Insurance & Accounting
In an income statement for an insurance company, the incurred loss for a period is defined as the paid losses plus the difference between the ending loss reserves and the beginning loss reserves. Sometimes a company seeks to transfer some of its risk to a re-insurer, thus allowing itself to discount its loss reserves. This can raise a controversy, for example when regulatory authorities don't agree that risk has actually been transferred successfuly.
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Paying Claims
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Even at what may be the simplest insurance transaction, the payment of losses, accounting treatment does not exactly track cash flow. For example, an adjuster may write checks in a catastrophe zone, such as a region recently hit by an earthquake, and this may not go into the claim accounting ledgers for days.
Ralph S. Blanchard III, in a discussion of "Basic Insurance Accounting -- Selected Topics," has noted that in such a case there may be a claim suspense account. "Growth in the claim suspense account would normally signify some backlog in the clearing of records in the claim system, or an influx of claim activity."
Changes in the Loss Reserve
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Another basic accounting transaction is the increase or decrease of a claim reserve. These are distinct types of claim reserve. On the one hand, there are specific "case reserves," and on the other there are "incurred but not reported" reserves. Several jurisdictions mandate that the IBNR figure be reported separately from the case reserves. Somewhere between those extremes, there are bulk reserves, defined by Blanchard as "the estimated deficiency in the aggregate of case reserves for known claims." Finally, there are "additional case reserves" that are employed when an assuming company (a reinsurer) has an estimate of the necessary case reserve different from that of the ceding company.
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Reinsurance and Controversy
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Insurance companies regularly enter into reinsurance contracts with one another. Some of these contracts come in for criticism as a means by which a company can prettify its books for its investors without changing the underlying economic reality. Such controversies often involve the amount of loss reserves claimed on a balance sheet.
In February 2005, both the New York Attorney General and the Securities and Exchange Commission subpoenaed the giant insurer AIG, seeking documentss regarding the validity of certain reinsurance contracts. AIG had entered into some of the contested contracts with Union Excess Reinsurance Co. Ltd., a Barbados domiciled concern.
AIG Restatement Regarding Union Excess
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In June 2005 AIG restated previously filed financial results in part due to the controversy over Union Excess. AIG conceded that it had "control over certain transactions undertaken directly or indirectly with Union Excess," i.e., that Union Excess was a shell, and the contracts didn't result in actual risk transfer.
The reinsurance contracts had come with a discount to AIG's loss reserves, and when AIG acknowledged the invalidity of these transactions it had to eliminate that discount, in other words, it had to increase its loss reserves.
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