Insurance ExpenseExplained, Advantages & Disadvantages, and Examples

Written By:
Lisa Borga

Insurance expense is the total cost that a company incurs in order to acquire an insurance contract, as well as additional payments known as premiums.

The cost of insurance is recorded as an expense in the period in which it has been used.

For insurance policies that protect a manufacturer’s production functions, the expense will be allocated to the cost of production, where it will be divided by the number of units manufactured.

This will allow the expense to be allocated accurately between the cost of goods sold (COGS) and ending inventory.

What is Insurance Expense?

In order to acquire insurance policies that protect the company in case of certain unexpected incidents, generally, these policies will provide that the company pay a certain sum, and if one of the certain incidents provided in the policy occurs, the insurance policy’s provider will pay for it.

In order to acquire these policies, a company must pay premiums.

These insurance premiums are the payments that must be made in order to acquire the policy, and they are often paid in advance and referred to as prepaid insurance policies.

Once a premium expires, it will be listed as an expense, whereas an unexpired premium will be recorded as an asset account named prepaid insurance.

Insurance expense will most often be considered an operating expense, and for many companies, it is tax-deductible.

Types of Insurance Expense

There are many types of insurance policies that protect different facets of a company.

However, the most common three types are often bundled together as one package for businesses’ liability, casualty, and property insurance policies.

Property insurance protects any buildings or equipment which belong to the company, and both liability and casualty protect the business in case any harm were to come to its customers or its workers while they are on the job.

The Difference Between Insurance Expense and Insurance Payable

Insurance expense and payable are distinct but interrelated concepts.

First, a company’s insurance expense is the cost that a company incurs in acquiring insurance policies.

Once an insurance premium has been paid and the coverage for the period has ended, the cost of the insurance premium will be recorded as an insurance expense.

Insurance payable is a liability that records any unpaid premiums which the company owes.

Typically insurance payable will be quickly paid by a company in order to avoid any additional fees or loss of coverage.

Once paid for the insurance, it will become an asset until the coverage expires, at which time it will become an insurance expense.

Insurance payable is recorded on a company’s balance sheet.

Advantages of Insurance Expense

• Protects the Business: Insurance will protect a company in case of unforeseen events which could otherwise harm or even force the business to shut down.
• Provides a Financial Safety Net: Commercial insurance policies can provide a safety barrier to ensure that a business can meet its obligations during periods in which adverse circumstances arise.
• Provides Protection for Employees: When employees suffer from injuries, a business may be responsible for covering any medical expenses. Liability insurance can take charge of the process and provide this coverage regardless of the extent. It will also generally ensure that any claims are legitimately protecting the company from fraudulent claims.

Disadvantages of Insurance Expense

May Not Be Required: Often, commercial insurance policies such as general liability insurance are not required by law. Instead, it is up to a company to choose what policies they believe would prove beneficial.

May Never Come Into Use: A promise to reimburse the company in case of loss does not mean that such a loss will ever occur. In the majority of cases, a company will pay more for insurance than it will ever make back in covered expenses.

High Degree of Complexity: For many small businesses which lack experienced legal services, insurance policies may prove to be highly confusing. This can result in acquiring unnecessary coverage or failing to acquire the right type or extent of coverage for their company.

In Summary

Nearly all businesses will face some type of insurance expense in order to protect their operations in the event of unforeseen adverse events.

This expense includes all costs faced in acquiring an insurance policy, including regular premiums.

When a premium is paid, it will become an asset and be recorded on the balance sheet until the coverage period expires, at which time it will be recorded as an insurance expense.