Audit of Insurance Companies

Insurance – ia a means of protection from a financial loss

Insurance Company - is a financial institution that issues insurance policies and covers financial losses.
Insurance Company makes money by dealing risks.

Insurance Contracts - combine features of both a financial instrument and a service contract. In addition,
many insurance contracts generate cash flows with substantial variability over a long period.

Policyholder - "a party that has a right to compensation under an insurance contract if an insured event
occurs."

Insured event - "an uncertain future event that is covered by an insurance contract and creates insurance
risk."

Insurer (issuer of insurance contract) is the party that has an obligation under an insurance contract to
compensate a policyholder if an insured event occurs (e.g., insurance company).

Elements of an Insurance Contracts:

a. Transfer of significant insurance risk - there is a transfer of significant insurance risk from the insured
(policyholder) to the insurer (insurance provider).

b. Payment from the insured (premium) - generally, the insured pays to a common fund from which
losses are paid. However, not all insurance contracts have explicit premiums (e.g., insurance cover
bundled with some credit card contracts).

c. Indemnification against loss - the insurer agrees to indemnify the insured or other beneficiaries against
loss or liability from specified events and circumstances (i.e., insured event) that may occur or be
discovered during a specified period.

Significant insurance risk (Uncertain future event)

• Risk (uncertainty) is an essential element of an insurance contract. Risk is the possibility of loss
or injury when an uncertain future event occurs.
• Insurance risk - is "risk, other than financial risk, transferred from the holder of a contract to the
issuer."
• A contract that transfers only an insignificant insurance risk is not an insurance contract.
• A contract that exposes the issuer to financial risk is not an insurance contract, unless it also
exposes the issuer to significant insurance risk.

Legal principles of insurance

1. Principle of Insurable Interest -The insured has an insurable interest in the property if he is benefited
by the property's existence and prejudiced by its destruction.

2. Principle of Utmost Good Faith - all insurance contracts must be negotiated with utmost honesty and
fairness because the contracting parties do not have the same access to relevant information.
3. Principle of Indemnity - the insured is compensated for the loss he incurred and reverted back to his
previous financial condition before the occurrence of the loss event. The insured neither profits nor
incurs loss due to the occurrence of the loss event. This principle does not apply to life insurance
because the value of human life cannot be measured in monetary terms.

4. Principle of Contribution-This principle applies when the insured obtains insurance from more than
one insurer. In case of a loss event, the insured can only claim compensation for the actual losses he
incurred from either insurer or both insurers on a proportionate basis. There is no "double"
compensation for actual losses incurred by the insured. If any of the insurers, compensates in full the
insured, that insurer can claim from the other insurers their shares on the losses incurred by the insured.

5. Principle of Subrogation - Subrogation means substituting one entity (e.g., the insurer) for another
entity's (e.g., the insured) legal right to collect a debt or damages.

6. Principle of Loss Minimization - in cases of sudden loss events (e.g., fire), the insured should try his
best to minimize the loss of his insured property by taking all necessary steps to control and reduce the
losses and save what is left of the property (e.g., calling the fire department in case of fire). This prevents
the insured from neglecting the loss event just because the property is insured.

7. Principle of Proximate Cause - when a loss is caused by more than one loss events, the closest
(proximate) cause, not the furthest cause, is taken into consideration when determining the extent of
the insurer's liability. This principle does not apply to life insurance.

Characteristics of an Insurance Contract

Contract of insurance has the following characteristics:

1. Consensual – perfected by the meeting of the minds of the parties2.

2. Voluntary – it is not compulsory and the parties may incorporate such terms and conditions as
they may deem convenient which will be binding provided they are not against the law or public
policy
3. Aleatory – depends upon some contingent event
4. Executed – as to the insured after the payment of the premium
5. Executory – as to the insurer as it is not executed until payment for a loss
6. Conditional – subject to conditions the principal one of which is the happening of the event
insured against
7. Personal – each party in the contract have in view the character, credit and conduct of the other

Kinds Of Insurance Contract

Insurance contracts are classified as follows:

1) Life insurance contracts

a) Individual 2) Non-Life Insurance Contracts
b) Group Life a) Marine
c) Industrial Life b) Fire
c) Casualty

3) Contracts of Suretyship and bonding

Perils or Risks That May Be Insured

The following risks may be insured:

1.Any contingent or unknown event whether past or future which may cause damage to a person having
an insurable interest; or

2.Any contingent or unknown event, whether past or future, which may create liability against the
person insured.

Insurance Audits are expected to maintain Quality Control between insurance companies and policy
holders.

Insurance Audits Shall examine:

• Policy and Liability
• Risk Valuation
• Tax Documents
• Financial Records of Insurance
• Claims and Commissions
4 important audit points in profit or loss:
• Verification of Premium
• Verification of Claims
• Verification of Commissions
• Verification of Operating Expenses
Audit points to be considered in the Verification of Operating Expenses:
• Investments
• Cash in bank balances
• Outstanding Premium
• Agent’s Balances
There will be complexities in any industry that require you to make adaptations to your accounting
methods. There are numerous distinctive factors in insurance accounting that distinguish it from other
accounting principles, this includes:
• Insurers assume risk on return for a premium
• Statutory accounting principles apply to the insurance industry
• Insurance category impacts accounting practices
• How liabilities, revenues, expenses, etc. are classified and accounted for
• The purpose of financial statements to evaluate the business
Insurance Accounting Basics
The fundamental factors of insurance accounting that make it unique from other industries:
• Property/Casualty Insurance vs. Health/Lifestyle Insurance
• The first thing to note is that the insurance industry is generally divided into two
overarching specialties:
 • Property/Casualty: This category of insurance policies is designed to protect
against liability and cover damages. Property insurance protects property in the
case of damage or theft or protects the owner if someone is injured on their
property. Casualty insurance helps protect individuals from liability if they are
responsible for damaging another person’s property or causing an accident that
resulted in injuries to another person. This is a Non-Life Insurance.
• Health/Lifestyle: Health and lifestyle insurance policies such as dental, life,
vision, disability, estate planning, and more are
designed to cover individual lifestyle needs and medical requirements.
Whichever classification the insurance company belongs to will have an influence on certain
parts of the accounting. Among the significant distinctions are:
• Varying Contract Durations: Health/life insurance policies contain a long-term contract, while
the other has a shorter-term contract.
• Predictability of Claim Outcomes: Health/life insurance policies have pre-
set terms that establish parameters for claim outcomes. However,
property/casualty insurance policies are much less predictable because
there are external factors that can significantly impact claim outcomes.
• Asset Categories: For property/casualty insurance, the primary asset categories are bonds,
common stocks, and reinsurance recoverable. On the other hand, the primary asset category is
commercial mortgages.
Accounting Method in Insurance Accounting
There are two general accounting methods:
• Cash-Basis Accounting: Transactions are recorded when money changes hands.
• Accrual-Basis Accounting: Transactions are recorded as soon as the income is earned, or
an expense is incurred. In here you would record the sale of a policy when the agreement is
signed, regardless of whether the customer pays or not.
When deciding between cash and accrual accounting, it's easy to choose cash-basis accounting due to
its simplicity. However, accrual-basis accounting will provide you with a better long-term picture of
your company's financial health, thus, accrual basis accounting is chosen over cash accounting.
Unique Transactions That Apply to Insurance Accounting
Due to the specific nature of the insurance industry, some transactions must be accounted for, such as:
• Premium Payments: The amount you have been paid as a premium on a policy is accounted for
as income. Policy premiums will be your primary source of income.
• Claim Payment: Claims paid to a policyholder are accounted for as an expense.
• Interest Payments: If any interest is required on a claim payout, this will also be accounted for as
an expense.
• Reserves: The amount your insurance agency needs to have for future payouts. These
amounts are recorded as liabilities.
• Agent Commissions: The commission agents earn when they sell a policy is recorded as an
expense.
Implementation of IFRS 17

IFRS 17 is effective for annual reporting periods beginning on or after 1 January 2023 with earlier
application permitted as long as IFRS 9 is also applied.

Insurance contracts combine features of both a financial instrument and a service contract. In addition,
many insurance contracts generate cash flows with substantial variability over a long period. To provide
useful information about these features, IFRS 17:

• combines current measurement of the future cash flows with the recognition of profit over the
period that services are provided under the contract;
• presents insurance service results (including presentation of insurance revenue) separately from
insurance finance income or expenses; and
• requires an entity to make an accounting policy choice of whether to recognize all insurance
finance income or expenses in profit or loss or to recognize some of that income or expenses in
other comprehensive income.

The key principles in IFRS 17 are that an entity:

• identifies as insurance contracts those contracts under which the entity accepts significant
insurance risk from another party (the policyholder) by agreeing to compensate the policyholder
if a specified uncertain future event (the insured event) adversely affects the policyholder;
• separates specified embedded derivatives, distinct investment components and distinct
performance obligations from the insurance contracts;
• divides the contracts into groups that it will recognize and measure;
• recognizes and measures groups of insurance contracts at:
1. a risk-adjusted present value of the future cash flows (the fulfilment cash flows) that
incorporates all of the available information about the fulfilment cash flows in a way
that is consistent with observable market information; plus (if this value is a liability) or
minus (if this value is an asset)
2. an amount representing the unearned profit in the group of contracts (the contractual
service margin);
• recognizes the profit from a group of insurance contracts over the period the entity provides
insurance contract services, and as the entity is released from risk. If a group of contracts is or
becomes loss-making, an entity recognizes the loss immediately;
• presents separately insurance revenue (that excludes the receipt of any investment
component), insurance service expenses (that excludes the repayment of any investment
components) and insurance finance income or expenses; and
• discloses information to enable users of financial statements to assess the effect that contracts
within the scope of IFRS 17 have on the financial position, financial performance and cash flows
of an entity.