of the major concerns of the insurance industry being addressed in the final standard
when it was issued in March 2004. IFRS 4 was first applicable for accounting periods
beginning on or after 1 January 2005 with earlier adoption encouraged. [IFRS 4.41].
1.3
Mitigating the impact on insurers of applying IFRS 9 before
applying IFRS 17
The time it has taken to issue IFRS 17 means that the effective date of this standard is
three years after the effective date of IFRS 9. Consequently, the IASB was asked to
address concerns that additional accounting mismatches and profit or loss volatility
could result if IFRS 9 was applied before the new insurance accounting standard.
Insurance contracts (IFRS 4) 4285
The IASB agreed that these concerns should be addressed and, in September 2016,
issued Applying IFRS 9 Financial Instruments with IFRS 4 Insurance Contracts that
amends IFRS 4 in order to address these concerns. An entity applies these amendments
for annual periods beginning on or after 1 January 2018. These amendments are
discussed at 10 below.
As a result of these amendments, many insurers will continue to apply IAS 39 until 2021.
Therefore, this chapter refers to both IAS 39 and IFRS 9 and all extracts also illustrate
application of IAS 39 not IFRS 9.
1.4
Existing accounting practices for insurance contracts
Existing local accounting practices for insurance contracts are diverse. Typically such
practices, including the definition of what constitutes an insurance contract, are driven by
regulatory requirements. There may also be separate GAAP and regulatory rules for insurers.
Many jurisdictions have also evolved different accounting rules for non-life
(property/casualty) or short-term insurance and life or long-term insurance. However,
the boundaries between what is considered non-life and life insurance can vary
between jurisdictions and even within jurisdictions.
1.4.1 Non-life
insurance
Non-life or short-term insurance transactions under local GAAP are typically accounted
for on a deferral and matching basis. This means that premiums are normally recognised
as revenue over the contract period, usually on a time apportionment basis. Claims are
usually recognised on an incurred basis with no provision for claims that have not
occurred at the reporting date. Within this basic model differences exist across local
GAAPs on various points of detail which include:
• whether or not claims liabilities are discounted;
• the basis for measuring claims liabilities (e.g. best estimate or a required confidence
level);
• whether and what acquisition costs are deferred;
• whether a liability adequacy test (see 7.2.2 below) is performed on the unearned
revenue or premium balance and the methodology and level of aggregation applied
in such a test; and
• whether reinsurance follows the same model as direct insurance and whether
immediate gains on retroactive reinsurance contracts are permitted or not
(see 7.2.6 below).
1.4.2 Life
insurance
Most local GAAP life insurance accounting models recognise premiums when
receivable and insurance contract liabilities are typically measured under some form of
discounted cash flow approach that calculates the cash flows expected over the lifetime
of the contract. In many jurisdictions the key inputs to the calculation (e.g. discount
rates, mortality rates) are set by regulators. Key assumptions may be current or ‘locked-
in’ at the contract inception. Differences across jurisdictions also include:
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• whether or not certain investment-type products are subject to ‘deposit
accounting’ (i.e. only fees are recognised as revenue rather than all cash inflows
from policyholders);
• if, and how (contracts with) discretionary participation features are accounted for
(discussed at 6 below);
• whether and what acquisition costs are deferred;
• how to account for options and guarantees embedded within contracts; and
• the use of contingency reserves or provisions for adverse deviation.
1.4.3 Embedded
value
The embedded value (EV) of a life insurance business is an estimate of its economic
worth excluding any value which may be attributed to future new business. The EV is
the sum of the value placed on the entity’s equity and the value of the in-force business.
Typically, an embedded value calculation would involve discounting the value of the
stream of after tax profits. For insurance liabilities the income stream would normally
be calculated by using the income stream from the backing invested assets as a proxy.
EV is used as an alternative (non-GAAP) performance measure by some life insurers to
illustrate the performance and value of their business because local accounting is rarely
seen as providing this information. This is because local accounting is often driven by
what management consider are ‘unrealistic’ regulatory rules and assumptions.
[IFRS 4.BC140].
There is no standardised global measure of embedded value and embedded value
practices are diverse. For example, in Europe, the European Insurance CFO Forum, an
organisation comprising the Chief Financial Officers of Europe’s leading life and
property and casualty insurers, has published both European Embedded Values (EEV)
and Market Consistent Embedded Value Principles (MCEV). Either of these embedded
value models can be applied by Forum members.2
The potential use of embedded value under IFRS 4 is discussed at 8.2.4 below.
2
THE OBJECTIVES AND SCOPE OF IFRS 4
2.1
The objectives of IFRS 4
The stated objectives of IFRS 4 are:
(a) to make limited improvements to accounting by insurers for insurance contracts; and
(b) to require disclosures that identify and explain the amounts in an insurer’s financial
statements arising from insurance contracts and help users of those financial
statements understand the amount, timing and uncertainty of future cash flows
from insurance contracts. [IFRS 4.1].
It is not IFRS 4’s stated objective to determine, in a comprehensive way, how insurance
contracts are recognised, measured and presented. This is addressed by IFRS 17.
Instead, issuers of insurance contracts are permitted, with certain limitations, to
continue to apply their existing, normally local, GAAP. This is discussed further at 7
and 8 below.
Insurance contracts (IFRS 4) 4287
2.2
The scope of IFRS 4
2.2.1 Definitions
The following definitions are relevant to the application of IFRS 4. [IFRS 4 Appendix A].
An insurer is the party that has an obligation under an insurance contract to compensate
a policyholder if an insured event occurs.
An insurance contract is 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.
A reinsurer is the party that has an obligation under
a reinsurance contract to
compensate a cedant if an insured event occurs.
A reinsurance contract is an insurance contract issued by one insurer (the reinsurer) to
compensate another insurer (the cedant) for losses on one or more contracts issued by
the cedant.
An insured event is an uncertain future event that is covered by an insurance contract
and creates insurance risk.
An insurance asset is an insurer’s net contractual rights under an insurance contract.
A reinsurance asset is a cedant’s net contractual rights under a reinsurance contract.
An insurance liability is an insurer’s net contractual obligations under an insurance contract.
A cedant is the policyholder under a reinsurance contract.
A policyholder is a party that has a right to compensation under an insurance contract
if an insured event occurs.
Fair value is 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. This
definition of fair value is the same as in IFRS 13 – Fair Value Measurement.
Guaranteed benefits are payments or other benefits to which a particular policyholder
or investor has an unconditional right that is not subject to the contractual discretion of
the issuer.
A discretionary participation feature (DPF) is a contractual right to receive, as a
supplement to guaranteed benefits, additional benefits:
(a) that are likely to be a significant portion of the total contractual benefits;
(b) whose amount or timing is contractually at the discretion of the issuer; and
(c) 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
(iii) the profit or loss of the company, fund or other entity that issues the contract.
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A financial guarantee contract is 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.
2.2.2
Transactions within the scope of IFRS 4
Unless specifically excluded from its scope (see 2.2.3 below) IFRS 4 must be applied to:
(a) insurance contracts (including reinsurance contracts) issued by an entity and
reinsurance contracts that it holds; and
(b) financial instruments that an entity issues with a discretionary participation feature
(see 6.2 below). [IFRS 4.2].
It can be seen from this that IFRS 4 applies to insurance contracts and not just to entities
that specialise in issuing insurance contracts. Consistent with other IFRSs it is a
transaction-based standard. Consequently, non-insurance entities will be within its
scope if they issue contracts that meet the definition of an insurance contract.
IFRS 4 describes any entity that issues an insurance contract as an insurer whether or
not the entity is regarded as an insurer for legal or supervisory purposes. [IFRS 4.5].
Often an insurance contract will meet the definition of a financial instrument but IAS 39
and IFRS 9 contain a scope exemption for both insurance contracts and for contracts
that would otherwise be within its scope but are within the scope of IFRS 4 because
they contain a discretionary participation feature (see 6 below). [IAS 39.2(e), IFRS 9.2.1(e)].
Although the recognition and measurement of financial instruments (or investment
contracts) with a discretionary participation feature is governed by IFRS 4, for
disclosure purposes they are within the scope of IFRS 7. [IFRS 4.2(b)].
Contracts that fail to meet the definition of an insurance contract are within the scope
of IAS 39 or IFRS 9 if they meet the definition of a financial instrument (unless they
contain a DPF). This will be the case even if such contracts are regulated as insurance
contracts under local legislation. These contracts are commonly referred to as
‘investment contracts’.
Consequently, under IFRS, many insurers have different measurement and disclosure
requirements applying to contracts that, under local GAAP or local regulatory rules,
might, or might not, have been subject to the same measurement or disclosure
requirements. The following table illustrates the standards applying to such contracts.
Type of contract
Recognition and Measurement
Disclosure
Insurance contract issued (both with
IFRS 4
IFRS 4
and without a DPF)
Reinsurance contract held and issued
IFRS 4
IFRS 4
Investment contract with a DPF
IFRS 4
IFRS 7/IFRS 13
Investment contract without a DPF
IAS 39/IFRS 9
IFRS 7/IFRS 13
Insurance contracts (IFRS 4) 4289
Many local GAAPs and local regulatory regimes prescribe different accounting requirements
for life (long term) and non-life (short-term) insurance contracts (see 1.3 above). However,
IFRS 4 does not distinguish between different types of insurance contracts.
IFRS 4 confirms that a reinsurance contract is a type of insurance contract and that all
references to insurance contracts apply equally to reinsurance contracts. [IFRS 4.6].
Because all rights and obligations arising from insurance contracts and investment
contracts with a DPF are also scoped out of IAS 39 and IFRS 9, IFRS 4 applies to all the
assets and liabilities arising from insurance contracts. [IAS 39.2(e), IFRS 9.2.1(e)]. These include:
• insurance and reinsurance receivables owed by the policyholder direct to the
insurer;
• insurance receivables owed by an intermediary to an insurer on behalf of the
policyholder where the intermediary is acting in a fiduciary capacity;
• insurance claims agreed with the policyholder and payable;
• insurance contract policy liabilities;
• claims handling cost provisions;
• the present value of acquired in-force business (discussed at 9.1 below);
• deferred or unearned premium reserves;
• reinsurance assets (i.e. expected reinsurance recoveries in respect of claims incurred);
• deferred acquisition costs; and
• discretionary participation features (DPF).
However, payables and receivables arising out of investment contracts fall within the
scope of IAS 39 or IFRS 9 and the capitalisation and deferral of costs arising from such
contracts currently fall within the scope of IFRS 15, IAS 38 and IAS 39 or IFRS 9.
Receivables due from intermediaries to insurers that have a financing character and
balances due from intermediaries not acting in a fiduciary capacity, for example loans
to intermediaries repayable from commissions earned, would also seem to be outside
the scope of IFRS 4 as they do not arise from insurance contracts.
2.2.3
Transactions not within the scope of IFRS 4
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 (which are
within the scope
of IAS 32, IAS 39, IFRS 7 and IFRS 9), except: [IFRS 4.3]
• insurers that meet specified criteria are permitted to apply a temporary exemption
from IFRS 9 for annual periods beginning on or after 1 January 2018 (see 10.1 below);
• insurers are permitted to apply what the IASB describes as the ‘overlay approach’
to designated financial assets for annual periods beginning on or after
1 January 2018 (see 10.2 below); and
• insurers are permitted to reclassify in specified circumstances some or all of their
financial assets so that the assets are measured at fair value through profit or loss
(see 8.4 below).
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IFRS 4 also describes transactions to which IFRS 4 is not applied. These primarily relate
to transactions covered by other standards that could potentially meet the definition of
an insurance contract. It was not the intention of the IASB in issuing IFRS 4 to reopen
issues addressed by other standards unless the specific features of insurance contracts
justified a different treatment. [IFRS 4.BC10(c)]. These transactions are discussed below.
2.2.3.A Product
warranties
Product warranties issued directly by a manufacturer, dealer or retailer are outside the
scope of IFRS 4. These are accounted for under IFRS 15 and IAS 37. [IFRS 4.4(a)].
Without this exception many product warranties would have been covered by IFRS 4
as they would normally meet the definition of an insurance contract. The IASB has
excluded them from the scope of IFRS 4 because they are closely related to the
underlying sale of goods and because IAS 37 addresses product warranties while IFRS 15
deals with the revenue received for such warranties. [IFRS 4.BC71].
However, a product warranty is within the scope of IFRS 4 if an entity issues it on behalf
of another party i.e. the contract is issued indirectly. [IFRS 4.BC69].
Other types of warranty are not specifically excluded from the scope of IFRS 4. For
example, a warranty given by a vendor to the purchaser of a business, such as in respect
of contingent liabilities related to unagreed tax computations of the acquired entity, is
an example of a transaction that may also fall within the scope of this standard.
However, since IFRS 4 does not prescribe a specific accounting treatment, issuers of
such warranties are likely to be able to apply their existing accounting policies.
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