What is Nonadmitted Balance
A nonadmitted balance is an item on an insurer’s balance sheet that represents reinsured liabilities for which the reinsurer has not provided collateral. Nonadmitted balance entries reduce the policyholders’ surplus because they represent a liability.
BREAKING DOWN Nonadmitted Balance
Insurance companies cede risk to reinsurers in order to reduce their exposure to the risks associated with the policies that they underwrite. In exchange for taking on some of the insurer’s risk the reinsurer is provided a fee, often a portion of the premium. The reinsurer is thus responsible for claims made up to a certain level, and is required to demonstrate that it will be able to handle those claims if losses do arise.
Insurers may require a reinsurance company to provide assets as collateral as proof that the reinsurer will be able to cover a risk if a claim is made against the policy. If the reinsurer is required to provide collateral then this will reduce the nonadmitted balance, and thus increase the insurer’s surplus. Reinsurers and other captive insurance companies typically use a letter of credit (LOC) as the source of collateral. The letter of credit is issued by a bank. If the ceding insurance company does not require the reinsurer to provide collateral to cover the nonadmitted balance and the reinsurer becomes insolvent, the insurance company will treat the nonadmitted balance as the loss reserve and write the balance off.
The nonadmitted balance represents the portion of unearned premiums and loss reserves that do not count on the insurer’s statutory statements, which is where the insurer accounts for any capital and surplus required to maintain its license to conduct insurance business. Because the balance is nonadmitted, the insurer cannot count the balance toward its solvency ratio or any regulatory required reserve level, meaning that the loss reserve associated with the nonadmitted balance cannot count toward the general loss reserve. For this reason, insurance companies have an incentive to require reinsurers to provide collateral.
Examples of Nonadmitted Assets
Some examples of nonadmitted assets include assets consisting of goodwill, furniture and fixtures, automobiles, agent debt balances, accrued income on investments in default and other items. They are excluded in order to present a balance sheet that is as conservative as possible. However, a rise in the proportion of nonadmitted assets to admitted assets is an indication that a company may be investing in nonproductive or risky assets. However, this isn't always this case. To determine one way or another, an insurance company's financial's must be closely scrutinized to determine if the proportion of nonadmitted assets on the balance sheet is truly an indicator of nonproductive or risky assets.
