Cash surrender value life insurance is a unique financial product that intersects the worlds of insurance and accounting. This type of policy provides both death benefit protection and an investment component that accumulates value over time. For businesses and individuals, understanding how to properly account for cash surrender value life insurance is crucial for accurate financial reporting and decision-making.
The cash surrender value represents the amount a policyholder can receive if they choose to terminate their life insurance contract before its maturity. As premiums are paid, this value grows, becoming an asset that companies must record on their balance sheets. Accounting standards require that the cash surrender value be reported at the amount realizable under the contract as of the balance sheet date.
For corporations holding life insurance policies on key employees, the accounting treatment can have significant financial implications. The increase in cash surrender value from year to year is not taxable, nor are the eventual life insurance proceeds. This tax-advantaged status makes cash surrender value life insurance an attractive option for businesses looking to protect against the loss of crucial personnel while also building a valuable asset.
Understanding Cash Surrender Value
Cash surrender value is a key feature of permanent life insurance policies. It represents the amount policyholders can receive if they choose to terminate their coverage before maturity or death.
Definition and Basics
Cash surrender value refers to the accumulated savings component of a permanent life insurance policy. It builds up over time as policyholders pay premiums. This value is separate from the death benefit, which is paid to beneficiaries upon the insured’s death.
Policyholders can access the cash surrender value through withdrawals or loans. However, doing so may reduce the death benefit. The cash surrender value typically grows tax-deferred and can be used for various purposes like supplementing retirement income or covering emergencies.
Calculating Cash Surrender Value
The calculation of cash surrender value depends on several factors. These include the policy type, premiums paid, interest credited, and any fees or charges deducted by the insurer. Generally, the cash value increases over time as more premiums are paid.
Insurance companies use complex formulas to determine the cash surrender value. Early in the policy’s life, it may be lower due to upfront costs and fees. As the policy matures, the cash value often grows more rapidly. Some policies guarantee a minimum cash surrender value, while others tie it to the performance of underlying investments.
Accounting Principles for Life Insurance
Life insurance accounting follows specific guidelines to accurately represent policies on financial statements. Key considerations include the cash surrender value, premiums paid, and death benefits.
GAAP Considerations
Under Generally Accepted Accounting Principles (GAAP), companies report life insurance on the balance sheet at its cash surrender value. This value represents the amount the policyholder would receive if they canceled the policy.
Premiums paid in excess of the increase in cash surrender value are recorded as an expense on the income statement. Any increases in cash surrender value above premiums paid are recognized as other income.
When a death benefit is received, it’s reported as income to the extent it exceeds the recorded asset value. The life insurance asset is then removed from the balance sheet.
International Financial Reporting Standards
IFRS accounting for life insurance differs from GAAP in several aspects. Under IFRS, insurers use a current fulfillment value approach to measure insurance contract liabilities.
This method considers the present value of future cash flows, including premiums, claims, and expenses. It also incorporates a risk adjustment for non-financial risk and a contractual service margin.
IFRS requires more detailed disclosures about insurance contracts, including sensitivity analyses and explanations of significant judgments made in applying the standard.
Policyholder’s Accounting Treatments
Policyholders must carefully account for cash surrender value life insurance policies. Key considerations include properly recording premium payments, tracking policy values, and understanding tax implications.
Premium Payments and Cash Outflows
Premium payments for cash surrender value life insurance are typically recorded as an asset on the policyholder’s balance sheet. The initial premium payment establishes the cash surrender value, which is reported at the amount realizable under the contract at the balance sheet date.
Subsequent premium payments increase the cash surrender value. These payments are recorded as cash outflows in the statement of cash flows. The difference between premiums paid and the increase in cash surrender value is recognized as an insurance expense on the income statement.
Policyholders should regularly update the recorded cash surrender value to reflect its current realizable amount. This may include adjustments for policy earnings or changes in surrender charges.
Reporting and Tax Implications
Cash surrender value is reported as an asset on the balance sheet, typically classified as a long-term investment. The value should be disclosed in the financial statement notes, including any restrictions on access to the funds.
For tax purposes, premium payments are generally not deductible for individual policyholders. However, businesses may deduct premiums paid on policies covering key employees, subject to certain limitations.
Increases in cash surrender value are not taxable as they accrue. Taxation occurs only if the policy is surrendered for more than the policyholder’s basis or upon death benefit payout exceeding the policy’s value.
Policyholders should maintain detailed records of premiums paid and policy values to accurately calculate potential tax liabilities if the policy is surrendered or terminated.
Corporate Accounting for Life Insurance
Corporate-owned life insurance policies have specific accounting implications for businesses. These policies impact financial statements and taxable income in unique ways.
Corporate-Owned Life Insurance
Corporate-owned life insurance (COLI) policies are purchased by companies on the lives of key employees. The cash surrender value of these policies is recorded as an asset on the balance sheet. Premiums paid are generally not tax-deductible. When the insured employee dies, the company receives a tax-free death benefit.
COLI accounting follows FASB ASC 325-30. Companies report the policy at its cash surrender value on the balance sheet. Any difference between premiums paid and cash surrender value is recorded as an expense or income.
Policy loans taken against COLI are recorded as liabilities. These loans do not affect the asset value of the policy on the balance sheet.
Impact on Financial Statements
COLI policies affect multiple financial statements. On the balance sheet, the cash surrender value is listed as an asset. This value typically increases over time as premiums are paid.
The income statement reflects changes in cash surrender value. Increases are recorded as other income, while decreases are expenses. Death benefits received are also reported as income.
Cash flow statements show premium payments as operating outflows. Policy loans and repayments appear in the financing section. Death benefits received are classified as investing inflows.
COLI can impact a company’s financial ratios. The asset value boosts total assets, potentially improving liquidity ratios. However, large premium payments may temporarily reduce profitability metrics.
Journal Entries for Life Insurance Policies
Proper accounting for life insurance policies involves specific journal entries to record expenses and track changes in cash surrender value. These entries ensure accurate financial reporting and compliance with accounting standards.
Recording Insurance Expenses
When a company pays premiums for a life insurance policy, it records the expense in its books. The journal entry typically debits Insurance Expense and credits Cash. For example:
Dr. Insurance Expense $10,000
Cr. Cash $10,000
This entry reflects the payment of a $10,000 premium. Companies may allocate premiums over multiple accounting periods if the coverage extends beyond the current year.
Adjustments to Cash Surrender Value
As the cash surrender value (CSV) of a life insurance policy changes, companies must adjust their accounting records. The journal entry for an increase in CSV is:
Dr. Cash Surrender Value $5,000
Cr. Other Income $5,000
This entry records a $5,000 increase in the policy’s CSV. If the CSV decreases, the entry is reversed. Companies report the CSV as an asset on their balance sheet, typically under investments or other assets.
