24th method: Unearned premium reserve calculation

column-dennis funaEVERY nonlife insurance company must set aside and maintain an amount corresponding to the legal reserves required under Section 219 of the Amended Insurance Code.

Thus, Section 219 states: “Every insurance company, other than life, shall maintain a reserve for unearned premiums on its policies in force, which shall be charged as a liability in any determination of its financial condition. Such reserve shall be calculated based on the 24th method.” Under the previous Insurance Code, Section 213 provided: “Every insurance company, other than life, shall maintain a reserve for unearned premiums on its policies in force, which shall be charged as a liability in any determination of its financial condition. Such reserve shall be equal to 40 per centum of the gross premiums, less returns and cancellations, received on policies or risks having not more than a year to run, and pro rata on all gross premiums received on policies or risks having more than a year to run: Provided, that for marine cargo risks the reserve shall be equal to 40 per centum of the premiums written in the policies upon yearly risks, and the full amount of the premiums written during the last two months of the calendar year upon all other marine risks not terminated.” Thus, in calculating the unearned premium reserve, the Philippines shifted from the 40-percent method to the 24th method. The 40-percent method simply imposed a flat rate of 40 percent as the reserve requirement.

Apparently, the move was to keep the Philippines aligned with other Asian countries.  Before we proceed, we will have to understand the concept of earned and unearned premiums. In determining the earned premium, the length of the policy and the time period that has elapsed will have to be determined. Thus, if premium has been paid for a one-year home insurance and nine months have elapsed, then the insurer has earned premium equivalent to three- fourths of the premiums paid, representing the nine months.  The rest of the paid premium would, of course, be the unearned premium. To give it a definition, unearned premium is “that portion of premium which is not earned by the insurer, i.e., the amount of premium that relates to the policy period that has yet to be utilized or is still an ongoing concern or being the unexpired future periods of cover.” And pursuant to Section 219, a reserve has to be established for the unearned premiums, which shall be charged as a liability. It is an actual liability in the balance sheet.

There are different methods of computing the reserves for unearned premiums. Among these are the flat-rate method, the pro rata temporis method, and the fractional value method that includes the 1/8th method, the 1/12th method, and the 1/24th method or the 24th method. Different jurisdictions require different methods. Some jurisdictions require no method at all, like the United States.  The Philippines now requires the 24th method.

For a definition of the 24th method, we shall adopt that given by the Accounting and Reporting for the Non-Life Insurance Industry (Statement of Financial Accounting Standards 27), which states: “[It] is a method for computing an unearned premium reserve. It is computed by combining premiums having the same term [e.g., 12, six or three months, one month or any other term], each group being divided by the month in which premiums were written and each premium deemed to have been written in the middle of the month. Accordingly, any 12-month premium written in January will be considered to have been written on January 15 and will, therefore, provide coverage for 15 days beyond the closing date, i.e., 1/24th of the premium in question. A premium written in December of the same year will be deemed to take effect as of December 15 and provide coverage beyond the closing date of 23/24th of the said premium.” We may add: “[It is] a basis for estimating unearned premium reserves based on the assumption that premiums are received evenly over each month and risk is spread evenly over the year.”  Twelve months divided at the 15th of each month is equal to twenty four.

****

Atty. Dennis B. Funa is the Insurance Commission’s deputy commissioner for legal services. Send comments to [email protected]

 

House Manila Leaderboard
ECA 728×90 Leaderboard
Suntrust banner2
mm
Atty. Dennis B. Funa is the current Insurance Commissioner. Atty. Funa was appointed by President Rodrigo R. Duterte as the new Insurance Commissioner in December 2016.

LEAVE A REPLY

Please enter your comment!
Please enter your name here