Eastern and Western Methods of Accounting for Workers’ Compensation Contracts

When it comes to accounting for workers’ compensation contracts, the Eastern and Western Methods may have reporting implications for insurance carriers. However, does choosing one over the other introduce potential complexities? In this article, we’ll take a deep dive into this topic.

SSAP No. 53, Property and Casualty Contracts – Premiums, paragraph 6, requires the recording of written premiums as of the effective date of the contract. Upon recording written premium, a liability for the unearned premium shall be established for the unexpired portion of the insurance coverage. This method is commonly called the Eastern Method of accounting for premiums.

However, there is an alternative available in the same statement, specifically for workers’ compensation policies, termed the Western Method.

“For workers’ compensation contracts, which have a common premium but may periodically vary based upon changes in the activities of the insured, written premiums may be recorded on an installment basis to match the billing to the policyholders. Under this type of arrangement, the premium is determined and billed according to the frequency stated in the contract, and written premium is recorded on the basis of that frequency.” (SSAP No. 53, paragraph 4)

Accounting

Example: Insurance Company ABWC wrote a one-year workers’ compensation policy effective July 1^st with an estimated annual premium of $1,200 payable in monthly installments of $100 at the beginning of each month. The policyholder is required to submit the Self Reporting Payroll Form monthly.

As we can see in the example above, under the Western Method of accounting, there were no balances in the Deferred Premiums or Unearned Premium Reserve (UPR) accounts on August 31^st, the end of the second installment period.

Also note that there is no difference in total earned premiums between these two methods, as both methods result in total earned premiums of $205.

Impairment

The example above depicts an optimal scenario – the monthly installments are received when due, which is not always the case.

SSAP No. 6, Uncollected Premium Balances, Bills Receivable for Premiums, and Amounts Due From Agents and Brokers, paragraph9a, stipulates that to the extent there is no related unearned premium, any uncollected premium balances which are over ninety days due shall be nonadmitted. In addition, if an installment premium is over ninety days due, the amount over ninety days due plus all future installments that have been recorded on the policy shall be nonadmitted.

Continuing from our example above, let’s assume no premiums have been received by October 31^st (90 days past due). Also, assume that there is no mandatory submission of the Self Reporting Payroll Form; hence, there are no earned but unbilled premiums.

Due to no collections made by October 31^st, the entire balance in the asset account Premiums in Course of Collection of $400 should be nonadmitted.
The Deferred Premiums amounting to $800 are offset with a corresponding liability for unearned premium reserve for the same amount. Hence, this balance does not need to be nonadmitted.
All unpaid installments recorded after October 31^st will automatically be nonadmitted.

Tax Implications

For federal tax purposes, an insurance company needs to pick up 20% of unearned premium reserve as taxable income. This will create a deferred tax asset that reverses as the balance of unearned premium reserve decreases as the policy matures.

Could insurers benefit from using the Western Method of accounting for tax purposes, as this method produces lower unearned premium reserves? The answer is no.

For tax reporting purposes, insurance companies need to convert to the Eastern Method of accounting, as the Code of Federal Regulations §1.832-4 (IRS code) requires insurers to record the entire policy premium as gross premium written under the contract on the policy’s effective date.

Conclusion

The article above shows that both Eastern and Western methods result in the same earned premiums. The difference lies mainly in the Western Method, which does not record the Unearned Premium Reserve and its lower gross written premiums that match billings. For tax reporting purposes, the insurance companies that use the Western Method need to calculate the UPR for premiums not yet billed in order to properly account for the 20% UPR haircut.

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If you have questions about the impact this might have on your insurance company, JLK Rosenberger can help. Call us at 818-334-8645, or click here to contact us. We look forward to speaking with you soon.