Derivation of a framework for annual financial statements of a property-casualty insurance firm: From Adam Smith to the modern insurance firm

Abstract

This article derives a framework for annual financial statements of a property-casualty insurer from first principles using Adam Smith’s statement of the operation of an insurer as the point of departure. The derivation incorporates’ current standard accounting principles and regulatory requirements. In the end it will be seen that a substantial correlation exists between the final derived framework and current published statements of a modern property-casualty insurer. It remains to be seen if a similar correlation will continue to exist once the long awaited international accounting standard for insurers is finalised. The article accordingly demonstrates that Adam Smith’s statement can be used to derive a workable framework for the accounting and hence management of modern property-casualty insurers. A number of important conclusions flow from the article. Firstly the distinction between provisions and reserves must be understood and maintained failing which solvent insurers may be portrayed as being insolvent, second a new provision should be raised, a Year to Close Provision where it is unclear that existing provisions adequately cover outstanding liabilities and third the IBNR provision should be restricted to claims in the pipeline for the year under consideration.