Accounting for Cash Value Policies

Abstract

This paper reviews the set of previously suggested and currently used methods for accounting by the policyowner for cash value life insurance policies. The methods are criticized on the grounds that they do not reflect the economic realities and are not consistent with the characteristics of cash value insurance policies. A new accounting method is then suggested. This method is based on the characteristics of cash value policies and is in conformity with generally accepted accounting principles. A detailed illustration is also provided. Purchases of Cash Value Policies (CVP) increased very dramatically in the last decade.' This kind of life insurance is widely used by companies to insure key officers and other employees. However, little consideration was devoted in the literature to accounting problems involved in CVP insurance from the point of view of the insured. It is the purpose of this paper to suggest an accounting method for CVP based on the nature of the CVP insurance transaction and on generally accepted accounting principles. The relevant literature and the method currently used by accountants are described in the following paragraphs. Then the nature of cash value insurance policy is discussed. Finally the proposed method is presented and an illustration is also provided. The literature offers four different accounting methods: Gatewood's Equal Ratable Charge Method, 2 Rivers' Increasing Ratable Charge Method, Kingston's Digit Sum Ratable Charge Method, 3 and a so-called Generally Accepted Method. 4According to all four methods, the annual Haim Falk, Ph.D., CPA, is Visiting Associate Professor of in Indiana University. He has served as Consultant to the Israeli Government Companies Authorities and was a member of the Principles Board of the Institute of Certified Public Accountants in Israel. This paper was submitted in June, 1974. Helpful comments obtained in discussing this paper with Professors Joseph Belth, Samuel Frumer, Leon Hay, James Heintz, Serge Matulich, and John Myers are gratefully acknowledged. IFor example, in 1962 total purchases of Straight Life and Limited Payment Life policies, both of which are cash value policies, amounted to $20,519 million premium out of $56,998 million purchases of ordinary life insurance in the United States, while in 1972 the amounts have been $51,833 and $148,238 million, respectively. (See: Life Insurance Fact Book 1973, Institute of Life Insurance, New York, pp. 16-17.) 2 See: Robert P. Catewood, Accounting Business Insurance-The Ratable Charge Method, CLU Journal (October, 1967), 11-15. 3 Both Rivers' and Kingston's methods are well described in Stuart J. Kingston, Accounting Business Life Insurance New Ratable Charge Method, CLU Journal (July, 1970), 64-69. 4 For a general description of this method see: Richard C. Lytle and J. T. Ball, Unofficial Interpretation: for Key-Man Life Insurance (Accounting and Auditing Problems), Journal of Accountancy (November, 1970), p. 73.