What accounting action is required of an insurer if it provides tail coverage at no additional charge?

• A. Establish a policy reserve to ensure the premiums are not earned prematurely
• B. Record tail coverage as revenue
• C. Recognize tail coverage as an expense
• D. Delay any reserve until tail coverage ends

Answer: (A)

When tail coverage is provided at no charge, the insurer takes on a future obligation to extend coverage beyond the policy period. Even though no premium is charged for that tail, accounting rules require recognizing this future obligation and not earning revenue prematurely. Setting up a policy reserve (tail reserve) captures the expected liability for future tail claims and defers recognizing any related benefit as revenue until the tail period is actually fulfilled. It’s not an expense or revenue at this point, and delaying the reserve until the tail ends would understate liabilities earlier and distort earnings.