Insurance Policy

An operational definition of insurance is that it is

• the benefit provided by a particular kind of indemnity contract, called an insurance policy;
• that is issued by one of several kinds of legal entities (stock company, mutual company, reciprocal, or Lloyd's syndicate, for example), any of which may be called an insurer;
• in which the insurer promises to pay on behalf of or to indemnify another party, called a policyholder or insured;
• that protects the insured against loss caused by those perils subject to the indemnity in exchange for consideration known as an insurance premium.

In recent years this kind of operational definition proved inadequate as a result of contracts that had the form but not the substance of insurance. The essence of insurance is the transfer of risk from the insured to one or more insurers. How much risk a contract actually transfers proved to be at the heart of the controversy.

This issue arose most clearly in reinsurance, where the use of Financial Reinsurance to reengineer insurer balance sheets under US GAAP became fashionable during the 1980s. The accounting profession raised serious concerns about the use of reinsurance in which little if any actual risk was transferred, and went on to address the issue in FAS 113, cited above. While on its face, FAS 113 is limited to accounting for reinsurance transactions, the guidance it contains is generally conceded to be equally applicable to US GAAP accounting for insurance transactions executed by commercial enterprises.