Chapter 4 - Accounting

Question 1

Annual basis of accounting

Answer 1

Annual accounting is one of two statutory bases of accounting, the other being fund
accounting. Annual accounting is based on the cover provided during the accounting
period, regardless of when the contracts of insurance start and end. AKA one-year (accident-year) accounting

Question 2

Funded accounting

Answer 2

A method of accounting whereby premiums, claims and associated expenses are related
to the underwriting year in which the policies start. The recognition of any
underwriting profit is deferred until a subsequent accounting period (usually 3-years) but provision is made for losses as soon as they are foreseen

Question 3

Deferred Acquisition Costs (DAC)

Answer 3

Acquisition costs relating to contracts in force at the balance sheet date. They are carried forward as an asset from one accounting period to subsequent accounting periods in the expectation that they will be recoverable out of future margins within insurance contracts after providing for future liabilities

Question 4

Earned premiums

Answer 4

Different to written premiums. These are the premiums that are recognised during a financial year when considering the ‘deferral and matching’ accounting concept.
Unearned premiums = unearned premiums brought forward from earlier years + premiums written during the year - unearned premiums carried forward to later years

Question 5

Reinsurance to Close (RITC)

Answer 5

A concept in funded accounting in which a premium is paid to another account to pass on liabilities that are still remaining from a funded account that is being closed

Question 6

Going Concern

Answer 6

The enterprise will continue in operational existence for the foreseeable future

Question 7

Accruals Basis

Answer 7

Revenue and costs are recognised as they are earned or incurred, not as the money is received or paid

Question 8

Consistency

Answer 8

There is consistency of accounting treatment of like items within each accounting period and from one period to the next

Question 9

Prudence and realisation

Answer 9

Revenue and profits are not anticipated, and provision is made for all known liabilities, whether the amount of these is known with certainty or is the best estimate in the light of the information available

Question 10

Separate valuation of assets and liabilities

Answer 10

When determining the aggregate amount of any item the enterprise must determine separately the amount of each individual asset or liability that makes up that item

Question 11

Solvency ratio

Answer 11

The free reserves divided by the net written premiums

Question 12

Underwriting profit

Answer 12

The excess of earned premiums over incurred claims and expenses

Question 13

Insurance profit

Answer 13

The underwriting profit plus the investment income earned on the technical reserves.

Question 14

Profit before tax

Answer 14

The insurance profit plus investment income from other assets

Question 15

Retained profit

Answer 15

Profit remaining after the payment of tax and dividends

Question 16

Total shareholders’ funds

Answer 16

The excess of assets over liabilities

Question 17

24ths Method

Answer 17

A method of estimating UPR, is based on the assumption that annual policies are written evenly over each month and risk is spread evenly over the year.

Question 18

365ths Method

Answer 18

A method of estimating UPR, based on the assumption that the risk is spread evenly over the 365 days of a year of cover

Question 19

Accident year

Answer 19

An accident year grou[ping of claims means that all claims relating to loss events that occurred in a 12-month period (usually a calendar year) are grouped together, irrespective of when they are actually reported or paid and irrespective of the year in which the period of cover commenced

Question 20

Acquisition costs

Answer 20

Costs arising from the writing of insurance contacts (e.g. commission)

Question 21

Additional Reserve for for unexpired risk (AURR)

Answer 21

The reserve held in excess of the UPR which allows for any expectation that the UPR will be insufficient to cover the cost of claims and expenses incurred during the period of unexpired risk

Question 22

Claims ratio (AKA loss ratio)

Answer 22

Ratio of the cost of claims to the corresponding premiums, either gross or net of reinsurance.

Incurred claims/earned premiums

Question 23

Closed year

Answer 23

In the case of fund accounting a closed year is an underwriting year that is older than
the prescribed limit for the class in question. In the Lloyd’s market, a closed year is one
that has been closed by reinsurance to close (RITC).

Question 24

Combined Ratio

Answer 24

The sum of the claim ratio and the expense ratio. Also called the operating ratio or underwriting ratio

Question 25

Eights Method

Answer 25

A method of estimating UPR, based on the assumption that annual policies are written evenly over each quarter and the risk is spread evenly over the year

Question 26

Open year

Answer 26

Under fund accounting an open year is one that has not yet reached the stipulated period
for closure. In the Lloyd’s market, an open year is one that has not yet been closed by
RITC. I.e. it is not a ‘closed year’

Question 27

Reporting year

Answer 27

A reporting year grouping of claims will combine all the claims that are reported within a given calendar year, irrespective of the date on which the relevant policy commenced, irrespective of when the claims are actually paid and irrespective of the year in which the incident actually arose

Question 28

Underwriting year

Answer 28

An underwriting year grouping of claims will combine all the claims relating to loss events that can be attributed to all policies that commenced cover within a given calendar year, irrespective of when they are actually reported or paid and irrespective of the year in which the incident actually arose