AGENDA

Introduction and Overview

Definition of an Insurance Contract

Accounting for Insurance Contracts

Financial Components and investment contracts

Disclosures

NEED FOR AN INTERNATIONAL STANDARD ON INSURANCE

Diversity in accounting practice for insurance contracts internationally

Accounting practices for insurance contracts differ from practices in

other sectors

Other IFRSs do not address accounting for insurance contracts

OVERVIEW OF IASB & FASB JOINT INSURANCE PROJECT

Phase I

Objective was to:

Make limited improvements to accounting for insurance contacts

Provide disclosures that identify and explain amounts in an insurer‟s

financial statements arising from insurance contracts and provide

information about the amount, timing and uncertainty of future cash

flows from insurance contracts until the board completes phase II

Resulted in IFRS 4 Insurance contracts, an interim standard that permits

a wide variety of accounting practices for insurance contracts.

OVERVIEW OF IASB & FASB INSURANCE PROJECT(CONT’D)

Phase II

Currently ongoing

Objective is to develop a standard to replace the interim insurance

standard and to provide a basis for consistent accounting for insurance

contracts in the longer term

Joint project with FASB

DP Preliminary view on insurance contracts published in May 2007

ED expected in near future

OVERVIEW OF IFRS 4

Defines an insurance contract and focuses on types of contracts rather

than types of entities

Applies to:

Insurance contracts, including reinsurance contracts, that an entity

issues

Reinsurance contracts that an entity holds

Financial instruments issued with a discretionary participation features

Does not address accounting by policy holders

Does not apply to other assets and other liabilities of an insurer, such as

financial assets and financial liabilities within the scope of IAS 39/ IFRS

9

OVERVIEW OF IFRS 4 (CONT’D)

Generally insurers are required to continue their existing accounting

policies with respect to insurance contracts except where the standard

requires or permits changes in accounting policies

Requires some embedded derivatives and some deposit components to

be separated from insurance contracts

Requires a minimum liability adequacy test to be applied to recognized

insurance liabilities

Requires significant disclosures of the terms, conditions and risk

related to insurance contracts, consistent in principle with those

required for financial assets and liabilities

INSURANCE CONTRACTS – SCOPE EXEMPTION

Product warranties issued directly by a manufacturer, dealer or retailer

Employers assets and liabilities under employee benefit plans

Contractual right and obligations contingent on future use or right to

use a non-financial item (e.g. some royalties) and lessee‟s residual

value guarantee embedded in a finance lease

Financial guarantee contracts, except for contracts previously

accounted for as insurance contracts in respect of which issuer may

choose to apply IAS 39/IFRS 9

Contingent consideration payable or receivable in a business

combination

Direct insurance contracts held by policyholder

DEFINITION OF INSURANCE CONTRACTS

The definition of IFRS 4 refers to some traditional features of insurance

contracts, distinguishing them from financial instruments.

IFRS 4 definition:

“ 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 affect the policyholder”

INSURANCE RISK VS FINANCIAL RISK

INSURANCE RISK FINANCIAL RISK

Risk, other than financial risk,

transferred from the holder of

a contract to the issuer.

Risk of a potential future change in one

or more of:

Interest rate

Security price

Commodity price

Foreign exchange risk

Index of prices or rates

Credit rating

Credit index

Other variables, such as a non-financial

variable, that is not specific to a party to

the contract

Some insurance contracts expose the issuer to both insurance risk and financial risk. If insurance risk is

significant, such contracts are insurance contracts.

SIGNIFICANT INSURANCE RISK

Insurance risk is significant if, and only if, an insured even could cause

an insurer to

Pay significant additional benefits

In any scenario

Excluding scenarios that lack commercial substance

The condition may be met even if the insured event is extremely unlikely

or even if the expected (i.e. probability weighted) present value of

contingent cash flows is a small portion of expected present value of

contractual cash flows

„Additional benefits‟ are amounts in excess of those that would be

payable if no insured event occurred

SIGNIFICANT INSURANCE RISK (CONT’D)

Significance of insurance risk is to be assessed on a contract by

contract basis

If a relatively homogenous book of small contracts is known to consist

of contracts that all transfer insurance risk, an insurer need not

examine each contract within that book to identify a few non –

derivative contracts that transfer insignificant insurance risk

UNCERTAIN FUTURE EVENTS

Uncertainty (or risk) is the essence of an insurance contract

At least one of the following should be uncertain at the inception of an

insurance contract

Whether an insured event will occur

When it will occur

How much the insurer will need to pay if it occurs

CASE STUDY 1

Saving contract – investor pays in stream of money which insurer

invests in bonds

At the end of the fixed term contract, investor receives amount paid to

insurer plus interest linked to the return on bonds

Contract contains a clause that if the investor dies during the term of

contract, 110% of balance outstanding ( principal + interest accrued)

would be paid out of the investor‟s beneficiary

CASE STUDY 2

Unit – linked savings contract containing guaranteed minimum death or

survival benefits.

Benefit payable either upon the death of policy holder or upon maturity

of the contract, if the guaranteed minimum benefit is higher than the

unit value at the time a claim is made

If the contract is surrendered, then the policy holder receives cash for

the value of the units surrendered (less surrender penalties)

ACCOUNTING OF INSURANCE CONTRACTS

Temporary exemption from the IAS 8 hierarchy

IFRS 4 exempts an insurer from applying IAS 8 hierarchy (Para 10-

12) for developing accounting policies for insurance contracts

The implication of this temporary exemption is that accounting

policies for insurance contracts are generally retained during phase I,

with some exceptions

The objective of this exemption in phase I of the insurance project

was to avoid, for insurers transitioning to IFRSs, changes in

accounting for insurance contracts ahead of Phase II of the project

LIMITATIONS OF IAS 8 EXEMPTION

The IAS 8 exemption does not exempt an insurer from some implications of para 10-12 of IAS 8; specifically an insurer should

Not recognize as a liability any provisions for possible future claims under insurance contracts that are not in existence at the end of the reporting period, such as catastrophe and equalization provisions

Carry out a liability adequacy test

Remove an insurance liability from its statement of financial position only when the obligation specified in the contract is extinguished

An insurer should

Not offset

Reinsurance assets against the related insurance liabilities, or

Reinsurance income and expenses against expenses or income from the related insurance contracts

Consider whether its reinsurance assets are impaired

LIABILITY ADEQUACY TEST

An insurer should assess at the end of each reporting period whether

its recognized insurance liabilities are adequate, using current

estimates of future cash flows under its insurance contracts

IFRS 4 only specifies minimum requirements for conducting the liability

adequacy test

The test considers current estimates of all contractual cash flows, and

of related cash flows such as claims handling cost, as well as cash

flows resulting from embedded options and guarantees

If liability is inadequate, entire deficiency is recognized in profit or loss

LIABILITY ADEQUACY TEST (CONT’D)

If existing accounting policies include an

assessment that meets the specified

minimum requirements, no further action

required

If current policy is not sufficient to comply

with IFRS 4, then the carrying amount of

the liability should be tested against the

requirements of IAS 37 and, if necessary

increased ( DR PL, CR liability)

If

not?

IMPAIRMENT OF REINSURANCE ASSETS

A cedant should consider at each reporting date whether its

reinsurance assets are impaired

A reinsurance asset is impaired if, any only if

There is a objective evidence, as a result of an event that occurred after

initial recognition of the reinsurance asset, that the cedant may not

receive all amounts due to it under the terms of the contract; and

That event has a reliably measurable impact on the amounts that the

cedant will receive from the reinsurer

CHANGE IN ACCOUNTING POLICIES

An insurer may change its accounting policies for insurance contracts

if, and only if, the changes make the financial statements

More relevant for decision making and no less reliable; or

More reliable and no less relevant

An insurer judges relevance and reliability using the criteria in IAS 8

This guidance applies to both changes made by an insurer applying

IFRSs and to changes made by insurers adopting IFRSs for the first time

CHANGE IN ACCOUNTING POLICIES ( CONT’D)

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 market interest rates and recognizes changes in those liabilities

in profit and loss

Shadow accounting

An insurer may apply “shadow accounting” to remeasure insurance

liabilities to reflect recognized but unrealized gains and losses on

related financial assets in the same way as realized gain and losses.

Adjustments to the insurance liabilities are recognized in other

comprehensive income only if the unrealized gains and losses on the

related assets are recognized in other comprehensive income

CHANGE IN ACCOUNTING POLICIES ( CONT’D)

An insurer may continue the following practices, but not introduce

them:

Measuring insurance liabilities on an undiscounted basis

Using non – uniform accounting policies for insurance contracts ( and

related deferred acquisition costs and related intangible assets, if any)

of subsidiaries

Insurer need not change accounting policy to eliminate excessive

prudence but cannot introduce additional prudence if insurance

contracts are already measured with sufficient prudence

CHANGE IN ACCOUNTING POLICIES ( CONT’D)

An insurer is permitted to continue applying and permitted to introduce

following accounting policies

Using shadow accounting

Remeasure designated insurance liabilities to reflect current market

interest rates / other assumptions and recognize changes in those

liabilities in profit and loss

INSURANCE AND INVESTMENT CONTRACTS

Unbundling of deposit component

Some insurance contracts contain both an insurance component and

a deposit component. For such contracts

Unbundling of a deposit component is permitted if

The deposit component can be measured separately; and

Insurer’s accounting policies require it to recognize all rights and

obligations arising from the deposit component, regardless of the

basis used to measure those rights and obligations

Unbundling of a deposit component is required if:

The deposit component can be measured separately; and

Insurer’s accounting policies do not otherwise require it to recognize

all rights and obligations arising from the deposit component

Unbundling of deposit component ( cont‟d)

Unbundling of a deposit component is prohibited if:

An insurer cannot measure the deposit component separately

EMBEDDED DERIVATIVES

A embedded derivative is a component of a hybrid (combined) contract

that includes both the derivative and a host contract

Components of insurance contracts that meet the definition of a

derivative are within the scope of IAS 39 / IFRS 9 and are therefore

subject to the general requirements for embedded derivatives under IAS

39 / IFRS 9:

However, there are two exceptions:

Components that meet the definition of an insurance contract ( e.g.;

components that transfer significant insurance risk); and

Surrender options with fixed terms

EMBEDDED DERIVATIVES (CONT’D)

As insurance contracts are not within the scope of IFRS 9, the

requirements in that standard to separate embedded derivatives are not

applicable to insurance contracts embedded in a host contract. A

component meeting the definition of an insurance contract does not

need to be separated from its host contract

For example, an option to take a life-contingent annuity contract would

not be separated from a host insurance contract

EMBEDDED DERIVATIVES (CONT’D)

Surrender option with fixed terms

A policyholder option to surrender an insurance contract

For a fixed amount

Or for an amount based on a fixed amount and an interest rate

Even if the exercise price differs from the carrying amount of the host

insurance liability

need not be separated from the host insurance contract

DISCRETIONARY PARTICIPATION FEATURES

Definition

A contractual right to receive, as a supplement to guaranteed benefits,

additional benefits

That are likely to be a significant portion of the total contractual

benefits;

Whose amounts or timing is contractually at the discretion of the issuer;

and

That are contractually based on, the performance of a specified pool of

contracts, or investment returns on a specified pool of assets owned by

the issuer, or the profit or loss of the issuer of the contract

IFRS 4 addresses limited aspects of DPFs contained in insurance

contracts or in financial instruments

DISCLOSURES

Disclosures comprise

Explanation of recognized amounts

Nature and extent of risks arising from insurance contracts

Explanation of recognized amounts

Accounting policies for insurance contracts and related assets, liabilities, income and expense

Amounts of recognized assets, liabilities, income and expense arising from insurance contracts, as well as gains/ losses recognized on reinsurance by the cedant

How the most significant assumptions used to measure recognized amounts are determined, and if practicable, quantified disclosure of assumptions

Effect of changes in assumptions used to measure insurance assets and liabilities

DISCLOSURES (CONT’D)

Nature and extent of risks

Risk management objectives, policies and processes, and method used

for managing risk from insurance contracts

Sensitivity of insurance risk

Concentrations of insurance risk

Actual claims compared with previous estimates, i.e. claims

development

Information about credit risk, liquidity risk and market risk that IFRS 7

would require if the insurance contracts were within the scope of IFRS

7, with certain exceptions