[Oimie]

NINJA Question –

In 20X1, Chain, Inc., purchased a $1,000,000 life insurance policy on its president, of which Chain is the beneficiary. Information regarding the policy for the year ending December 31, 20X6, follows:

Cash surrender value (01/01/X6) $ 87,000

Cash surrender value (12/31/X6) 108,000

Annual advance premium paid (01/01/X6) 40,000

During 20X6, dividends of $6,000 were applied to increase the cash surrender value of the policy. What amount should Chain report as life insurance expense for 20X6?

Answer: 19,000

Wouldn’t the answer me 25,000? Cash surrender value went up by 21,000. Of this 21,000, 6,000 were from dividends (whatever that means). So 15,000 increased in cash surrender value must have been from the 40,000. The left over 25,000 would be the insurance expense?

FAR 85 June 2015
AUD 80 Nov 2015
REG 83 Nov 2015
BEC 79 Feb 2016

[NfalconsE35]

For a little background, mutual life insurance companies are considered to be owned by their policyholders (usually their life policyholders) and therefore are entitled to the profits from the company as a whole or simply the life block of business. Therefore, dividends are considered a return of premium instead of a true return of equity and therefore is considered an expense to the mutual company and not a charge to retained earnings. As a result, in this case, the dividend is more so a reduction to the policyholders expense rather than income. Therefore let's look at the journal entries:

1. The $40 premium payment:

DR – Policy Asset 40

CR – Cash 40

2. The $6 dividend (reduction to the ultimate expense)

Dr – Policy Asset 6

Cr – Insurance Expense 6

3. The plug for the actual expense on the year of $25

Dr – Insurance Expense 25

Cr – Policy Asset 25

Using a t-chart you will see our ending policy asset is $108 and our insurance expense on the year is $19. What is tough about this problem is the concept of a dividend with regards to insurance policies. Also, in this situation, the concept of the insurance expense is more so the charge the insurance company reduces from the policyholders cash value and not the amount paid as premium on the year as that premium payment goes fully to the policyholders cash value and the insurance company then reduces that value through insurance expenses which is known as COI (cost of insurance).

FAR - PASS (8/13)
AUD - PASS (10/13)
BEC - PASS (12/13)
REG - PASS (3/14)!

[Oimie]

@NfalconsE35: Thank you so much! Very informative.

FAR 85 June 2015
AUD 80 Nov 2015
REG 83 Nov 2015
BEC 79 Feb 2016

[Author]

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