PNE plc, an insurer currently evaluating proposed delegation
authority arrangement with BMU plc, the insurance broker. In this scenario, PNE
plc only transacts delegation authority arrangement with the insurance broker
that is financially stable. In this regard, BMU plc shares some information
about its business. After studying the information, PNE plc considers five
issues that require further investigation in order to assess the proposal.     

1.   
Broking Commission
and fees: the main current asset of the brokerage
company is the commission and fee. For a broker, the main source of revenue
comes from the commission which broker will get it from insurance companies by
placing the business. As per the information shared by BMU plc, it is clearly
showing that in 2015, the broker commission was £20m in comparison with 2016
which is £19.2m. It seems that the BMU plc is losing the client and this declining
trend needs to be further investigated by BMU plc. Either the effect is because
of the change in the management/technical team/key sale person or loss of key
account or change in the business strategy or reduction the brokerage
commission.

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2.   
Cost of Finance:  is an amount of interest
and other expenses which is paid against borrowings. Cost of Finance comes
under the section of company’s income statement which eventually reduces the
operating profit. If we look at the broking commission and fee, it is reducing which
means that business is shrinking but at the same time, the cost of Finance is going
upward from £0.35m in 2015 to £0.45m in 2016. It is hinting that due to the reduction
in the business, BMU plc faces difficulties to run the operation and the company
acquired a loan from a bank to cover business expenses. The loan could be used
to pay the liabilities such as the premiums owed to an insurance company,
salaries of the staff or to maintain broker’s solvency/liquidity.

3.   
Salaries of staff: As a Broker, BMU plc main cost item is the staff salaries and it
comes under the expense section of the company’s income statement. All the
given information provided by BMU plc is interlinked with each other. Usually, the
market practice is that when the business income decreases (broking commission
and fees), company start downsizing or taking other measures to cut down the
operational cost to maintain the company stability and produce a profit within
their prevailing circumstances. The same has been seen here, the number of
staff decreased from 314 in 2015 to 280 in 2016. However, the salaries of staff
have increased by £1m from £11m in 2015 to £12m in 2016 which further raise the
question on BMU plc because on one hand staff is decreasing and on the other
hand salaries of staff is increasing.     

4.   
Operating expense: are the amounts that are used to run the operation and it can be
fixed and variable. The operating expense comes under broker’s income
statement. As far as BMU plc, an insurance broker, the main expense is the cost
of the staff. In this case, broker incurred operating expenses of £5.2m in 2015
and £4.5m in 2016 other than salaries of the staff which is considered as a major
expense. This means that further documentation requires in order to understand
the nature of these expenses. It seems BMU plc has less control over its
expenditure. One must easily notice that income (broking commission) and the number
of staff is reduced but operating expense does not reduce in the same
proportion.           

5.   
Trade receivables (money owed by customer): this comes under the current assets segment of the broker’s balance
sheet. Trade receivables are known as Debt/account receivables. Money/premium
due to the clients (individual/corporate) either in full or in instalments. In
this scenario, it is apparent that the trade receivables are reduced by £1m
from £5m in 2015 to £4m in 2016 but the collection span has increased if
comparing with the BMU plc earning (broking commission and fee). At this point
in time, little information is available but one can certainly assume that the
cost of Finance has increased. This means that BMU plc is taking borrowing support
to deal their day to day operations. Consequentially, this is also validating
that BMU plc has weak control over the receivable collection. If the receivable
management is not effective then the company liquidity is in question, however,
most of the companies that become bankrupt is not due to non-profitability but
due to inability to pay their liabilities.

 

Answer 5 (b)

Five additional items of financial information could be.

1.    Investment Income: this would give an indication of how the investment incomes will
adequate to cover the deficit in an operating loss. The company uses investment
income to fund the operation and also use to pay off any type of liabilities.
This will also show how well the investment portfolio is managing.

 

2.    Cash & Cash Equivalents: this also includes any local/foreign currency, coins, cheque received but not yet deposited and
short-term investment & saving certificates which can easily liquidate at a
short notice if in case of BMU plc require cash to settle the liabilities. For
the survival of a business, it is mandatory to maintain the current ratio.

 

3.    Premium owed to insurance company and
commission due from insurance companies. This would an
important for PNE plc how well BMU plc matching its asset and liability.
Premium owed to insurance company means that BMU plc holds a certain amount of
premium which will be payable to the insurance company. Secondly, when the BMU
plc places the business to insurance companies in return BMU plc receives a
commission which is part of a current asset on the balance sheet. If the
balance between receivable and payable is adequate when the current ratio will
be stable. 

 

4.    Borrowing; this would indicate
that how much the loan BMU plc acquires at one point. This will know the total
borrowing amount and the nature of loan (either short-term or long-term) and
how will they settle this lend amount.

 

5.    Reserves: this would indicate
that the amount set aside as reserve is adequate to fulfil the regulatory
requirement and to meet the future contingencies in case of shortfall of
money. It can also be used to meeting the emergency liquidity requirement.   

Answer 6 (a)

It is critical of the R plc to set up the reserve accurately for
the recent flood affecting numerous properties. Consequentially, numbers of valid
claims are notified and further claims of the recent flood will be expected
during the next two months. The reserve will be booked on the balance sheet of
the R plc as the financial year-end is in three weeks.

Liaison with the underwriting team to track the aggregate maximum
exposure of the affected location (usually via postcode) because the underwriter
is in a better position to provide a number of policies insured, their sum
insured and other relevant information and this information also considers as a
useful tool for estimating the correct reserve.     

The claims team needs to identify flood claim reported in the prior
years. This will help in understanding how the reserve was established against
similar claims. Claims with an incident date up to balance sheet date are
taken, whether intimate or not and rest is done through IBNR. Reserve for
reported but not settled claims is an estimated value use for the settlement of
intimated claims and to compute the total value of reserve for incurred but not
reported is multiplying the number of such claims by the average cost of
claims.  

The claim’s department has a range of methodologies for assessing
the claims. The best methodology suited for this scenario is:

Projection of Incurred Claims: this method
produced more accurate in such scenario as it is based on incurred claims in a
particular class of insurance, as long as the procedures for handling claims have
no significant change. However, the variation on this method is to adjust to
inflation.     

It will be helpful for the claim’s department to employed external
actuarial firm to assist in establishing the claims reverse. This will ensure
that appropriate estimates are made to cover the outstanding liabilities and to
ensure all regulatory requirements are fulfilled.

Answer 6 (b)

The total claims reserves for flood will be funded through unearned
premium reserve which is the unexpired portion the policies that have not yet
passed. Insurer set aside an adequate amount to cover the expected cost of
claims. If the loss will exceed certain level then the unearned premium provision
is set up as a liability in the financial statement. The provision will take
into consideration along with the investment income which is expected to be
earned in future from asset backed operation.