Premium Revenue (AASB1023_07-04_COMPmay19_01-20)

Premium revenue comprises:

(a) premiums from direct business, that is, premiums paid by a policyholder (that is neither an insurer nor reinsurer) to a general insurer; and

(b) premiums from reinsurance business, that is, premiums received by a reinsurer from an insurer or from another reinsurer.

Premiums from direct business arise from contracts when a policyholder transfers significant insurance risk to an insurer.

Premiums from reinsurance business arise from contracts when an insurer or reinsurer transfers significant insurance risk to another reinsurer.

Premium revenue shall be recognised from the attachment date as soon as there is a basis on which it can be reliably estimated.

The amount of premium is determined by a general insurer or reinsurer so as to cover anticipated claims, reinsurance premiums, administrative, acquisition and other costs, and a profit component (having regard to expected income from the investment of premiums). The amounts collected in respect of these components are income of an insurer on the basis that they are collected in consideration for the insurer rendering services by indemnifying those insured against specified losses.

For certain classes of general insurance business, government authorities may require the payment of levies and charges. For example, workers’ compensation insurance levies, annual licence fees and fire brigade charges may apply. Such levies and charges are expenses of the insurer, rather than government charges directly upon those insured. The insurer is not acting simply as a collector of these levies and charges. Although not compelled to collect these amounts from those insured, the insurer is entitled to include in premiums an amount to cover the estimated amount of the levies and charges. The insurer is usually responsible for paying the levies and charges at a later date. The amount paid by the insurer does not depend on the amounts collected from those insured in relation to the levies and charges. Therefore, the amounts collected to meet levies and charges are income of the insurer. The insurer accrues for all levies and charges expected under the general insurance contracts written in the period.

In most States, stamp duty is charged on individual general insurance contracts and is separately identified by insurers on policy documents. The insurer is normally required to collect and pass on to the government an equivalent amount. Because such stamp duty is a tax collected on behalf of a third party and there is no choice on the part of the insurer but to collect the duty from the insured, it is not income of the insurer. Similarly, Goods and Services Tax (GST) is not income of the insurer.

Premium revenue needs to be recognised from the date of the attachment of risk in relation to each general insurance contract because insurers earn premium revenue by assuming insurance risks from that date on behalf of those insured. However, for reasons of practicality, many general insurers use bases of recognition that attempt to approximate this date. Such bases are acceptable provided that they do not result in the recognition of a materially different amount of premium revenue in a particular reporting period than would be the case if recognition occurred from the date of attachment of risk for each general insurance contract.

In recognising premium from the attachment date, an insurer may recognise premiums relating to general insurance contracts when the contract period commences after the reporting period, commonly referred to as premiums in advance. The attachment date is the date from which an insurer accepts risk. An insurer may accept risk prior to the date a contract commences: for example, it is not unusual for insurers to issue renewals, and for renewals to be paid for by policyholders, prior to the commencement date of an insurance contract. For commercial lines insurance, where the policyholder may be using the services of an insurance broker, the renewal terms could be agreed by both the insurer and policyholder prior to the commencement date and before the policyholder has paid the premium. In this situation, there may also have been a transfer of risk. As premiums in advance relate entirely to insurance cover to be provided in a future period, premiums in advance are recognised as part of the unearned premium liability. Premiums in advance are considered as part of the liability adequacy test required by section 9.

Reinsurance premiums

From the perspective of the reinsurer, reinsurance premiums accepted are akin to premiums accepted by a direct insurer. The reinsurer recognises inwards reinsurance premiums ceded to it as revenue in the same way as a direct insurer treats the acceptance of direct premiums as revenue.

Premiums accepted by the reinsurer are recognised from the attachment date, that is, the date from which the reinsurer bears its proportion of the relevant risks underwritten by the cedant. Reinsurers usually use bases of recognition that approximate the dates of bearing the risks. For example, the reinsurer may assume that its acceptance of risks occurs from the middle of the period for which the aggregate ceded premiums are advised by the cedant. This approach is acceptable provided that the premiums received or receivable in respect of the reporting period are recognised in that period, whether or not the periodic advice from the cedant has been received.

Premium revenue shall be recognised in the statement of comprehensive income from the attachment date:

(a) over the period of the general insurance contract for direct business; or

(b) over the period of indemnity for reinsurance business;

in accordance with the pattern of the incidence of risk expected under the general insurance contract.

In the case of business where the premium is subject to later adjustment, the adjusted premium shall be used, where possible, as the basis for recognising premium revenue. Where this is not possible, the deposit premium, adjusted for any other relevant information, shall be recognised as the premium revenue, provided that it is expected that this amount will not be materially different from the actual amount of premium.

Premium revenue is recognised in the statement of comprehensive income when it has been earned. An insurance contract involves the transfer of significant insurance risk. The insurer estimates the pattern of the incidence of risk over the period of the contract for direct business, or over the period of indemnity for reinsurance business, and the premium revenue is recognised in accordance with this pattern. This results in the allocation of the premium revenue and the claims incurred expense and hence the gross underwriting result over the period of the contract for direct business, or over the period of indemnity for reinsurance business, in accordance with the pattern of the incidence of risk.

Measuring premium revenue involves the following steps:

(a) estimating the total amount of premium revenue expected under the contract;

(b) estimating the total amount of claims expenses expected under the contract and estimating when the claims are expected to arise;

(c) estimating the pattern of the incidence of risk from the result of (b); and

(d) recognising the premium revenue under the contract identified in (a) when it will be earned, that is, in accordance with the pattern of the incidence of risk determined in (c).

For some general insurance contracts, especially complex multi-year reinsurance contracts, these estimations involve the use of significant judgement. The estimates are reassessed at the end of each reporting period. This prospective estimate of all of the income and expenses expected under the contract is also necessary for the purposes of the liability adequacy test. Refer to section 9.

Direct business

For most direct general insurance contracts the specified period of the contract is one year. For many direct insurance contracts the pattern of the incidence of risk will be linear, that is, the risk of events occurring that will give rise to claims is evenly spread throughout the contract period. For these contracts the premium revenue will be earned evenly over the period of the contract. However, for some direct insurance contracts the risk of events occurring that will give rise to claims is not evenly spread throughout the contract. For example, with motor insurance contracts, the risk of events occurring that will give rise to claims may be subject to seasonal factors.

Insurers estimate the pattern of the incidence of risk expected under the general insurance contracts from the attachment date. An insurer may be able to reliably estimate the pattern for a particular type of insurance business based upon past experience. However, when there have been changes in the nature of the cover provided, or, when there has been a change in loss experience, the insurer reflects this in the estimations.

Reinsurance business

Reinsurers recognise reinsurance premiums over the period of indemnity provided by the reinsurance contract in accordance with the pattern of the incidence of risk. For a typical twelve-month proportional treaty, such as a quota share treaty, written on a “risks attaching basis”, the period of indemnity will be twenty-four months, as the proportional treaty will indemnify the direct insurer (or, for retrocession, the reinsurer) for losses arising under direct policies written during the twelve-month contract period. Hence, an underlying annual direct contract written on the last day of the reinsurance contract has twelve months of insurance cover beyond the last day of the reinsurance contract. The reinsurer estimates the pattern of the incidence of risk over the twenty-four-month indemnity period.

The reinsurer may be able to reliably estimate the pattern for a particular type of reinsurance business based upon past experience. The reinsurer is likely to seek information from the cedant to estimate the pattern of the incidence of loss expected. When there have been changes in the nature of the cover provided or when there has been a change in loss experience the insurer will need to reflect this in the estimations.

To determine the pattern of the incidence of risk, reinsurers first determine the total reinsurance premiums expected under the contract. The premiums receivable under reinsurance treaties often depend on the volume of business written by the cedant after the reporting period but before the treaty expiry date. This is always true of proportional (quota share and surplus) treaties that span the end of the reporting period, and is often true of non-proportional treaties. For such treaties, to estimate the total premium revenue expected under the reinsurance contract, the reinsurer estimates the inwards reinsurance premium it will receive under the contract by estimating the gross premium revenue that the cedant is likely to receive. The reinsurer is likely to estimate this by communicating with the cedant, and by reviewing past experience.

For a typical non-proportional treaty, such as an excess of loss treaty, the period of indemnity is usually the same as the contract period. For example, an excess of loss treaty could indemnify a cedant for all claims incurred above the excess (either individual claims or in aggregate) during the contract period, or for all claims made during the contract period. For some of these contracts the pattern of the incidence of risk is likely to be linear and hence for these contracts the premium revenue expected under the contract is earned evenly over the contract period.

With a non-proportional treaty the reinsurer estimates the total liabilities that are likely to arise under the underlying insurance contracts to enable an estimation of the total inwards reinsurance premium revenue expected under the contract. Where relevant, the reinsurer estimates whether the cedant is likely to want to reinstate the contract, in which case the reinsurer considers the additional reinstatement premiums it is expected to receive and the extent that they may have been earned at the end of the reporting period. A reinsurer liaises closely with the cedant, reviews any market information on significant losses or events that may have arisen, for example a hailstorm or earthquake, and reviews past experience.

Some reinsurance contracts might involve an experience account. Whilst such contracts may require annual renewal, in substance the contract period is likely to be greater than one year. In estimating the total inwards reinsurance premium expected under the contract and in estimating the total reinsurance claims, to determine the pattern of the incidence of risk, the reinsurer considers the probability-weighted expected cash flows over the expected period of the contract, and discounts these cash flows to reflect the time value of money. Section 6 discusses the determination of discount rates. In determining the expected cash flows, the reinsurer considers any cash flows such as profit commissions and commission rebates.

Adjusted premiums

For some classes of insurance it is usual for the premium to be adjusted as a result of events and information that only become known during or after the insurance contract period. For example, marine cargo insurance is a type of “adjustable” business for which a deposit premium is paid at the beginning of the contract period and subsequently adjusted on the basis of a cargo declaration.

Premium revenue relating to unclosed business shall be recognised in accordance with paragraphs 4.2, 4.3 and 4.4.

Frequently, there is insufficient information available at the end of a reporting period to enable a general insurer to accurately identify the business written close to the end of the reporting period for which the date of attachment of risk is prior to the end of the reporting period. This is often referred to as unclosed business. Consistent with the principle stated in paragraph 4.2, that premium revenue is to be recognised from the attachment date, all unclosed business is estimated and the premium relating to unclosed business included in premium revenue.

Estimates of the amount of unclosed business can be made using information from prior periods adjusted for the impact of recent trends and events. In addition, information about unclosed business may become available after the reporting period and before the financial statements are authorised for issue and may enable more reliable estimates to be made.