting pronouncements issued by
FASB the AICPA, or the SEC

 Liability for unpaid claims and claim adjustment expenses

Auditing Loss Reserves
 The auditor’s design of loss reserve auditing procedures
needs to take into consideration the effects of relevant
activities of the entity and changes in factors including:
 Changes in the entity (mergers, acquisitions, dispositions)

 Underwriting and claim trends
 The reinsurance program of the entity (including any
significant transactions)
 Management turnover
 IT system changes
 Process changes

Audit & Accounting Guide Property and
Liability Insurance Entities
AICPA
(AICPA)

Accounting, Auditing and Governance for
Takaful Operations
Sheila Nu Nu Htay; Mohamed Arif; Younes Soualhi;
Hanna Rabittah Zaharin; Ibrahim Shaugee
(AAGTO)

AICPA Chapter 6
Reinsurance

Types of Reinsurance
 Indemnity reinsurance agreements
 The ceding entity
 Remains primarily liable to the policyholder
 Bears the risks that the reinsurer may be unable to meet its
obligations for the risks assumed under the reinsurance
agreement
 The policyholder is generally not aware of any indemnity
reinsurance transactions that may occur and continues to hold
the original contract.

 Assumption reinsurance
 Used to legally replace one insurer with another and so cancel
the ceding company’s liability to the policyholder
 The policyholder must consent to releasing the ceding company

Types of Reinsurance
 Excess of loss per risk reinsurance
 Requires the insurer to retain all claims up to a stated amount
or retention on each risk covered under the reinsurance
 Reinsurer reimburses the insurer for the portion of any claim
in excess of the insurer’s retention, subject to the limit stated
in the reinsurance agreement.

 Excess of loss per occurrence reinsurance
 Requires the insurer to retain all claims up to a stated amount
or retention on all losses arising from a single occurrence
 The reinsurer pays claims in excess of the insurer’s retention,
subject to the limit stated in the reinsurance agreement

Types of Reinsurance
 Aggregate excess of loss reinsurance
 Requires the insurer to retain all claims during a specified
period up to a predetermined limit for the period on all its
business or any definable portion of the business

 The limit is sometimes expressed as a loss ratio.
 The reinsurer reimburses the insurer for losses above the
specified loss ratio
 Also referred to as stop loss reinsurance

Types of Reinsurance
 The following four types of private reinsurance companies
exist in the United States
 Professional reinsurers that engage almost exclusively in
reinsurance
 Reinsurance departments of primary insurance companies
 Groups or syndicates of insurers referred to as reinsurance
pools or associations
 Groups or syndicates of professional investors such as
sidecars cat bonds or transformers

Reinsurance Contracts
 Quota share reinsurance
 A kind of pro-rata reinsurance

 The ceding company cedes a percentage of
risks to the reinsurer and in turn, will recover
from the reinsurer the same percentage of all
losses on those risks
 Frequently used for new lines or by new
companies

Reinsurance Contracts
 Surplus share reinsurance
 Reinsures on a pro-rata basis only those risks
for which the coverage exceeds a stated
amount

 Premiums and losses are shared by the
reinsurer and insurer on a pro rata basis in
proportion to the amount of risk insured or
reinsured by each.

Accounting Practices
 FASB ASC 944 Financial Services – Insurance specifies the
accounting by insurance enterprises for the reinsurance
(ceding) of insurance contracts
 FASB ASC 340-30 provides guidance for accounting for
reinsurance contracts that do not transfer Insurance risk

 FASB ASC 944-20-55 includes implementation questions
and answers related to accounting for reinsurance.

Special Risk Considerations
 The reinsurance market continues to evolve
with structures such as sidecars transformers
and other special purpose vehicles being
introduced to the marketplace

 Financial statement preparers must
understand both the legal form and substance
of these structures and to read the related
contracts to ensure that the accounting
treatment and related disclosures are
appropriate

Special Risk Considerations
 Financial statement preparers and auditors
should be mindful of additional considerations
including
 The potential for consolidation or equity
method accounting
 The existence of any embedded derivatives
and the possibility of the existence of related
party transactions.
 Entities should generally be considered the
primary beneficiary of the sidecar if the sidecar
is a VIE

Auditing Reinsurance
 Per AU-C section 300, the auditor should plan the audit so
that it is responsive to the assessment of the risks of
material misstatement based on the auditor’s understanding
of the entity and its environment
 The size and complexity of the entity depends on


The nature



The timing



The extent of planning



The auditor’s
 Experience with the entity

 Understanding of the entity

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