What is General Account?
General Account is referred to pool of premiums received from its policyholders in the form of collective investments, which is not only used to meet the operating expenses of the company, but also for the payment of various insurance claims and benefits.
How Does it Work?
It starts when the policyholder purchases a policy from the insurance company. Thereafter, the premium that is received by the insurer is used in the following manner:
- Day-to-Day expenses say administrative expensesAdministrative ExpensesAdministrative expenses are indirect costs incurred by a business that are not directly related to the manufacturing, production, or sale of goods or services provided, but are necessary for the smooth functioning of business operations, such as information technology, finance & accounts.read more.
- Creation of contingency reserve to meet unexpected and uncertain claims.
- Investments in varying assets so as to match the return and risk.
All the claims, they are backed by individual/separate assets, are settled through the general account. If the claims arising out of the individual or separate account is insufficient, then the residual would be settled through the general account.
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For eg:
Source: General Account (wallstreetmojo.com)
Example of General Account
An insured avails motor insurance from the insurance company for a period of 5 years at prescribed charges as per the regulatory norms. After a year, his vehicle gets damaged, and he claims for the damages from the company.
The company availed Lawyer and Surveyor services to assess the claim of the claimant and rewards the claim after it received the assessment report from the surveyors.
The claim was paid out of the premiums received from the several insured over the period. The accumulated fund is known as the general account and is used for settlement of the non-separate claims.
Investment Strategy
Insurance companies follow either of the two methodologies of investing their general fund balances:
- Managing the funds in-house through the creation of a separate department which takes care of the risk, return, dividend, etc. of the invested funds.
- Outsourcing the functions to an external vendor, who would charge his management fees and would manage the funds.
Many companies prefer the latter, due to increased cut-throat competition. Corporates feel that they should focus their attention on their core activities and outsource the non-core functions to the third party, resulting in meeting the liabilities of the policyholders as and when they accrue.
The companies also look for their risk appetiteTheir Risk AppetiteRisk appetite refers to the amount, rate, or percentage of risk that an individual or organization (as determined by the Board of Directors or management) is willing to accept in exchange for its plan, objectives, and innovation.read more as the claims of policyholders can arise anytime, so companies need to ensure that their liquidityLiquidityLiquidity shows the ease of converting the assets or the securities of the company into the cash. Liquidity is the ability of the firm to pay off the current liabilities with the current assets it possesses.read more is at their disposal. They prefer to invest their general account funds in debt or fixed income securities as compared to the stock of the companies.
Debt would ensure the consistent inflow of the funds and would be less risky as compared to investing in the ownership of the companies.
General Account vs Separate Account
| Basis | General Account | Separate Account |
|---|---|---|
| Definition | It is an account where funds of the insurance company are utilized for payment of day-to-day expenses and not attributable to any specific claim or policyholder. | It is an account that is held separately from the general pool of assets and used for the purpose for which it has been created. |
| Annuity | Here, funds are invested for fixed annuities. | Here, funds are invested for variable annuities. |
| Risk Involvement | The risk is less, as the investment is in fixed income securities. | The risk is more, as the investment is in those securities which tend to give variable returns. |
| Creditors Stake | The fund is entitled to the first claim of creditors. | The fund is not entitled to the first claim of creditors as it can’t be used as collateral. |
| Return | It gives you a certainty of the returns as the fund is majorly invested in the fixed income securitiesFixed Income SecuritiesFixed income investment is a type of investment in which the investor receives a fixed and relatively stable stream of income in the form of dividends or interest over a period of time. Companies and governments typically issue fixed investments in the form of debt securities.read more of the company. | Uncertainty is more as the fund is invested in the stock market. |
| Loss / Gain of the Stock Market | It is unaffected by the ups or downs of the stock marketStock MarketStock Market works on the basic principle of matching supply and demand through an auction process where investors are willing to pay a certain amount for an asset, and they are willing to sell off something they have at a specific price.read more. | It is affected by the ups or downs of the stock market. |
Conclusion
Unless there is a statutory requirement or insured specific mandate, the premiums received from the policyholders are pooled in a general fund, which is applied against meeting day to day expenses and invested in the fixed income fundsFixed Income FundsFixed Income Funds are those mutual funds that invest in high quality fixed income securities like the government debt, treasury bill, money market and pay the investors a fixed rate of return as per the payment terms and period.read more. The company needs to maintain good liquidity in general funds as the claim can arise anytime, unlike separate accounts, where there is a certainty for the tenure of the liability.
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