Multi-Year Industrial Policy: Written Premium, UPR and Premium Deficiency
Vayu General Insurance writes a 24-month industrial all-risks policy for a textile plant covering 1 October 2024 to 30 September 2026. Gross premium is ₹48,00,000, paid in full on 5 October 2024. Brokerage is 12.5% of gross premium. A 40% quota share is ceded from inception; the reinsurer pays a ceding commission of 7.5% of ceded premium. The finance team has recorded the entire ₹48,00,000 as premium income in FY 2024-25 and has deferred none of the brokerage. At 31 March 2025, the actuarial team advises an expected loss ratio of 85% on this policy and says the company's unexpired risk reserve policy is 50% of net premium for the remaining period. The CFO wants the correct FY 2024-25 revenue-account treatment, including unearned premium, acquisition cost and any premium deficiency. The statutory auditor has questioned whether a 24-month policy can be treated like an annual policy. The policy is not cancellable.
1. Compute gross and net written premium, ceded premium, net earned premium and the unexpired premium reserve at 31 March 2025 on a daily pro-rata basis. Show the reasoning for the basis you use.
Read the worked answer
Use daily pro-rata because the policy runs 24 months, not 12. Policy term 1 October 2024 to 30 September 2026 = 730 days. Elapsed to 31 March 2025 = 182 days (October 31 + November 30 + December 31 + January 31 + February 28 + March 31); unexpired = 548 days.
Gross written = ₹48,00,000. Gross earned = 48,00,000 × 182/730 = ₹11,96,712. Gross UPR = 48,00,000 − 11,96,712 = ₹36,03,288.
Ceded premium = 40% × 48,00,000 = ₹19,20,000. Ceded earned = 19,20,000 × 182/730 = ₹4,78,685. Ceded UPR = ₹14,41,315.
Net written = ₹28,80,000. Net earned = 11,96,712 − 4,78,685 = ₹7,18,027. Net UPR = 36,03,288 − 14,41,315 = ₹21,61,973.
The revenue account should show gross written premium, less ceded premium, and the UPR movement. The balance sheet carries gross UPR as a liability and ceded UPR as a reinsurance asset. Recording the full ₹48 lakh as income overstates FY 2024-25 profit and understates liabilities.
2. How should the brokerage and ceding commission be treated in FY 2024-25? Is deferral of acquisition cost acceptable?
Read the worked answer
Brokerage = 12.5% × 48,00,000 = ₹6,00,000. Ceding commission = 7.5% × 19,20,000 = ₹1,44,000; net acquisition cost = ₹4,56,000.
Under the general-insurance revenue account, acquisition costs are charged in the year the policy is written; they are not deferred merely because the policy is multi-year. The matching argument for deferral is understandable, but it requires a regulatory basis and a consistent policy for all multi-year contracts. On the facts, charge ₹6,00,000 brokerage and credit ₹1,44,000 ceding commission in FY 2024-25, and disclose the accounting policy.
If the company instead defers, it must defer both the gross brokerage and the ceding commission and test the deferred amount for recoverability. It cannot defer only the brokerage, because that would create a one-sided asset and overstate profit. The auditor's concern is valid if the company has adopted an undisclosed or inconsistent deferral policy.
3. Assess whether a premium deficiency reserve is required at 31 March 2025. Show the calculation and explain the effect of the acquisition-cost policy.
Read the worked answer
Compare the net UPR with expected claims and expenses for the unexpired period, plus any deferred acquisition cost.
Expected claims on the full net premium = 85% × 28,80,000 = ₹24,48,000. Unexpired share = 24,48,000 × 548/730 = ₹18,37,808. Add expected maintenance expenses, say 5% of unexpired net premium = ₹1,08,099. Total expected outgo = ₹19,45,907. Net UPR = ₹21,61,973. No deficiency because ₹19,45,907 < ₹21,61,973.
If the company had deferred net acquisition cost of ₹4,56,000, the comparison would be ₹19,45,907 + ₹4,56,000 = ₹24,01,907, creating a deficiency of about ₹2,39,934. That is the key judgement: because the company expensed acquisition cost, it should not add a notional deferred amount. It should, however, disclose the sensitivity and the fact that a deferral policy would have created a deficiency.