Subchapter L: Insurance-In-Force Is A Valuable Asset

It is well understood among actuaries and insurance tax professionals that insurance-in-force is an intangible asset that can be purchased as part of the acquisition of an insurance business. In the context of reinsurance, the purchase price for insurance-in-force usually takes the form of a ceding commission. In many cases there is an expectation that the future net cash flows from in-force policies (premiums, plus investment earnings on future premiums, less benefits and expenses) will be negative, as usually would be the case for a closed block of single premium or paid-up life insurance contracts where there are no future premiums. In the real world, this block of contracts generating future negative cash flows would be considered a liability. Yet, in the insurance business, this block of business is considered a valuable asset called insurance-in-force. Can you believe it?

How can an economic liability be an intangible asset? As explained below, the answer lies in 1) insurance regulatory accounting conventions that require the establishment of reserves for future unaccrued claims, 2) the assumption that assets backing the reserves will be available to pay future claims, and 3) the fact that future net cash flows become available to the owner of an insurance business only as they become distributable under insurance regulatory accounting and capital requirements. Insurance accounting is different from accounting methods for other businesses because premiums are received before claims are paid out. Obviously, the entire premium charged is not earned economic income; a large portion must be set aside as a liability on the balance sheet to pay future unaccrued claims. Also, to account for the periodic emergence of profit or loss in gain from operations, it is necessary to offset premium income by a reserve liability for future claims so that premiums are considered earned over the entire period to which they relate, i.e., the duration of the insurer’s risk for which the premiums are charged.