for Accounting Professionals
IFRS 4 Insurance contracts
2011
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IFRS 4 Insurance Contracts
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Financial University
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2011 Updated
CONTENTS
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IFRS 4 Insurance Contracts
1. Insurance Contracts - Introduction
3
2. BACKGROUND (taken from
5
IFRS 4: The future for insurance reporting- for now
(PWC))
5
3. RECOGNITION AND MEASUREMENT
20
4. Changes in accounting policies
22
5. Discretionary participation features
25
7. DISCLOSURE
26
8. Multiple choice questions
28
9. Answers to multiple choice questions
32
10. Appendix. Similarities and Differences – A
comparison of IFRS
and US GAAP – PwCSeptember 2004
33
1. Insurance Contracts - Introduction
OVERVIEW
Aim
The aim of this workbook is to assist the individual in
understanding the IFRS treatment of Insurance Contracts. This is
the subject of IFRS 4.
Currently applicable IFRS does not yet contain comprehensive
accounting treatment of transactions that are specific to
insurance contracts. As a result, insurance groups generally tend
to apply the provisions as set out under USGAAP for insurance
contracts, modified as appropriate to comply with the IFRS
framework and applicable standards.
OBJECTIVE
The objective of IFRS 4 is to specify the financial reporting for
insurance contracts, by any insurer that issues such contracts,
until the IAS Board completes the second phase of its project on
insurance contracts.
In particular, IFRS 4 requires:
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(i)
certain improvements to accounting, by insurers, for
insurance contracts.
(ii)
disclosure that identifies (and explains) the amounts in an
insurer’s financial statements, arising from insurance
contracts, and helps users understand the amount, timing
and uncertainty of cash flows from insurance contracts.
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IFRS 4 Insurance Contracts
Definitions
cedant
The policyholder under a
reinsurance contract.
deposit component
A contractual component that is not
accounted for as a derivative
underIFRS 9, (and would be within
the scope of IFRS 9 if it were a
separate instrument).
(iii) the income statement of the
company, fund or other undertaking
that issues the contract.
fair value
The price that would be received
to sell an asset, or paid to
transfer a liability, in an orderly
transaction between market
participants at the measurement
date. (IFRS 13)
direct insurance contract An insurance contract that is not a
reinsurance contract.
discretionary
participation feature
A contractual right to receive (as a
supplement to guaranteed benefits),
bonus benefits:
financial guarantee
contract
A contract that requires the issuer to
make specified payments to
reimburse the holder for a loss it
incurs because a specified debtor
fails to make payment when due in
accordance with the original or
modified terms of a debt instrument.
financial risk
The risk of a possible future change
in a specified interest rate, financial
instrument price, commodity price,
foreign exchange rate, index of
prices or rates, credit rating or credit
index or other variable, provided (in
the case of a non-financial variable)
that the variable is not specific to a
party to the contract.
guaranteed benefits
Payments (or other benefits) to
which a particular policyholder (or
(1) that are likely to be a significant
portion of the total contractual
benefits;
(2) whose amount (or timing) is
contractually at the discretion of the
issuer; and
(3) that are contractually based on:
(i) the performance of a specified
pool of contracts, or a specified type
of contract;
(ii) realised and/or unrealised
investment returns on a specified
pool of assets held by the issuer; or
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IFRS 4 Insurance Contracts
investor) has an unconditional right,
that is not subject to the contractual
discretion of the issuer.
liability adequacy test
An assessment of whether the
carrying amount of an insurance
liability needs to be increased (or the
carrying amount of related deferred
acquisition costs, or related
intangible assets decreased), based
on a review of future cash flows.
A party that has a right to
compensation (under an insurance
contract) if an insured event occurs.
A cedant’s net contractual rights
under a reinsurance contract.
guaranteed element
An obligation to pay guaranteed
benefits, included in a contract that
contains a discretionary participation
feature.
insurance asset
An insurer’s net contractual rights,
under an insurance contract.
policyholder
insurance contract
A contract under which the insurer
accepts significant insurance risk
from the policyholder, by agreeing to
compensate the policyholder if the
insured event adversely affects the
policyholder.
reinsurance assets
insurance liability
insurance risk
An insurer’s net contractual
obligations under an insurance
contract.
Risk, other than financial risk,
transferred from the holder of a
contract to the issuer.
Insured event
An uncertain future event that is
covered by an insurance contract,
and creates insurance risk.
Insurer
The party that has an obligation
(under an insurance contract) to
compensate a policyholder, if an
insured event occurs.
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reinsurance contract
An insurance contract issued by the
reinsurer to compensate the cedant
for losses on contracts issued by the
cedant.
reinsurer
The party that has an obligation
under a reinsurance contract to
compensate a cedant (if an insured
event occurs).
unbundle
Account for the components of a
contract as if they were separate
contracts.
2. BACKGROUND (taken from
IFRS 4: The future for insurance reporting- for now (PWC))
IFRS 4 contains the sections outlined below:
Scope5
IFRS 4 Insurance Contracts
List of contracts not covered by the standardEmbedded derivatives scope exemptionsUnbundling of deposit components
Recognition and measurementTemporary exemption from some other IFRSsLiability adequacy testChanges in accounting policiesInsurance contracts acquired in a business combination or
portfolio transferDiscretionary participation features
DisclosureExplanation of recognised amountsAmount, timing and uncertainty of cash flows
Effective date and transitionDisclosureRedesignation of financial assets
AppendicesDefinitionsDefinition of insurance contract –
application guidanceAmendments to other IFRSs
IFRS is much more than just a technical issue, and will result in
fundamental changes to the way in which the industry does
business, and communicates value to analysts, investors and
other key stakeholders.
IFRS 4 addresses accounting and disclosures for both insurance
and reinsurance contracts. It includes a new insurance contract
definition that will result in many savings, and pension plans (now
classified as insurance under existing accounting principles)
being re-designated as investment contracts and becoming
subject to the financial instrument standard IFRS 9.
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The IFRS valuation criteria could have crucial implications for
earnings, incentives and investor relations.
1) New definition of an insurance contract
Definition of an insurance contract Source: IASB, IFRS 4
‘A contract under which one party (the insurer) accepts
significant insurance risk from another party (the
policyholder) by agreeing to compensate the policyholder if
a specified uncertain future event (the insured event)
adversely affects the policyholder.’
This definition covers most motor, travel, life, annuity, medical,
property, reinsurance and professional indemnity contracts.
However, policies that transfer no significant insurance risk (such
as some savings and pensions plans) will be designated as
financial instruments, and covered by IFRS 9, regardless of their
legal form.
Definition of financial risk
‘The risk of a possible future change in one or more of a
specified interest rate, financial instrument price, commodity
price, foreign exchange rate, index of prices or rates, credit
rating or credit index or other variable, provided in the case
of a nonfinancial variable that the variable is not specific to a
party to the contract.
’Source: IASB, IFRS 4
Insurance contracts (as defined in IFRS 4) will continue to be
covered by existing accounting policies during Phase I. This is an
unprecedented exemption from the IFRS ‘framework’ (see
Framework workbook) and ‘hierarchy’, which is designed to allow
more time to develop a finalised Phase II for insurance contracts.
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IFRS 4 Insurance Contracts
1. Insurers can use ‘current interest rates’ to value liabilities,
bringing them more into line with movements in associated
interest-sensitive assets. This provision is designed to
meet concerns over the potential mismatch between
assets and liabilities.
2.
3.
4.
5.
6.
Companies can adjust their liabilities to reflect future
investment margins only if this is part of a switch to a
‘widely used’ and ‘comprehensive investor oriented basis
of accounting’.
Insurers can adopt a form of ‘shadow accounting’ that
would allow them to adjust their liabilities for changes that
would have arisen if any unrealised gains, or losses, on
securities had been realised. Liability movements can be
recognised in equity in line with the recognition of
unrealised investment gains or losses.
Companies can elect to measure, at fair value,
investment properties used to support liabilities linked to
the fair value of those properties, leaving all the other
investment properties at cost.
Insurers can recognise an intangible asset that covers the
difference between the fair value and the book value of the
insurance liabilities, taken on through a business
combination (or portfolio transfer). This is a concession to
insurers, as such an asset does not exist within IFRS.
Companies can continue to value insurance and
investment contracts with discretionary participatory
features (DPF) using their existing accounting policies.
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Discretionary participatory features allow clients to share in
the investment profits made by the insurer. The insurer can
guarantee a minimum profit, but can then increase this at his
discretion.
The fixed guaranteed element should be regarded as the
minimum liability.
1.
The rest of the DPF contract could be classified as an
additional liability, or included in equity, or split between
equity and liabilities.
2.
DPF contracts without significant insurance risk still
require fair value disclosure.
3.
Companies are permitted to continue to report premiums
from DPF investment contracts as revenue, with a
corresponding expense representing the change in the
liability.
The IFRS 9 minimum liability test applies to the fixed guaranteed
element of DPF investment contracts, only when an equity
component is recognised.
Derivative features (such as certain types of index-linked options
that are embedded into a host insurance contract) may need to
be separated and fair valued. An insurance contract can contain
both deposit and insurance components.
An example might be a profit sharing reinsurance contract where
the cedant is guaranteed a minimum repayment of its premium.
Such contracts may need to be split and valued separately, as
the application of existing local accounting principles to the
deposit component could result in the reinsurer not fully
recognising its obligations to repay amounts received, or the
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IFRS 4 Insurance Contracts
cedant omitting from the balance sheet (SFP) its rights to recover
amounts paid.
‘Unbundling’ is designed to ensure that any rights and obligations
are recorded on the balance sheet as assets and liabilities, rather
than treated as expenses or revenue.
IFRS 4 requires insurers ‘to disclose information that helps users
to understand the estimated amount, timing and uncertainty of
future cash flows’, arising from insurance contracts.
They will also need to give more details about the risks being run
including concentrations of risk, and the impact of market
variables on the key assumptions used to estimate insurance
assets and liabilities (sensitivity analysis).
This asset is measured by the incremental transaction costs
incurred to secure revenue from investment management
services contracts.
This change allows insurers to capitalise in their balance sheet
acquisition costs such as the commissions paid to intermediaries
to secure contracts where income is earned from long-term
savings being actively managed. These costs can only be
capitalised to the extent they are recoverable out of future
revenue.
SCOPE
An undertaking shall apply IFRS 4 to:
(i)
insurance contracts (including reinsurance contracts) that
it issues and reinsurance contracts that it holds.
(ii)
financial instruments that it issues with a discretionary
participation feature. IFRS 7 Financial Instruments:
Disclosures requires disclosure about financial instruments
that contain such features.
IFRS 4-crucial changes from the disclosure requirements set
out in ED 5
1. Need to disclose the gains and losses from purchased
reinsurance contracts.
Insurers will need to disclose the gains and losses from
purchased reinsurance contracts. If the insurer’s reinsurance
rights are potentially damaged, based on the asset impairment
test in IFRS 9, the cedant shall reduce the balance sheet amount
accordingly.
IFRS 4 describes any undertaking that issues an insurance
contract as an insurer, whether (or not) the issuer is regarded as
an insurer for legal, or supervisory purposes.
2. New intangible asset: future investment management fees.
A reinsurance contract is a type of insurance contract. All
references to insurance contracts, also apply to reinsurance
contracts.
IFRS 4 amends IAS 18 to require companies to recognise an
intangible asset representing the right to future investment
management fees.
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IFRS 4 does not address other aspects of accounting by insurers,
such as accounting for financial assets held by insurers, and
financial liabilities issued by insurers (see IAS 32 and IFRS 9
Financial Instruments).
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IFRS 4 Insurance Contracts
An undertaking shall not apply IFRS 4 to:
Uncertain future event
(i)
product warranties, issued directly by a manufacturer,
dealer or retailer (see IAS 18 and IAS 37).
Uncertainty (or risk) is the essence of an insurance contract. At
least one of the following is uncertain at the start of a contract:
(ii)
employers’ assets and liabilities under staff benefit plans
(see IAS 19 and IFRS 2) and retirement benefit obligations
reported by defined benefit retirement plans (see IAS 26).
(i)
whether an insured event will occur;
(ii)
when it will occur; or
contractual rights or (obligations) that are contingent on
the future use of, or right to use, a non-financial item (for
example, some licence fees, royalties, contingent lease
payments and similar items), as well as a lessee’s residual
value guarantee embedded in a finance lease (see IAS 17,
IAS 18 and IAS 38).
(iii)
how much the insurer will need to pay, if it occurs.
(iii)
(iv)
(v)
(vi)
financial guarantee contracts unless the issuer has
previously asserted explicitly that it regards such contracts
as insurance contracts and has used accounting
applicable to insurance contracts, in which case the issuer
may elect to apply either IFRS 9, IAS 32 and IFRS 7 or
IFRS 4 to such financial guarantee contracts. The issuer
may make that election contract by contract, but the
election for each contract is irrevocable. .
contingent consideration payable (or receivable) in a
business combination (see IFRS 3).
direct insurance contracts that the undertaking holds (i.e.
direct insurance contracts, in which the undertaking is the
policyholder). However, a cedant shall apply IFRS 4 to
reinsurance contracts that it holds.
In some contracts, the insured event is the discovery of a loss
during the term of the contract, even if the loss arises from an
event that occurred before the start of the contract.
EXAMPLE - loss from an event that occurred before the start
of the contract
An insurance contract covers environmental damage. Unknown
to the insurer effluent had been flowing out of the client’s mine
before the contract started. It now flows into a lake, and the client
claims under the contract.
In other contracts, the insured event is an event that occurs
during the term of the contract, even if the resulting loss is
discovered after the end of the contract term.
EXAMPLE - resulting loss is discovered after the end of the
contract term
An office insurance contract expires on December 31st. The office
is closed from the 28th, and the office is robbed. This is not
discovered until January 1st, (after the end of the contract term)
but video cameras confirm the date of the theft.
Definition of an insurance contract
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IFRS 4 Insurance Contracts
Some contracts cover events that have already occurred, but
whose financial effect is still uncertain.
affects its owner, and the contract compensates the owner (in
repairs, rather than cash).
EXAMPLE - whose financial effect is still uncertain
A reinsurance contract covers the insurer against adverse
development of claims, already reported by policyholders. In such
contracts, the insured event is the discovery of the ultimate cost
of those claims.
EXAMPLE - fixed-fee service contract 2
The insurer issues a contract for car breakdown services, in
which a firm agrees, for a fixed annual fee, to provide roadside
assistance (or tow the car to a nearby garage).
This is an insurance contract, even if the firm does not carry out
repairs, nor replace parts.
Payments in kind
Some insurance contracts require (or permit) payments to be
made in kind.
EXAMPLES - payments to be made in kind
The insurer replaces a stolen article directly, instead of
reimbursing the policyholder.
An insurer uses its own hospitals (and medical staff) to provide
medical services, covered by the contracts.
Some fixed-fee service contracts, in which the level of service
depends on an uncertain event, meet the definition of an
insurance contract in IFRS 4, but are not regulated as insurance
contracts, in some countries.
EXAMPLE - fixed-fee service contract 1
A maintenance contract, in which the service provider agrees to
repair specified equipment (such as a washing machine), after a
malfunction, passes the risk to the service provider.
The fixed service fee is based on the expected number of
malfunctions, but it is uncertain how often a particular machine
will break down. The malfunction of the equipment adversely
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EXAMPLE -car breakdown service
The contract will not cover malfunctions that existed prior to the
start of the contract. Revenue will be recorded on an elapsed
time basis, unless another method (a seasonal bias, if winter
claims are high) is more appropriate.
The service provider considers whether the cost of meeting its
contractual obligation to provide services exceeds the revenue
received in advance.
EXAMPLE-costs exceeding revenue
A firm provides a car breakdown service. Revenue= the number
of clients multiplied by the fees. Costs are the infrastructure (staff,
vehicles) and the variable costs (fuel, parts), which will be
incurred in providing the service. As clients pay in advance, their
fees are fixed. If costs increase dramatically, they may exceed
revenue.
To estimate if costs exceed revenue, the company applies the
liability adequacy test (see below). If IFRS 4 did not apply to
these contracts, the service provider would apply IAS 37
Provisions to determine whether the contracts are onerous.
Distinction between insurance risk and other risks
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IFRS 4 Insurance Contracts
To decide whether there is an insurance contract:
1. There must be a risk (not a certainty).
2. It must not be a ‘financial’ risk (see example below).
3. It must be transferred from the holder of a contract to the
issuer.
EXAMPLE-risk transfer
An insurer is the issuer of a building insurance contract. The
owner (holder of the contract) has the risks of the building, but
has transferred them to the insurer, by buying the contract.
to pay $2 million, if there is an earthquake there, this year. This is
not insurance, as he has no insurable interest in the property
damaged. His interest is indirect: he knows that his investments
will fall, in the event of an earthquake.
The risk of changes in the fair value of a non-financial asset is an
insurance risk, if the fair value reflects not only changes in market
prices for such assets (a financial variable), but also the condition
of a specific non-financial asset held by a party to a contract (a
non-financial variable).
Some contracts expose the issuer to financial risk, in addition to
significant insurance risk.
A contract that exposes the issuer to financial risk, without
significant insurance risk, is not an insurance contract.
EXAMPLE-financial risk
The bank provides a fixed contract to exchange 1 million Euros
for Roubles in 3 months time. The bank is taking a financial risk
(of changing exchange rates), but no insurance risk.
EXAMPLE- contracts with both financial and insurance risk
Many life insurance contracts both:
-guarantee a minimum rate of return to policyholders (creating
financial risk) and
The definition of financial risk includes a list of financial, and nonfinancial, variables.
-promise death benefits, that may significantly exceed the
premiums paid to date (creating insurance risk in the form of
mortality risk).
The list includes non-financial variables that are not specific to a
party to the contract, such as an index of earthquake losses in a
particular region, or an index of temperatures in a particular city.
Such contracts are insurance contracts.
EXAMPLE- non-financial variables
An investor has an investment portfolio in Japanese firms. He
knows that the region is prone to earthquakes, and has a contract
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Under some contracts, an insured event triggers the payment of
an amount linked to a price index. Such contracts are insurance
contracts, provided the payment (that is contingent on the insured
event) can be significant in relation to the premium.
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IFRS 4 Insurance Contracts
EXAMPLE- contracts linked to a price index
A life-contingent annuity, linked to a cost-of-living index, transfers
insurance risk, as payment is triggered by an uncertain event—
the survival of the annuitant. After the annuitant dies, no payment
is made.
In this example, the beneficiary has bought an annuity for (say)
100.
Each year after retirement age, he will receive a pension.
It may start at 6 in the first year.
The second year, it will be 6 plus the increase in the cost of living
index.
The payments will cease on his death.
The insurer is taking the risk for the initial payment of 100.
The link to the price index is an embedded derivative, but it also
transfers insurance risk.
If the resulting transfer of insurance risk is significant, the
embedded derivative meets the definition of an insurance
contract, in which case it need not be separated and measured at
fair value.
Insurance risk is the risk that the insurer accepts from the
policyholder. Insurance risk is a pre-existing risk, transferred from
the policyholder to the insurer. Thus, a new risk created by the
contract is not insurance risk.
The definition of an insurance contract refers to an adverse effect
on the policyholder. The definition does not limit the payment, by
the insurer, to an amount equal to the financial impact of the
adverse event.
EXAMPLE-no limit to the insurer’s payment
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Insurance contracts can offer ‘new-for-old’ coverage, that pays
the policyholder sufficient funds to replace a damaged old asset
with a new asset.
Similarly, the definition does not limit payment (under a term life
insurance) contract to the financial loss suffered by the
deceased’s dependants, nor does it preclude the payment of
predetermined amounts to quantify the loss, caused by death (or
an accident).
EXAMPLE- insurer’s payment not limited to provable loss
An insurer has insured his client’s life for $1 million. The
deceased’s dependants will not have to prove their financial loss
in order to claim this amount.
Some contracts require a payment if a specified uncertain event
occurs, but do not require an adverse effect on the policyholder
(as a precondition for payment). Such a contract is not an
insurance contract, even if the holder uses the contract to
mitigate an underlying risk exposure.
EXAMPLE – no adverse effect, but payment will be made
The client uses a derivative to hedge property values. The
derivative is based on a national property index. The client holds
investment property, which is rarely sold.
The derivative is not an insurance contract, as payment is not
conditional on whether the holder has realised a loss from the
sale of the asset.
Conversely, the definition of an insurance contract refers to an
uncertain event for which an adverse effect on the policyholder is
a contractual precondition for payment.
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IFRS 4 Insurance Contracts
This contractual precondition does not require the insurer to
investigate whether the event actually caused an adverse effect,
but permits the insurer to deny payment, if it is not satisfied that
the event caused an adverse effect.
EXAMPLE –adverse effect needed for payment to be made
The client has property insurance. A fire destroys the property,
and the client claims under the policy.
The insurer can deny payment, until investigations confirm the
value of the claim, and that there has been no contributory
negligence by the client.
Lapse, or persistency risk (the risk that the client will cancel the
contract earlier (or later) than the issuer had expected in pricing
the contract) is not insurance risk, as the payment to the client is
not contingent on an uncertain future event that adversely affects
the client.
EXAMPLE – lapse risk
An insurer has priced his product liability insurance, based on an
expected life of 5 years for a new product. The product is
withdrawn after 3 years and the insurance is cancelled. The early
termination of the policy is not insurance risk.
Similarly, expense risk (the risk of unexpected increases in the
administrative costs associated with the servicing of a contract,
rather than in costs associated with insured events) is not
insurance risk, as an unexpected increase in expenses does not
adversely affect the client.
EXAMPLE – costs increasing
An insurer provides a car breakdown service. Its costs are the
infrastructure (staff, vehicles) and the variable costs (fuel, parts),
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which will be incurred in providing the service. If administration
costs increase dramatically, this is not an insurance risk, as this
does not adversely affect the client.
Therefore, a contract that exposes the issuer to lapse risk,
persistency risk, or expense risk, is not an insurance
contract, unless it also exposes the issuer to insurance risk.
If the issuer of that contract mitigates that risk by using a second
contract to transfer part of that risk to another party (reinsurance),
the reinsurance contract exposes that other party to insurance
risk.
An insurer can accept significant insurance risk from the client
only if the insurer is an undertaking, separate from the client. In
the case of a mutual insurer, the mutual accepts risk from each
policyholder and pools that risk.
Although policyholders bear that pooled risk collectively (in their
capacity as owners) the mutual has still accepted the risk that is
the essence of an insurance contract.
EXAMPLE-mutual insurer
A group of businesses form an insurance mutual organisation to
insure their vehicle risks. The organisation is jointly-owned by the
participants. Though the participants are trading with themselves,
pooling their risks (and receiving any profit), the mutual has still
accepted the risk that is the essence of an insurance contract.
Examples of insurance contracts
The following are examples of contracts that are insurance
contracts, if the transfer of insurance risk is significant:
(i)
insurance against theft (or damage) to property.
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IFRS 4 Insurance Contracts
(ii)
insurance against product liability, professional liability,
civil liability or legal expenses.
(iii)
life insurance and prepaid funeral plans (although death is
certain, it is uncertain when death will occur or, for some
types of life insurance, whether death will occur within the
period covered by the insurance).
(iv)
life-contingent annuities and pensions (i.e. contracts that
provide compensation for the uncertain future event—the
survival of the annuitant (or pensioner)—to assist the
annuitant (or pensioner) in maintaining a given standard of
living, which would otherwise be adversely affected by his
survival – the longer he lives, the less money he will have
as his savings diminish).
(v)
disability and medical cover.
(vi)
surety bonds, fidelity bonds, performance bonds and bid
bonds (contracts that provide compensation, if another
party fails to perform a contractual obligation, for example
an obligation to construct a building).
EXAMPLE-fidelity bonds
A client runs a company. The insurer provides fidelity insurance
to cover losses from fraud, or misbehaviour by his staff.
a specified debtor fails to make payment when due, under
the original (or modified) terms of a debt instrument.
EXAMPLE-credit insurance
A client is an exporter, selling goods on credit. He buys insurance
against non-payment by clients.
These contracts could have various legal forms, such as
that of a financial guarantee, letter of credit, credit
derivative default product, or insurance contract.
However, although these contracts meet the definition of
an insurance contract, they also meet the definition of a
financial guarantee contract in IFRS 9 and are within the
scope of IFRS 7. and IFRS 9, not IFRS 4.
Nevertheless, if an issuer of financial guarantee contracts
has previously asserted explicitly that it regards such
contracts as insurance contracts and has used accounting
applicable to insurance contracts, the issuer may elect to
apply either IFRS 9 and IFRS 7 or IFRS 4 to such financial
guarantee contracts.
(viii)
However, product warranties issued directly by a
manufacturer, dealer or retailer are outside its scope,
because they are within the scope of IAS 18 Revenue and
IAS 37 Provisions.
EXAMPLE-performance bonds
A client is building a shopping mall. The insurer provides a
performance bond, guaranteeing completion of the project on
time, by the client.
(vii)
credit insurance that provides for specified payments to be
made to reimburse the holder for a loss it incurs, because
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product warranties. Product warranties issued by another
party for goods sold by a manufacturer, dealer or retailer
are within the scope of IFRS 4.
(ix)
title insurance (i.e. insurance against defects in title to land
that were not apparent when the insurance contract was
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IFRS 4 Insurance Contracts
written). In this case, the insured event is the discovery of
a defect in the title, not the defect itself.
(x)
travel assistance (i.e. compensation in cash, or in kind, to
policyholders for losses, suffered while they are traveling).
(xi)
catastrophe bonds that provide for reduced payments of
principal, interest (or both), if a specified event adversely
affects the issuer of the bond (unless the event does not
create significant insurance risk, for example if the event is
a change in an interest rate, or foreign exchange rate).
EXAMPLE- catastrophe bonds
A client is building a sports complex. The insurer insures his
property against earthquakes, floods and land subsidence.
(xii)
insurance swaps, and other contracts that require a
payment based on changes in climatic, geological or other
physical variables, that are specific to a party to the
contract.
EXAMPLE- changes in climate, that are specific to a party to
the contract
A client is a farmer. He is insured against bad weather in the area
of his farm.
(xiii)
reinsurance contracts.
The following are examples of items that are not insurance
contracts:
(i)
EXAMPLE-life assurance with no mortality risk.
When life insurance contracts are written in which the insurer
bears no significant mortality risk, such contracts are noninsurance financial instruments or service contracts.
The client pays premiums, and will receive a lump sum at the end
of the policy. His death will result in the repayment of premiums,
plus some interest.
The contract is merely one of investment.
(ii)
contracts that have the legal form of insurance, but pass
all significant insurance risk back to the policyholder,
through non-cancelable and enforceable mechanisms, that
adjust future payments by the policyholder as a direct
result of insured losses.
EXAMPLE- legal form of insurance, but pass all significant
insurance risk back to the policyholder
These include some financial reinsurance contracts, or some
group contracts (such contracts are normally non-insurance
financial instruments, or service contracts). Here the client keeps
all the risks, as any claims paid will be reimbursed by the client
through higher premiums, in the future.
investment contracts that have the legal form of an
insurance contract but do not expose the insurer to
significant insurance risk,
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IFRS 4 Insurance Contracts
(iii)
self-insurance, in other words retaining a risk that could
have been covered by insurance (there is no insurance
contract, as there is no agreement with another party).
EXAMPLE- self-insurance
A firm has an internal insurance department. It has a large
number of vehicles. The firm decides that to meet all claims
internally, rather than insure with a third party. The firm retains
the risks. There is no insurance contract, as there is no
agreement with another party
(iv)
contracts (such as gambling contracts) that require a
payment if a specified uncertain future event occurs, but
do not require, as a contractual precondition for payment,
that the event adversely affects the policyholder.
in the case of a non-financial variable that the variable
is not specific to a party to the contract (see IFRS 9).
EXAMPLE- changes in an index
A client buys a derivative. He will receive a fixed amount for
every point gained by a stock exchange in the next year,
excluding the first 100 points. This enables the client to benefit
from the gain, without buying shares. (The insurer can buy
shares to cover the risk, if required.) This is not an insurance
contract.
(vi)
EXAMPLE- gambling contracts
A client signs a contract with an insurer. The insurer will pay a
fixed amount for every point gained by a stock exchange in the
next year, excluding the first 100 points. This enables the client to
benefit from the gain, without buying shares. (The insurer can
buy shares to cover the risk, if he wishes.) This is a gambling
contract, not an insurance contract.
However, this does not preclude the specification of a
predetermined payout to quantify the loss caused by a
specified event, such as death (or an accident).
EXAMPLE-no-loss financial guarantee contract
An insurer insures a shipment of oil against credit default. The
client defaults, but the oil is resold at a profit to another client.
Under this contract, the insurer still has to make payment, even
though holder has not incurred a loss.
(vii)
(v)
derivatives that expose one party to financial risk, but
not insurance risk, because they require that party to
make payment based solely on changes in a specified
interest rate, financial instrument price, commodity
price, foreign exchange rate, index of prices or rates,
credit rating (or credit index) or other variable, provided
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a credit-related guarantee contract (or letter of credit,
credit derivative default product, or credit insurance
contract) that requires payments, even if the holder has
not incurred a loss on the failure of the debtor to make
payments when due (see IFRS 9).
contracts that require a payment based on a climatic,
geological or other physical variable that is not specific to
a party to the contract (commonly described as weather
derivatives).
EXAMPLE-weather derivatives
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IFRS 4 Insurance Contracts
Purely for speculation, a speculator gambles on how many
hurricanes will hit the USA in the next year. The speculator has
no commercial interest in the USA.
reference to the stage of completion of the transaction, if the
outcome of the transaction can be estimated reliably.
Significant insurance risk
(viii)
catastrophe bonds that provide for reduced payments of
principal, interest (or both), based on a climatic, geological
or other physical variable that is not specific to a party to
the contract.
EXAMPLE- catastrophe bonds - variable that is not specific
to a party to the contract
A client finds that the insurer sells catastrophe bonds relating to
Japan.
The client has no business interest in Japan, but learns that he
can reduce his interest payments (by buying this bond), if Japan
is hit by an earthquake.
For the client, this is a gambling contract.
If the contracts (described above) create financial assets or
financial liabilities, they are within the scope of IFRS 9.
In summary, the parties to the contract use deposit accounting,
which involves the following:
(i)
one party records the consideration received as a financial
liability, rather than as revenue.
(ii)
the other party records the consideration paid as a
financial asset, rather than as an expense.
If these contracts do not create financial assets or financial
liabilities, IAS 18 applies. Under IAS 18, revenue associated with
a transaction (involving the rendering of services) is recorded by
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A contract is an insurance contract, only if it transfers significant
insurance risk.
Insurance risk is significant, only if an insured event could cause
an insurer to pay significant additional benefits.
If significant additional benefits would be payable, the condition in
the previous sentence may be met, even if the insured event is
extremely unlikely, or even if the expected (probability-weighted)
present value of contingent cash flows is a small proportion of the
expected present value of all the remaining contractual cash
flows.
The additional benefits refer to amounts that exceed those that
would be payable if no insured event occurred. Those additional
amounts include claims handling and claims assessment costs,
but exclude:
(i)
the loss of the ability to charge the policyholder for future
services.
EXAMPLE-exclusion from additional benefits (costs to the
insurer)
In an investment-linked life insurance contract, the death of the
policyholder means that the insurer can no longer perform
investment management services, and collect a fee for doing so.
However, this economic loss for the insurer does not reflect
insurance risk, just as a mutual fund manager does not take on
insurance risk in relation to the possible death of the client.
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IFRS 4 Insurance Contracts
Therefore, the potential loss of future investment management
fees is not relevant in assessing how much insurance risk is
transferred by a contract.
(ii)
(iii)
waiver on death of charges that would be made on
cancellation (or surrender). As the contract brought those
charges into existence, the waiver of these charges does
not compensate the policyholder for a pre-existing risk.
Hence, they are not relevant in assessing how much
insurance risk is transferred by a contract.
a payment conditional on an event that does not cause a
significant loss to the holder of the contract.
EXAMPLE-exclusion from additional benefits (costs to the
insurer)
A contract requires the issuer to pay $1million, if an asset suffers
physical damage, causing an insignificant economic loss of one
currency unit to the holder.
In this contract, the holder transfers (to the insurer) the
insignificant risk of losing one currency unit. At the same time, the
contract creates non-insurance risk that the issuer will need to
pay $999,999, if the specified event occurs.
As the issuer does not accept significant insurance risk from the
holder, this contract is not an insurance contract.
(iv)
possible reinsurance recoveries. The insurer accounts for
these separately.
An insurer shall assess the significance of insurance risk contract
by contract, (rather than by reference to materiality to the
financial statements). For this purpose, contracts entered into
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simultaneously with a single client (or contracts that are
otherwise interdependent) form a single contract.
Thus, insurance risk may be significant, even if there is a minimal
probability of material losses for a whole book of contracts. This
contract-by-contract assessment makes it easier to classify a
contract as an insurance contract.
However, if a relatively homogeneous book of small contracts is
known to consist of contracts that all transfer insurance risk, an
insurer need not examine each contract to identify a few nonderivative contracts, that transfer insignificant insurance risk.
If a contract pays a death benefit exceeding the amount payable
on survival, the contract is an insurance contract, unless the
additional death benefit is insignificant (judged by reference to
the contract, rather than to an entire book of contracts).
The waiver on death of cancellation (or surrender charges) is not
included in this assessment, if this waiver does not compensate
the policyholder for a pre-existing risk.
Similarly, an annuity contract that pays out regular sums for the
rest of a policyholder’s life is an insurance contract, unless the
aggregate life-contingent payments are insignificant.
Additional benefits could include a requirement to pay benefits
earlier, if the insured event occurs earlier, and the payment is not
adjusted for the time value of money.
EXAMPLE-early deaths- a requirement to pay benefits earlier
A whole-life insurance that is for a fixed amount (insurance that
provides a fixed death benefit, whenever the policyholder dies,
with no expiry date for the cover).
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IFRS 4 Insurance Contracts
It is certain that the policyholder will die, but the date of death is
uncertain. The insurer will suffer a loss on those individual
contracts for which policyholders die early, even if there is no
overall loss on the whole book of contracts.
A contract that qualifies as an insurance contract, remains an
insurance contract, until all rights and obligations are
extinguished (or expire).
Embedded derivatives
If an insurance contract is unbundled into a deposit component,
and an insurance component, the significance of insurance risk
transfer is assessed by reference to the insurance component.
The significance of insurance risk, transferred by an embedded
derivative, is assessed by reference to the embedded derivative.
Changes in the level of insurance risk
Some contracts do not transfer any insurance risk to the issuer at
the start of a contract, although they do transfer insurance risk at
a later time.
EXAMPLE- transfer insurance risk at a later time
A contract provides a specified investment return, and includes
an option for the policyholder, to use the proceeds of the
investment on maturity, to buy a life-contingent annuity (at the
current annuity rates charged by the insurer to other new
annuitants, when the policyholder exercises the option).
The contract transfers no insurance risk to the issuer until the
option is exercised, as the insurer remains free to price the
annuity on a basis that reflects the insurance risk transferred to
the insurer, at that time.
However, if the contract specifies the annuity rates (or a basis for
setting the annuity rates), the contract transfers insurance risk to
the issuer at start.
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IFRS 9 requires an undertaking to:
- separate some embedded derivatives from their host
contract,
- measure them at fair value, and
- include changes in their fair value in the income statement.
IFRS 9 applies to derivatives, embedded in an insurance
contract, unless the embedded derivative is itself an insurance
contract.
EXAMPLES-embedded derivatives
1.
A put option attached to a share, or bond.
2.
A call option attached to a share, or bond.
3.
An option to extend the term of a bond.
4.
Equity-indexed interest, or principal payments.
5.
Commodity- indexed interest, or principal payments.
6.
Option to convert a bond into shares.
7.
Credit derivatives, relating to credit risk, that enable
a guarantor to assume the risk, without owning the
related asset.
As an exception to IFRS 9, an insurer need not separate (and
measure at fair value) a policyholder’s option to surrender an
insurance contract for a fixed amount (or for an amount based on
a fixed amount, plus an interest rate), even if the exercise price
differs from the carrying amount of the host insurance liability.
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IFRS 4 Insurance Contracts
However, IFRS 9 does apply to a put option (or cash surrender
option) embedded in an insurance contract, if the surrender value
varies in response to the change in a financial variable (such as
an equity, or commodity price, or index), or a non-financial
variable that is not specific to a party to the contract.
(3)
That requirement also applies if the holder’s ability to exercise a
put option (or cash surrender option) is triggered by a change in
such a variable (for example, a put option that can be exercised if
a stock market index reaches a specified level).
EXAMPLE- policies that do not require an insurer to record
all obligations
An insurer’s policies do not require it to record all obligations
arising from a deposit component. A cedant receives
compensation for losses from a reinsurer, but the contract obliges
the cedant to repay the compensation in future years.
This applies equally to options to surrender a financial instrument
containing a discretionary participation feature.
Unbundling of deposit components
arising from the deposit component, regardless of the
basis used to measure those rights (and obligations).
unbundling is prohibited if an insurer cannot measure the
deposit component separately as in (1)(i).
That obligation arises from a deposit component. If the cedant’s
policies otherwise permit it to record the compensation as
income, without recognising the resulting obligation, unbundling
is required.
Some insurance contracts contain both an insurance component
and a deposit component. In some cases, an insurer is required
(or permitted) to unbundle those components:
To unbundle a contract, an insurer shall:
(i)
apply IFRS 4 to the insurance component.
(1)
met:
unbundling is required if both the following conditions are
(ii)
apply IFRS 9 to the deposit component.
(i)
the insurer can measure the deposit component (including
any embedded surrender options) separately (without
considering the insurance component).
(ii)
the insurer’s policies do not otherwise require it to record
all obligations and rights arising from the deposit
component.
(2)
unbundling is permitted, but not required, if the insurer can
measure the deposit component separately as in (1)(i) but
its policies require it to record all obligations (and rights)
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3. RECOGNITION AND MEASUREMENT
Temporary exemption from some other IFRSs
IAS 8 provides criteria for an undertaking to use in developing a
policy if no IFRS applies specifically to an item. However, IFRS 4
exempts an insurer from applying those criteria to its policies for:
(i)
insurance contracts that it issues (including related
acquisition costs and related intangible assets); and
(ii)
reinsurance contracts that it holds.
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IFRS 4 Insurance Contracts
Nevertheless, IFRS 4 does not exempt an insurer from some of
the criteria of IAS 8. Specifically, an insurer:
(1)
shall not record as a liability any provisions for possible
future claims, if those claims arise under insurance
contracts that are not in existence at the reporting date
(such as catastrophe provisions and equalisation
provisions).
(2)
shall carry out the liability adequacy test (see below).
(3)
shall remove an insurance liability (or a part of an
insurance liability) from its balance sheet only when it is
extinguished—when the obligation specified in the contract
is discharged (or cancelled, or expires).
(4)
shall not offset:
(i)
reinsurance assets, against the related insurance
liabilities; or
(ii)
(5)
income (or expense) from reinsurance contracts, against
the expense (or income) from the related insurance
contracts.
shall consider whether its reinsurance assets are impaired.
Liability adequacy test
An insurer shall assess (at each reporting date) whether its
recorded insurance liabilities are adequate, using estimates of
cash flows under its insurance contracts.
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If that assessment shows that the carrying amount of its
insurance liabilities (less related deferred acquisition costs, and
related intangible assets) is inadequate, in the light of the
estimated cash flows, the entire shortfall shall be recorded in the
income statement.
If an insurer applies a liability adequacy test that meets the
minimum requirements, IFRS 4 imposes no further requirements.
The minimum requirements are the following:
(i)
The test considers estimates of all contractual cash flows
(and of related cash flows, such as claims handling costs),
as well as cash flows resulting from embedded options,
and guarantees.
(ii)
If the test shows that the liability is inadequate, the entire
shortfall is recorded in the income statement.
If an insurer’s policies do not require a liability adequacy test, the
insurer shall:
(1)
determine the carrying amount of the relevant
liabilities**less:
(i)
any related deferred acquisition costs; and
(ii)
any related intangible assets, such as those acquired in a
business combination (or portfolio transfer). However,
related reinsurance assets are not considered, as an
insurer accounts for them separately.
*
The relevant liabilities are those insurance liabilities (and
related deferred acquisition costs and related intangible assets)
for which the insurer’s policies do not require a liability adequacy.
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IFRS 4 Insurance Contracts
(2)
determine whether the amount described in (1) is less than
the carrying amount, if the relevant insurance liabilities
were within the scope of IAS 37 Provisions.
(ii)
that event has a reliably measurable impact on the
amounts that the cedant will receive from the reinsurer.
4. Changes in accounting policies
If it is less, the insurer shall record the entire shortfall in the
income statement, and decrease the carrying amount of the
related deferred acquisition costs (or related intangible assets), or
increase the carrying amount of the relevant insurance liabilities.
If an insurer’s liability adequacy test meets the minimum, the test
is applied at the level of aggregation specified in that test.
If its liability adequacy test does not meet those minimum
requirements, the comparison shall be made at the level of a
portfolio of contracts that are subject to broadly-similar risks, and
managed together as a single portfolio.
An insurer may change its accounting policies for insurance
contracts only if the change makes the financial statements more
relevant for users. An insurer shall refer to the criteria in IAS 8.
To justify changing its accounting policies for insurance contracts,
an insurer shall show that the change brings its financial
statements closer to meeting the criteria in IAS 8, but the change
need not achieve full compliance with those criteria. The following
specific issues are discussed below:
(i)
current interest rates;
The result of applying IAS 37 shall reflect future investment
margins only if the amount described in (1) also reflects those
margins.
(ii)
continuation of existing practices;
(iii)
prudence;
Impairment of reinsurance assets
(iv)
future investment margins; and
(v)
shadow accounting (see below).
If a cedant’s reinsurance asset is impaired, the cedant shall
reduce its carrying amount, and record that impairment loss in
the income statement.
A reinsurance asset is impaired only if:
(i)
there is objective evidence, as a result of an event that
occurred after initial recording of the reinsurance asset,
that the cedant may not receive all amounts due to it under
the terms of the contract; and
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Current market interest rates
An insurer is permitted (but not required) to change its accounting
policies, so that it remeasures designated insurance liabilities to
reflect current interest rates, and records changes in those
liabilities, in the income statement.
Insurance liabilities include related deferred acquisition costs,
and related intangible assets. It may also introduce policies that
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IFRS 4 Insurance Contracts
require other current estimates (and assumptions) for the
designated liabilities.
The election permits an insurer to change its policies for
designated liabilities, without applying those policies consistently
to all similar liabilities, as IAS 8 would otherwise require.
If an insurer designates liabilities for this election, it shall continue
to apply interest rates (and, if applicable, the other current
estimates and assumptions) consistently, in all periods, to all
these liabilities, until they are extinguished.
Continuation of existing practices
An insurer may continue the following practices, but the
introduction of any of them does not satisfy IFRS:
(i)
measuring insurance liabilities on an undiscounted basis.
(ii)
measuring contractual rights to future investment
management fees, at an amount that exceeds their fair
value (as implied by a comparison with current fees,
charged by others for similar services). It is likely that the
fair value, at the start, equals the origination costs paid
(unless future investment management fees, and related
costs, are out of line with market comparables).
(iii)
using non-uniform policies for the insurance contracts (and
related deferred acquisition costs, and related intangible
assets, if any) of subsidiaries.
If those policies are not uniform, an insurer may change them, if
the change does not make the policies more diverse, and also
satisfies the other requirements in this IFRS.
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Prudence
An insurer need not change its policies for insurance contracts, to
eliminate excessive prudence. However, if an insurer already
measures its insurance contracts with sufficient prudence, it shall
not introduce additional prudence.
Future investment margins
An insurer need not change its policies for insurance contracts to
eliminate future investment margins. However, there is a
rebuttable presumption that an insurer’s financial statements will
become less relevant (and reliable) if it introduces a policy that
reflects future investment margins in the measurement of
insurance contracts, unless those margins affect the contractual
payments.
EXAMPLES- future investment margins
(i)
using a discount rate that reflects the estimated return on
the insurer’s assets; or
(ii)
projecting the returns at an estimated rate of return,
discounting those projected returns at a different rate, and
including the result in the measurement of the liability.
An insurer may overcome the presumption only if the other
components (of a change in policies) increase the relevance (and
reliability) of its financial statements sufficiently to outweigh the
decrease in relevance (and reliability) caused by the inclusion of
future investment margins.
EXAMPLE- future investment margins
An insurer’s existing policies for insurance contracts involve
excessively prudent assumptions set at start, and a discount rate
(prescribed by a regulator), without direct reference to market
conditions, and ignore some embedded options and guarantees.
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IFRS 4 Insurance Contracts
The insurer might make its financial statements more relevant
(and no less reliable) by switching to a comprehensive investororiented basis of accounting that is widely used and involves:
(i)
(ii)
In some accounting models, realised gains (or losses) on an
insurer’s assets have a direct effect on the measurement of some
(or all) of
(i)
its insurance liabilities,
(ii)
related deferred acquisition costs and
(iii)
related intangible assets.
current estimates, and assumptions;
a reasonable (but not excessively prudent) adjustment, to
reflect risk and uncertainty;
(iii)
measurements that reflect both the intrinsic value, and
time value, of embedded options and guarantees; and
(iv)
a current market discount rate, even if that discount rate
reflects the estimated return on the insurer’s assets.
An insurer is permitted (but not required) to change its policies,
so that a recorded but unrealised gain (or loss) on an asset
affects those measurements, in the same way that a realised
gain (or loss) does.
In some measurement approaches, the discount rate is used to
determine the present value of a future profit margin. That profit
margin is then attributed to different periods, using a formula.
The related adjustment to the insurance liability (or deferred
acquisition costs, or intangible assets) shall be recorded in equity
only if the unrealised gains (or losses) are recorded directly in
equity. This practice is sometimes described as ‘shadow
accounting’.
In those approaches, the discount rate affects the liability only
indirectly. In particular, the use of a less-appropriate discount rate
has a limited (or no) effect on the measurement of the liability, at
the start.
Insurance contracts acquired in a business combination or
portfolio transfer
However, in other approaches, the discount rate determines the
measurement of the liability directly. In the latter case, as the
introduction of an asset-based discount rate has a more
significant effect, it is highly unlikely that an insurer could
overcome the rebuttable presumption.
Shadow accounting (adjustments taken to equity)
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To comply with IFRS 3, an insurer shall, at the acquisition date,
measure at fair value the insurance liabilities assumed, and
insurance assets acquired, in a business combination.
However, an insurer is permitted (but not required) to use a
presentation, which splits the fair value of acquired contracts into
two components:
(i)
a liability measured in accordance with the insurer’s
policies for contracts that it issues; and
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IFRS 4 Insurance Contracts
(ii)
an intangible asset, representing the difference between (i)
the fair value of the contractual rights acquired, and
obligations assumed, and (ii) the amount described in (i).
The subsequent measurement of this asset shall be consistent
with the measurement of the related insurance liability.
If the issuer does not record them separately, it shall classify the
whole contract as a liability. If the issuer classifies them
separately, it shall classify the guaranteed element as a liability.
(ii)
An insurer acquiring a portfolio of insurance contracts may use
this presentation.
The intangible assets are excluded from the scope of IAS 36
Impairment of Assets and IAS 38 Intangible Assets.
However, IAS 36 and IAS 38 apply to customer lists (and
customer relationships) reflecting the expectation of future
contracts that are not part of the contractual insurance rights, and
contractual insurance obligations that existed at the date of a
business combination (or portfolio transfer).
5. Discretionary participation features
Discretionary participation features in insurance contracts
Some insurance contracts contain a discretionary participation
feature (DPF), as well as a guaranteed element. An example of a
DPF might be a profit-sharing reinsurance contract, where the
cedant is guaranteed a minimum repayment of its premium, and
a share of the profits, at the reinsurer’s discretion. The issuer of
such a contract:
(i)
may (but need not) record the guaranteed element
separately from the discretionary participation feature.
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shall, if it records the discretionary participation feature
separately from the guaranteed element, classify that
feature as either a liability or a separate component of
equity.
IFRS 4 does not specify how the issuer determines whether that
feature is a liability, or equity. The issuer may split that feature
into liability and equity components, and shall use a consistent
policy for that split.
The issuer shall not classify that feature as an intermediate
category, which is neither liability nor equity.
(iii)
may record all premiums received as revenue, without
separating any portion that relates to the equity
component.
The resulting changes in the guaranteed element, and in the
portion of the discretionary participation feature classified as a
liability, shall be recorded in the income statement.
If part (or all) of the discretionary participation feature is classified
in equity, a portion of the income statement may be attributable to
that feature (in the same way that a portion may be attributable to
minority interests).
The issuer shall record the portion of the income statement,
attributable to any equity component, as an allocation of the
income statement, not as expense or income (see IAS 1).
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IFRS 4 Insurance Contracts
(iv)
shall, if the contract contains an embedded derivative
within the scope of IFRS 9, apply IFRS 9 to that
embedded derivative.
(v)
shall, in all other respects, continue its existing policies for
such contracts, unless it changes those policies.
(iii)
although these contracts are financial instruments, the
issuer may continue to record the premiums for those
contracts as revenue, and record (as an expense) the
resulting increase in the carrying amount of the liability.
(iv)
although these contracts are financial instruments, an
issuer applying IFRS 7 (disclosing total interest income
and total interest expense for financial assets and liabilities
that are not at fair value through profit and loss) to
contracts with a DPF shall disclose the total interest
expense recorded in the income statement , but need not
use the effective interest method.
Discretionary participation features in financial instruments
The requirements above also apply to a financial instrument that
contains a discretionary participation feature. In addition:
(i)
if the issuer classifies the entire discretionary participation
feature as a liability, it shall apply the liability adequacy
test to both the guaranteed element and the discretionary
participation feature.
The issuer need not determine the amount that would result from
applying IFRS 9 to the guaranteed element.
(ii)
if the issuer classifies part (or all) of that feature as a
separate component of equity, the liability recorded for the
whole contract shall not be less than the amount, that
would result from applying IFRS 9 to the guaranteed
element.
That amount shall include the intrinsic value of an option to
surrender the contract, but need not include its time value that
option is exempted from measurement at fair value.
The issuer need not disclose the amount that would result from
applying IFRS 9 to the guaranteed element, nor present that
amount separately. Furthermore, the issuer need not determine
that amount, if the total liability recorded is clearly higher.
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7. DISCLOSURE
Explanation of recorded amounts
An insurer shall disclose information that identifies (and explains)
the amounts in its financial statements, arising from insurance
contracts.
An insurer shall disclose:
(1)
its policies for insurance contracts and related assets,
liabilities, income and expense.
(2)
the recorded assets, liabilities, income and expense (and,
if it presents its cash flow statement using the direct
method, cash flows) arising from insurance contracts.
Furthermore, if the insurer is a cedant, it shall disclose:
(i)
gains (and losses) recorded in the income statement on
buying reinsurance; and
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IFRS 4 Insurance Contracts
(ii)
(3)
if the cedant amortises gains (and losses) arising on
buying reinsurance, the amortisation for the period, and
the amounts remaining unamortised, at the beginning and
end of the period.
the process used to determine the assumptions, that have
the greatest effect on the measurement of the recorded
amounts described in (2). Where practicable, an insurer
shall also give quantified disclosure of those assumptions.
(ii)
concentrations of insurance risk including a description of
how management determines concentrations and a
description of the shared characteristic that identifies each
concentration (such as type of insured event, geographical
area, or currency).
(3)
actual claims compared with previous estimates (i.e.
claims development).
(4)
the effect of changes in assumptions used to measure
insurance assets and insurance liabilities, showing
separately the effect of each change that has a material
effect on the financial statements.
The disclosure about claims development shall go back to the
period when the earliest material claim arose, for which there is
still uncertainty about the amount (and timing) of the claims
payments, but need not go back more than ten years.
(5)
reconciliations of changes in insurance liabilities,
reinsurance assets and, if any, related deferred acquisition
costs.
An insurer need not disclose this information for claims for which
uncertainty about the amount (and timing) of claims payments is
normally resolved within one year.
Nature and extent of risks arising from insurance contracts
(4)
An insurer shall disclose information that helps users to
understand the amount, timing and uncertainty of cash flows from
insurance contracts.
the information about liquidity risk, market risk and credit
risk that IFRS 7 would require, if the insurance contracts
were within the scope of IFRS 7.
(5)
information about exposures to interest rate risk (or market
risk under embedded derivatives) contained in a host
insurance contract, if the insurer is not required to (and
does not) measure the embedded derivatives at fair value.
An insurer shall disclose:
(1)
its objectives in managing risks arising from insurance
contracts, and its policies for mitigating those risks.
(2)
(i)
information about insurance risk (both before and after
risk mitigation by reinsurance), including information
about:
the sensitivity of the income statement and equity to
changes in variables that have a material effect on them.
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To comply with the need to explain the sensitivity to insurance
risk, an insurer shall disclose either (1) or (2) as follows:
1
a sensitivity analysis that shows how the incme statement
and equity would have been affected had changes in the relevant
risk variable that were reasonably possible at the balance sheet
date occurred;
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IFRS 4 Insurance Contracts
the methods and assumptions used in preparing the sensitivity
analysis; and any changes from the previous period in the
methods and assumptions used.
However, if an insurer uses an alternative method to manage
sensitivity to market conditions, such as an embedded value
analysis, it may meet this requirement by disclosing that
alternative sensitivity analysis and the disclosures required by
IFRS 7 on sensitivity analysis.
2.
qualitative information about sensitivity, and information
about those terms and conditions of insurance contracts that
have a material effect on the amount, timing and uncertainty of
the insurer’s future cash flows.
Disclosure
An undertaking need not disclose information about claims
development, which occurred earlier than five years before the
end of the first financial year, in which it applies this IFRS.
Furthermore, if it is impracticable, when an undertaking first
applies this IFRS, to prepare information about claims
development, that occurred before the beginning of the earliest
period for which an undertaking presents full comparative
information that complies with this IFRS, the undertaking shall
disclose that fact.
Redesignation of financial assets
When an insurer changes its policies for insurance liabilities, it is
permitted (but not required) to reclassify some (or all) of its
financial assets as ‘at fair value through the income statement’.
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This reclassification is permitted if an insurer changes policies,
when it first applies IFRS 4, and if it makes a subsequent policy
change. The reclassification is a change in policy, and IAS 8
applies.
8. Multiple choice questions
1. IFRS 4 is:
1. A draft for discussion.
2. In force until the IAS Board completes the second phase
of its project on insurance contracts.
3. The final conclusion of the IAS Board on the reporting of
insurance contracts.
2. A cedant is:
1. The policyholder under a reinsurance contract.
2. The policyholder under an insurance contract.
3. An insurer.
4. An overseas insurer.
3. A direct insurance contract is:
1. A contract sold directly to the public by an underwriter.
2. A contract for tangible assets only.
3. An insurance contract that is not a reinsurance
contract.
4. Financial risk is the risk (not specific to a party to the
contract) of a possible future change in a:
(i)
specified interest rate,
(ii)
financial instrument price,
(iii)
commodity price,
(iv)
foreign exchange rate,
(v)
index of prices or rates,
(vi)
credit rating or credit index,
(vii) weather pattern.
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IFRS 4 Insurance Contracts
1.
2.
3.
4.
5.
6.
7.
(i)
(i)-(ii)
(i)-(iii)
(i)-(iv)
(i)-(v)
(i)-(vi)
(i)-(vii)
3. Companies can elect to measure, at fair value,
investment properties used to support liabilities linked to
the fair value of those properties, leaving all the other
investment properties at cost.
4. Insurers can recognise an intangible asset that covers
the difference between the fair value and the book value
of the insurance liabilities, taken on through a business
combination, or portfolio transfer.
5. Insurers can adopt a form of ‘shadow accounting’ that
would allow them to adjust their liabilities for changes that
would have arisen if any unrealised gains or losses on
securities had been realised.
6. Companies can continue to value insurance and
investment contracts with discretionary participatory
features using their existing accounting policies.
7. Insurers that do not report comparative performance
for prior years may continue this practice.
5. Liability adequacy tests are based on a review of:
1. Long-term liabilities.
2. Short-term liabilities.
3. Profit forecasts.
4. Cash flows.
6. IFRS 4 addresses accounting and disclosures for:
1. Insurance contracts.
2. Reinsurance contracts.
3. Both insurance and reinsurance contracts.
7. As a result of IFRS 4, many savings and pension plans will
be:
1. Re-designated as insurance contracts.
2. Re-designated as investment contracts.
3. Re-designated as re-insurance contracts.
8. Under IFRS 4, insurance contracts will continue to be
covered by existing accounting policies during Phase 1. This
allows firms to do the following:
1. Insurers can use ‘current interest rates’ to value
liabilities, bringing them more into line with movements in
associated interest-sensitive assets.
2. Companies can adjust their liabilities to reflect future
investment margins ‘if and only if’ this is part of a switch to
a ‘widely used’ and ‘comprehensive investor oriented basis
of accounting’.
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1.
2.
3.
4.
5.
6.
7.
(i)
(i)-(ii)
(i)-(iii)
(i)-(iv)
(i)-(v)
(i)-(vi)
(i)-(vii)
9. A profit sharing reinsurance contract where the cedant is
guaranteed a minimum repayment of its premium is an
example of a:
1. Embedded derivative.
2. Discretionary participatory feature.
3. Fixed guaranteed element.
10. Subject to the conditions of the contract, an insured
event can happen (and the insurer will be liable):
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IFRS 4 Insurance Contracts
(i)
(ii)
(iii)
During the term of the contract.
Before the contract starts.
After the contract ends.
1. (i)
2. (i)-(ii)
3. (i)-(iii)
11. To decide whether there is an insurance contract:
(i) There must be a risk (not a certainty).
(ii) It must not be a ‘financial’ risk.
(iii) It must be transferred from the holder of a contract to the
issuer.
(iv) It must require an adverse impact on the policyholder as
a precondition for payment.
(v) The contract must state that it is an insurance contract.
1.
2.
3.
4.
5.
(i)
(i)-(ii)
(i)-(iii)
(i)-(iv)
(i)-(v)
12. Examples of insurance contracts are:
(i)
insurance against theft (or damage) to property.
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(ii)
insurance against product liability, professional liability,
civil liability or legal expenses.
(iii)
life insurance and prepaid funeral plans (although death is
certain, it is uncertain when death will occur or, for some
types of life insurance, whether death will occur within the
period covered by the insurance).
(iv)
life-contingent annuities and pensions (i.e. contracts that
provide compensation for the uncertain future event—the
survival of the annuitant (or pensioner)—to assist the
annuitant (or pensioner) in maintaining a given standard of
living, which would otherwise be adversely affected by his
survival).
(v)
disability and medical cover.
(vi)
surety bonds, fidelity bonds, performance bonds and bid
bonds.
(vii) catastrophe bonds, not specific to the policyholder.
1.
2.
3.
4.
5.
6.
7.
(i)
(i)-(ii)
(i)-(iii)
(i)-(iv)
(i)-(v)
(i)-(vi)
(i)-(vii)
13. Significant insurance risk involves the payment of
additional benefits. These include:
(i)
Claims handling and claims assessment costs.
(ii)
A requirement to pay benefits earlier.
(iii)
The loss of the ability to charge the policyholder
for future services.
(iv)
Waiver on death of charges that would be made
on cancellation (or surrender).
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IFRS 4 Insurance Contracts
(v)
(vi)
1.
2.
3.
4.
5.
6.
A payment conditional on an event that does not
cause a significant loss to the holder of the
contract.
Possible reinsurance recoveries.
(i)
(i)-(ii)
(i)-(iii)
(i)-(iv)
(i)-(v)
(i)-(vi)
14. Examples of embedded derivatives are:
(i)
A put option attached to a share, or bond.
(ii)
A call option attached to a share, or bond.
(iii)
An option to extend the term of a bond.
(iv)
Equity-indexed interest, or principal payments.
(v)
Commodity- indexed interest, or principal
payments.
(vi)
Option to convert a bond into shares.
(vii)
Credit derivatives, relating to credit risk, that
enable a guarantor to assume the risk, without
owning the related asset.
1. (i)
2. (i)-(ii)
3. (i)-(iii)
4. (i)-(iv)
5. (i)-(v)
6. (i)-(vi)
7. (i)-(vii)
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15. If both of the following conditions are met:
(i)
the insurer can measure the deposit component (including
any embedded surrender options) separately (without
considering the insurance component).
(ii)
the insurer’s policies do not otherwise require it to record
all obligations and rights arising from the deposit
component.
Unbundling is:
1. Required.
2. Permitted
3. Prohibited.
16. If the liability adequacy test is inadequate, the shortfall
is:
1. Recorded as a provision.
2. Recorded in the income statement.
3. Taken directly to reserves.
17. The following practices:
(i)
measuring insurance liabilities on an undiscounted basis.
(ii)
measuring contractual rights to future investment
management fees, at an amount that exceeds their fair
value (as implied by a comparison with current fees,
charged by others for similar services). It is likely that the
fair value, at the start, equals the origination costs paid
(unless future investment management fees, and related
costs, are out of line with market comparables).
(iii)
using non-uniform policies for the insurance contracts (and
related deferred acquisition costs, and related intangible
assets, if any) of subsidiaries.
1. Are prohibited.
2. Are allowed.
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IFRS 4 Insurance Contracts
3. May be continued, but not introduced.
2. Realised gains in the same manner as unrealised
gains.
3. Realised gains directly in equity.
20. The issuer of a DPF contract:
may (but need not) record the guaranteed element separately
from the discretionary participation feature.
If the issuer classifies them separately, it shall classify the
guaranteed element as a liability and
it records the discretionary participation feature as:
1. A liability.
2. A separate component of equity.
3. Either 1 or 2.
18. A comprehensive investor-oriented basis of accounting,
that is widely used, involves:
(i)
current estimates, and assumptions;
(ii)
a reasonable (but not excessively prudent) adjustment, to
reflect risk and uncertainty;
(iii)
measurements that reflect both the intrinsic value, and
time value, of embedded options and guarantees;
(iv)
a current market discount rate, even if that discount rate
reflects the estimated return on the insurer’s assets;
(v)
increased prudence.
1.
2.
3.
4.
5.
(i)
(i)-(ii)
(i)-(iii)
(i)-(iv)
(i)-(v)
19. Shadow accounting records:
1. Unrealised gains in the same manner as realised
gains.
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21. The issuer of a DPF contract may record premiums
received as:
1. Revenue.
2. A split between revenue and the equity component.
3. A credit to the equity component.
9. Answers to multiple choice questions
Question
Answer
1.
2
2.
1
3.
3
4.
6
5.
4
6.
3
7.
2
8.
6
9.
3
10.
3
11.
4
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IFRS 4 Insurance Contracts
12.
13.
14.
15.
16.
17.
18.
19.
20.
21.
6
2
7
1
2
3
4
1
3
1
10. Appendix. Similarities and Differences – A comparison of
IFRS and US GAAP – PwC-September 2004
Insurance and reinsurance contracts – definition
IFRS introduces a definition of an insurance contract based on
the concept of insured event and significant insurance risk
transfer. This definition applies to both insurance contracts issued
and reinsurance contracts held.
US GAAP does not provide a single definition of insurance
contract. The classification of contracts is performed by reference
to the combined requirements of FAS 60, FAS 97 and FAS 120.
Reinsurance contracts are subject to the definition contained in
FAS 113. FAS 97 also covers investment contracts that would be
accounted for under IFRS 9 in IFRS financial statements.
The resulting population of insurance contracts under US GAAP
is a subset of the IFRS classification. In addition, ‘universal lifetype contracts’ within FAS 97 contain significant insurance risk
under IFRS but are required to be accounted for under US GAAP
using the deposit method of accounting rather than the deferral
and matching accounting model used for all other insurance
contracts (see below).
Reinsurance contracts that compensate the ceding party for
losses but contain a timing delay in reimbursement (i.e., the loss
will certainly occur but its timing is uncertain) are subject to
deposit accounting under FAS 113 but are classified as
insurance contracts under IFRS.
One of the results of applying the IFRS insurance contract
definition is that companies can no longer analogise to FAS 97
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IFRS 4 Insurance Contracts
measurement principles with respect to their accounting for
deferred acquisition costs (DAC).
IFRS preparers with investment contracts under IFRS 9must look
to IAS 18 for accounting guidance related to the recognition and
measurement of DAC.
IFRS also recognises that the fair value of an investment contract
cannot be less than the amount payable on demand (the ‘deposit
floor’); under US GAAP, the account value may fall below this
level.
Discretionary participation feature (DPF)
This is a new term under IFRS relating to the right of holders of
certain insurance contracts and/or financial instruments to
receive a supplemental return (in addition to guaranteed benefits)
arising from certain components of the residual interest of the
entity that has issued contracts with DPF.
IFRS defines insurance contracts and financial instruments with
DPF as compound instruments. IFRS does not require but
permits the separation of the DPF equity component.
The use of hybrid categories classified between equity and
liabilities is prohibited.
IFRS requires entities to perform an adequacy test for those
financial instruments with DPF. This liability adequacy test is
different for those financial instruments with DPF that have an
equity component. In this case, the liability adequacy test is
based onIFRS 9. In all other cases, IFRS 4 applies.
Other accounting and reporting topics
This type of participation is described under US GAAP as
policyholder dividends, and guidance is provided on accounting
for dividends paid out of insurance contracts.
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Entities must recognise a liability for the expected dividend
payout based on an estimate of the amount to be paid.
There are no requirements to disclose the portion of equity that
arises from contracts that pay dividends. However, any dividend
payments or declarations in excess of the liability are charged to
profit or loss when paid or declared.
The possibility of such dividends being paid on financial
instruments is not contemplated in US GAAP. Current US GAAP
reporters have adopted the insurance accounting guidelines for
measuring the obligations under such contracts.
Insurance and reinsurance contracts – measurement
The existing accounting policies for insurance contracts issued
and reinsurance contracts held (including related intangible
assets like deferred acquisition costs) are exempt from IFRS
hierarchy and need not be changed on adoption of IFRS 4,
except for the following five requirements:
1. Provisions for possible claims under contracts that are not in
existence at the reporting date (such as catastrophe and
equalisation provisions) are prohibited;
2. Insurance liabilities must be tested for adequacy;
3. Reinsurance assets must be tested for impairment;
4. Insurance liabilities can be de-recognised only when they are
discharged or cancelled or expire;
5. Insurance liabilities and income should not be offset against
related reinsurance assets and expenses.
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IFRS 4 Insurance Contracts
US GAAP has specific measurement guidance for insurance
contracts and reinsurance contracts. As explained above, IFRS
allows entities to continue with their accounting policies
developed under another GAAP. There are several differences
between US GAAP and the entity’s insurance and reinsurance
accounting policies that have been developed from another
GAAP basis. These are not covered by this publication.
Under IFRS, the liability adequacy test requirement is met by the
FAS 60 premium deficiency test. However, any deficiency
resulting from the assumed realisation of unrealised gains or
losses is always reflected through the income statement under
IFRS because IFRS does not have the option to reflect this type
of liability adequacy loss through equity.
This type of loss is known in US GAAP as a ‘shadow’ premium
deficiency adjustment. In addition, IFRS requires guaranteed
options to be considered in the liability adequacy test. In US
GAAP these are provided for under
SOP 03-01 and are not explicitly considered in the premium
deficiency test.
1.1
Insurance and reinsurance contracts – deposit
accounting and unbundling of deposit components
IFRS also allows the unbundling of deposit components on a
voluntary basis if the deposit component can be reliably
measured. This right would allow preparers to use the FAS 97
deposit accounting approach for universal life-type contracts
(these contracts most likely qualify as insurance contracts under
IFRS because they usually transfer significant insurance risk).
For these contracts, US GAAP requires the recognition of the
liability representing the policyholder’s account balance with the
insurer. The account balance concept is equivalent to the deposit
component concept in IFRS.
Other accounting and reporting topics
1.2 Insurance contracts sold by an insurer to its own
defined benefit plan
Insurance contracts sold by an insurer to its own defined benefit
plan will generally be eliminated on consolidation, as outlined in
IFRS 4 implementation guidance. The financial statements will
then include:
• the full amount of the pension obligation under IAS 19, Staff
Benefits, with no deduction for the plan’s rights under the
contract;
• no liability to policyholders under the contract; and
IFRS requires the unbundling and separate measurement of the
deposit component bundled in an insurance contract only if the
deposit can be reliably measured and the entity’s accounting
policies do not recognise all rights and obligations arising from it.
This requirement is limited in practice to situations in which the
insurer or reinsurer has established experience accounts that
refund the policyholder or cedant but has not appropriately
reflected this obligation in its balance sheet.
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• the assets backing the contract.
Under US GAAP, these contracts are recorded by including the
value of the insurance contract as plan assets in the calculation
of the company’s net defined benefit liability, and reflecting the
insurance contract liability in accordance with the applicable
insurance accounting guidance.
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IFRS 4 Insurance Contracts
Insurance and reinsurance contracts – embedded
derivatives
report (for example in the MD&A section). An example of such
disclosure is the claims development table.rate accounts
Under IFRS, embedded derivatives that also meet the definition
of insurance contracts are not required to be separated and fair
valued. Options to surrender the insurance contract are
exempted from separation and fair value measurement if the
option price is a fixed amount or a fixed amount plus interest.
This exemption also applies to derivatives embedded in financial
instruments with DPF.
IFRS Does not permit a single line presentation.
US GAAP FAS 60 and SOP 03-01 allow single line presentation
in the balance sheet and offsetting of investment results, with
changes in policyholder liabilities in the income statement.
Under US GAAP, these embedded derivatives are not subject to
exemptions from the general principle of separation and fair value
measurement when they are not closely related to the host
contract.
REFERENCES:
IFRS: IFRS 4.
US GAAP: FAS 60, 97, 120 and 113, SOP 03-1, SOP 95-1 for
insurance contracts and FAS 91 for financial instruments, FAS
133.
IFRS classifies persistency bonuses as embedded derivatives;
US GAAP treats them as an effective yield adjustment and does
not require them to be separated and fair valued.
Disclosures
IFRS Requires extensive disclosures to allow the users of
financial statements to understand the measurement bases
adopted, the materiality of the reported amounts arising from
insurance contracts and the factors that affect the uncertainty of
amount and timing of the cash flows arising from insurance and
reinsurance contracts.
US GAAP Disclosures are less demanding than IFRS. However,
similar disclosures are included in other sections of the annual
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