Updated July 12, 2023
Introduction to Insurance Expense
Insurance expense is a fixed & regular expense incurred per period by the insured person (i.e., the person who has taken the insurance cover) against any uncertain risk in the future that may occur due to any event (which may or may not be known today) and the same is based on a certain percentage of the sum assured, which give an assurance to the insured person.
Explanation
- Insurance means an assurance provided by one person to another to make good the loss if incurred. The person providing the assurance is an indemnifier. The person paying the insurance premium is an insured person or indemnity holder.
- Insurance expense means the insurance premium paid by the insured against an assurance that the insurer will make good the loss during the probable event.
- Insurance expense covers the risk of uncertain events in the future.
- It is calculated by actuaries based on a certain logical percentage of the sum assured & the same is based on equal quantum at certain intervals.
The Formula for Insurance Expenses
| Types of Insurance | Formula |
| Life Insurance | Sum assured * % set by an actuary |
| Other insurances | Value of asset undercover * % set by an actuary |
How to Calculate Insurance Expenses?
Calculating insurance premiums is a tough task handled by actuaries (experts in such a field). We will consider the factors focused on by the actuaries for the calculation of insurance expenses:
- Step 1: This is the most important item in the whole calculation. The amount of coverage to provide is set by the insurance company. The premium is higher or lower, completely depending on the coverage amount. This is the base amount on which the calculations are done. Lower coverage amount means lower premium & vice-versa.
- Step 2: The next step is deciding on the type of insurance. In the case of auto insurance, the amount is lower than the insurance for a home or building. The life insurance amount is higher than general insurance.
- Step 3: Age is the deciding factor for life insurance. If you are young, you will need lower premium expenses since the likelihood of occurring of health issues is lower. So, health factors are also considered. The amount of premium is bound to increase after a certain age.
- Step 4: Probability placed by the actuary to decide on the likelihood of occurrence of the event. This depends on many factors such as health, lifestyle, history of personal profile, etc.
- Step 5: After all the above considerations, the percentage decided by the actuaries, which is applied to the sum assured amount, i.e., the insurance coverage amount
Example of Insurance Expenses
The company needs to pay 2.25% of the value of assets as insurance expenses on different assets. The accounting period is from 1st January 2019 to 31st December 2019. The insurance coverage starts on 1st March 2019 & ends on 29th February 2020, i.e., 12 months. The data is as follows:
| Asset | Value($) |
| Plant & Machinery | 82,50,000 |
| Industrial Shed (Temporary) | 2,80,000 |
| Spares & Components | 1,20,000 |
| Equipment (others) | 90,000 |
| Total | 87,40,000 |
Calculations
| Asset | Value($) | Rate of Premium | Insurance Expense ($) |
| Plant & Machinery | 82,50,000 | 2.25% | 1,85,625 |
| Industrial Shed (Temporary) | 2,80,000 | 2.25% | 6,300 |
| Spares & Components | 1,20,000 | 2.25% | 2,700 |
| Equipment (others) | 90,000 | 2.25% | 2,025 |
| Total | 87,40,000 | 1,96,650 | |
| Period Expired (months) | 10 | ||
| Insurance expense for the calendar year 2019 (196650*10/12) | $1,63,875 | ||
| The balance amount is to be treated as a current asset | $32,775 |
Explanation
- Calculations are made every month as above.
- The accounting passed for recording the amount paid is:
| Prepaid Insurance (Debit) | $ 1,96,650 |
| Bank (Credit) | $ 1,96,650 |
- The accounting entry passed for transferring the expense amount is as follows:
| Insurance Expense (Debit) | $ 1,63,875 |
| Prepaid Insurance (Credit) | $ 1,63,875 |
Insurance Expenses in Accounting
- Per general accounting norms, insurance expense is the cost of insurance that has been used, incurred & relevant period that has expired.
- The current year expense is shown as expenditure in the profit & loss account & insurance expense about future periods is shown as a prepaid expense as current assets in the balance sheet.
- Following are the accounting entries made in books of account:
When insurance expense is paid:
| Prepaid Insurance (Debit) | XXXX |
| Bank (Credit) | XXXX |
When the period is expired:
| Insurance Expense (Debit) | XXXX |
| Prepaid Insurance (Credit) | XXXX |
- Presentation in financials is as follows:
| Statement of Profit & Loss | Amount ($) |
| OTHER EXPENSES | |
| Insurance Expense | XXXX |
| Balance Sheet | Amount ($) |
| OTHER CURRENT ASSETS | |
| Prepaid Insurance | XXXX |
- Prepaid insurance accounts get nullified once all periods are expired. It gets added whenever new insurance expenses are added.
Advantages
- The basic advantage is that the insured person attains financial security if the event occurs. Thus, financial security is the main reason why insurance coverage is taken.
- The insured person lives a stress-free life since the risk is not retained by him but transferred to another person.
- The premium amount is normally within the budget of a normal earning person & hence, paying the premium is not that difficult.
- In case the event happens, the sum assured is paid by the indemnity provided after confirmation of the facts.
- The money grows even at the end of the indemnity due to the investment strategy at the insurance company’s end.
- Some insurance also allows accumulating the funds at a higher interest rate & this investment portion of the insurance expense is paid back to the insured even if the event has not occurred. This portion of insurance expense is recorded separately at the insurance company’s end.
- With the investment portion, the insured person can also opt for a fixed income to be received after attaining a certain age. This works like a pension fund.
Disadvantages
- In case of non-occurrence of the uncertain event, the sum assured is not received.
- In the case of stock insurance & there is a fire in the warehouse, fraudulent mechanisms are placed to recover the sum assured on the stock valued at a higher price but is a dead stock in normal trade.
- There are conditions specified in each contract. If such conditions are not met, the insurance coverage lapses. So, the situation is either-or.
- There are some conditions in which the insured is not clear when availing of the insurance contract. Insurance companies sometimes manipulate such conditions to save on the sum assure. This is the reason why people lack trust in insurance claims.
- A lot of documentation is required to prove the fact & this is a tedious process.
Conclusion
Lots of subjectivity is involved in settling the insurance claim. If one has sure to keep the documentation ready at his end, he can avail of the insurance. Else, some people prefer to invest some amounts monthly to build an emergency fund at their end, which can be accessed as & when required without documentation. Such small-small investments may be made via mutual funds, recurring deposits, etc. This is getting more famous nowadays than normal insurance coverage. On the other hand, if one does not have the discipline to invest on his own, then covering for insurance is better for him.
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This is a guide to Insurance Expenses. Here we also discuss the introduction and how to calculate insurance expenses. Along with advantages and disadvantages. You may also have a look at the following articles to learn more –
