Orlando Harmon
Whether insurance is considered an asset or an expense in accounting depends on the context. Some people view insurance as an expense rather than an asset. However, insurance policies can be considered an asset in certain situations. For example, when a business policyholder pays the premium in advance, it is recorded as a current asset until the coverage is used. Additionally, life insurance policies with a cash value component, such as permanent life insurance, can be considered an asset since they accumulate cash value over time. On the other hand, term life insurance policies typically do not have a cash value and are not considered an asset. In the case of unforeseen risks or illnesses covered by an insurance plan, the policy can be seen as an asset when it provides financial protection through a successful payout.
| Characteristics | Values |
|---|---|
| Insurance policy matures | Becomes an asset |
| Surrender value of insurance policy is less than paid-up premiums | Not considered an asset |
| Surrender policy before maturity | Net loss |
| Risk covered in insurance plan | Becomes an asset |
| Prepaid insurance | Current asset |
| Coverage beyond 12-month accounting period | Long-term asset |
| Prepaid insurance contract | Initially recorded as an asset |
| Prepaid insurance is a current asset | Coverage used within one year of payment |
| Prepaid insurance | Converted to an expense |
| Insurance as an asset | Yes and no |
| Life insurance with cash value | Considered an asset |
| Prepaid expenditure | Asset |
| Payout from insurance | Not considered when journaling |
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What You'll Learn
Life insurance as an asset
Life insurance is often a significant asset, yet many people fail to recognise its value or the opportunities it presents. It can be the largest unmanaged asset a client owns and is rarely appraised or valued. It is important to treat life insurance as an asset, similar to how one treats other properties owned.
A life insurance policy can be sold, and there is a regulated institutional marketplace for this. A life settlement is the sale of an existing life insurance policy for an amount greater than the surrender value but less than the death benefit. This can create significant value, often six or seven figures, for other planning needs, such as long-term care, medical costs, and retirement.
Life insurance can also be a valuable asset for growing wealth. Traditional whole life insurance, or cash value life insurance, gives a policy owner wealth-building opportunities. Money inside a policy grows tax-deferred and can be borrowed against tax-deferred, all while still earning a rate of return. This can be used to invest in another performing financial asset. Whole life insurance can play a pivotal role in a balanced financial portfolio and help to grow and protect wealth.
In accounting terms, a prepaid insurance contract is initially recorded as an asset. When a business policyholder pays the premium in advance, the total amount is shown as a current asset and is carried as an asset until the coverage is used. As the coverage is used, the amount is expensed on the income statement and is no longer shown as an asset.
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Prepaid insurance as an asset
Prepaid insurance refers to payments made by individuals and businesses to their insurers in advance for insurance services or coverage. Premiums are usually paid a full year in advance, but they may also cover more than 12 months. Prepaid insurance is considered a prepaid expense, and it is carried on an insurance company's balance sheet as a current asset until it is consumed. This is because most prepaid assets are consumed within a few months of being recorded. When the insurance coverage comes into effect, it is moved from an asset and charged to the expense side of the company's balance sheet.
Prepaid insurance is also considered an asset because of its redeemable value. If a business has purchased six months of insurance and decides to cancel the policy after two months, it could redeem the value of the remaining four months of coverage. This is a source of future cash revenue for the business. Prepaid insurance has economic value, similar to an investment in stocks or bonds, that can be redeemed at a later time.
When a business policyholder pays the premium in advance, the total amount is shown as a current asset and is carried as an asset until the coverage is used. When the coverage is applied for one month, that amount is expensed on the income statement, and it is no longer shown as an asset. Prepaid insurance is a current asset if coverage is used within one year of payment. Should coverage extend beyond 12 months, that portion can be a long-term asset.
When a company uses the accrual method of accounting, the concept of prepaid insurance allows the accounting process to match the payment for expenses with the periods in which they are actually consumed. This enables the most accurate reflection of assets in the short term, as well as profit. Prepaid insurance is important because a business should correctly record all of its transactions and resources to have accurate financial statements.
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Insurance as a liability
Insurance can be considered a liability in several contexts. Firstly, in the context of accounting for businesses or individuals, insurance policies can be liabilities when they are prepaid. When a business pays for an insurance policy in advance, the total amount is initially recorded as a current asset. However, as time passes and the coverage period is utilised, the prepaid amount is gradually expensed on the income statement, and it is no longer considered an asset. This process involves creating adjusting journal entries each month to record the current month's expense and reduce the unexpired amount of prepaid insurance in the asset account.
In the context of insurance companies themselves, their financial statements include a balance sheet that presents the company's assets and liabilities. The policyholders' surplus, calculated as assets minus liabilities, serves as a financial cushion against potential losses and funding for expansion. Therefore, the liabilities of an insurance company directly impact its financial stability and ability to support the policies it offers.
Additionally, the concept of liability insurance is crucial for businesses and individuals. Liability insurance protects against potential claims or lawsuits arising from negligence, financial harm caused by professional advice, or other unforeseen events. For example, accounting professionals may obtain professional liability insurance to safeguard against contingent liabilities, which are potential obligations dependent on future events outside their control. Similarly, sole proprietors and general partners may face unlimited liability, where their personal assets are at risk if their business cannot pay its debts. In such cases, liability insurance provides essential protection against devastating claims.
Furthermore, understanding the difference between current and non-current liabilities is essential in accounting. Current liabilities, also known as short-term liabilities, are obligations that are due within one year or a normal operating cycle. They include accounts payable, wages payable, and accrued expenses. On the other hand, non-current liabilities, or long-term liabilities, are obligations that are not due for more than a year. Examples of long-term liabilities include mortgages and bonds payable.
In summary, insurance can be considered a liability in accounting when it involves prepayments, in the context of insurance companies' financial statements, as a form of protection against potential claims or lawsuits, and in the classification of current and non-current liabilities. Properly managing and understanding these liabilities is crucial for maintaining financial health and stability.
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Insurance as a financial asset
Insurance is a financial product that provides protection against various risks, such as property damage, liability, and unforeseen events like illness or death. While insurance is not typically classified as an asset in accounting, there are certain situations where it can be considered one.
An asset, by definition, is a resource controlled or owned by an individual or entity that has future economic value. In the context of insurance, the policy itself is a financial contract between the insurer and the policyholder, outlining the terms of the protection provided. This contract does not inherently hold value; instead, its value is realised when a claim is made, and the insurer provides reimbursement or financial protection to the policyholder.
However, insurance can be viewed as a financial asset in specific scenarios. One such scenario is when a policy has a cash value component, often found in permanent life insurance policies. In this case, the policyholder pays premiums that exceed the actual cost of insurance, and the excess amount accumulates as cash value that can be accessed or borrowed against. This cash value component is considered an asset because it represents a tangible monetary sum that can be utilised by the policyholder.
Another instance where insurance can be treated as an asset is when it is prepaid. When a business or individual pays for an insurance policy in advance, the total amount is initially recorded as a current asset. As the coverage period progresses, the value is gradually expensed on the income statement, no longer being considered an asset. This treatment of prepaid insurance as an asset is particularly relevant in accrual accounting, where it accurately reflects the short-term financial position and profitability of the entity.
Furthermore, insurance can become an asset when a covered risk materialises. For example, in the event of a critical illness, disability, or death, insurance provides financial protection to the policyholder or their beneficiaries. This payout can help maintain the standard of living of loved ones, repay debts, or fund future expenses such as education costs. Thus, while insurance is typically viewed as a form of protection, it can also serve as a financial asset in times of need.
In summary, while insurance is not always classified as an asset in accounting, there are specific circumstances where it can be considered one. These include insurance policies with cash value components, prepaid insurance where the coverage has not yet been utilised, and instances where insurance payouts provide financial support during challenging times. Understanding these nuances is essential for policyholders and accountants alike when evaluating the financial implications of insurance.
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Insurance as an intangible asset
Intangible assets are those that are not physical in nature but are identifiable, can be bought and sold, and have value. Examples include human capital, reputation, brand, and intellectual property. With the digital revolution, there has been a significant shift towards the insurance of intangibles. This is because the digital economy has turned enterprise value on its head, with over 70% of enterprise value now comprised of intangible assets.
Despite this, intangible assets are largely uninsured. This is because standard insurance policies generally cover tangible assets, and specialty line policies tend to focus on IP rights and legal events. However, there is a growing need for more insurance solutions that cater to intangible assets. This requires collaboration between risk managers, insurers, and underwriters, as well as brokers who can advise customers on the best cover for their needs.
One challenge with accounting for intangible assets is that only acquired assets or those with a stated value are recorded on company balance sheets. Additionally, the value of an intangible asset can vary over time, making it difficult to assign an accurate financial value. Intangible Asset Protection (IAP) is a tailored insurance offering that protects against financial loss caused by accidental or malicious insider actions impacting intangible assets.
Prepaid insurance contracts are initially recorded as assets and are carried as such until the coverage is used. Each month, adjusting journal entries are needed to record the current month's expense and reduce the unexpired amount of prepaid insurance in the asset account. This is reflected on the company's income statement and balance sheet.
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Frequently asked questions
It depends. Insurance is generally not considered an asset until it matures, i.e., you have paid for it and are credited with a lump sum. However, a life insurance policy with a cash value is considered an asset.
Insurance becomes an asset when a risk covered in your insurance plan is activated, allowing you to make a claim and receive a payout.
Prepaid insurance is initially recorded as an asset. However, as each month passes, the unexpired amount of the prepaid insurance is reduced and shown as an expense on the income statement.
