transferred by that benefit is significant, the contract is an insurance contract. [IFRS 4.IG2 E1.26].
3.9.2
Examples of transactions that are not insurance contracts
The following are examples of transactions that are not insurance contracts:
(a) investment
contracts that have the legal form of an insurance contract but do not
expose the insurer to significant insurance risk, for example life insurance
contracts in which the insurer bears no significant mortality risk;
(b) contracts that have the legal form of insurance, but pass all significant risk back to
the policyholder through non-cancellable and enforceable mechanisms that adjust
future payments by the policyholder as a direct result of insured losses, for
example some financial reinsurance contracts or some group contracts;
(c) self insurance, in other words retaining a risk that could have been covered by
insurance. There is no insurance contract because there is no agreement with
another party (see 3.2.2.A above);
(d) contracts (such as gambling contracts) that require a payment if an unspecified
uncertain future event occurs, but do not require, as a contractual precondition for
payment, that the event adversely affects the policyholder. However, this does not
preclude the specification of a predetermined payout to quantify the loss caused
by a specified event such as a death or an accident (see 3.7 above);
(e) 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 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
4306 Chapter 51
variable, provide in the case of a non-financial variable that the variable is not
specific to a party to the contract;
(f) a credit-related guarantee (or letter of credit, credit derivative default contract or
credit insurance contract) that requires payments even if the holder has not
incurred a loss on the failure of a debtor to make payments when due;
(g) contracts that require a payment based on a climatic, geological or other physical
variable that is not specific to a party to the contract. These are commonly
described as weather derivatives and are accounted for under IAS 39 or IFRS 9
(see Chapter 41 at 3.3.1); and
(h) 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. [IFRS 4.B19].
The following examples illustrate further situations where IFRS 4 is not applicable.
Example 51.13: Investment contract linked to asset pool
Entity A issues an investment contract in which payments are contractually linked (with no discretion) to
returns on a pool of assets held by the issuer.
This contract is within the scope of IAS 39 or IFRS 9 because the payments are based on asset returns and
there is no significant insurance risk. [IFRS 4.IG2 E1.10].
Example 51.14: Credit-related guarantee
Entity A issues a credit-related guarantee that does not, as a precondition for payment, require that the holder
is exposed to, and has incurred a loss on, the failure of the debtor to make payments on the guaranteed asset
when due.
This is a derivative within the scope of IAS 39 or IFRS 9 because there is no insurable interest.
[IFRS 4.IG2 E1.12].
Example 51.15: Guarantee fund established by law
Guarantee funds established by law exist in many jurisdictions. Typically they require insurers to contribute
funds into a pool in order to pay policyholder claims in the event of insurer insolvencies. They may be funded
by periodic (usually annual) levies or by levies only when an insolvency arises. The basis of the funding
requirement varies although typically most are based on an insurer’s premium income.
The commitment of participants to contribute to the fund is not established by contract so there is no insurance
contract. Obligations to guarantee funds are within the scope of IAS 37. [IFRS 4.IG2 E1.14].
Example 51.16: Right to recover future premiums
Entity A issues an insurance contract which gives it an enforceable and non-cancellable contractual right to
recover all claims paid out of future premiums, with appropriate compensation for the time value of money.
Insurance risk is insignificant because all claims can be recovered from future premiums and consequently
the insurer cannot suffer a significant loss. Therefore the contract is a financial instrument within the scope
of IAS 39 or IFRS 9. [IFRS 4.IG2 E1.18].
Insurance contracts (IFRS 4) 4307
Example 51.17: Catastrophe bond linked to index
Entity A issues a catastrophe bond in which principal, interest payments or both are reduced if a specified
triggering event occurs and that triggering event does not include a condition that the issuer of the bond
suffered a loss.
This is a financial instrument with an embedded derivative. Both the holder and the issuer should measure
the embedded derivative at fair value through profit or loss under IAS 39 or IFRS 9. [IFRS 4.IG2 E1.19].
Example 51.18: Insurance policy issued to defined benefit pension plan
Entity A issues an insurance contract to either (a) a defined benefit pension plan, covering the employees of
A, and/or (b) the employees of another entity consolidated within the same group financial statements as A.
This contract will generally be eliminated on consolidation from the group financial statements which will include:
(a)
the full amount of the pension obligation under IAS 19 with no deduction for the plan’s right under
the contract;
(b)
no liability to policyholders under the contract; and
(c)
the assets backing the contract. [IFRS 4.IG2 E1.21].
In January 2008, the Interpretations Committee considered a request for guidance on the
accounting for investment or insurance policies that are issued by an entity to a pension
plan covering its own employees (or the employees of an entity that is consolidated into
the same group as the entity issuing the policy). The Interpretations Committee noted the
definitions of plan assets, assets held by a long-term employee benefit plan and a
qualifying insurance policy as defined by IAS 19 and considered that, if a policy was issued
by a group company to the employee benefit fund then the treatment would depend on
whether the policy was a ‘non-transferable financial instrument issued by the reporting
entity’. Since the policy was issued by a related party, the Interpretations Committee
concluded that it could not meet the definition of a qualifying insurance policy as defined
by IAS 19. Because of the narrow scope of this issue the Interpretations Committee
declined to either issue an Interpretation or to add the issue to its agenda.3
Example 51.19: Market value adjustment without death or maturity benefits
A contract permits the issuer to deduct an MVA from surrender payments to reflect current market prices for
the underlying assets. The contract does not permit a MVA for death and maturity benefits. The amount
payable on death or maturity is the amount originally
invested plus interest.
The policyholder obtains an additional benefit because no MVA is applied on death or maturity. However,
that benefit does not transfer insurance risk from the policyholder because it is certain that the policyholder
will live or die and the amount payable on death or maturity is adjusted for the time value of money.
Therefore, the contract is an investment contract because there is no significant insurance risk. This contract
combines the two features discussed in Examples 51.11 and 51.12 at 3.9.1 above. When considered
separately, these two features transfer insurance risk. However, when combined, they do not transfer
insurance risk. Therefore, it is not appropriate to separate this contract into two insurance components.
If the amount payable on death were not adjusted in full for the time value of money, or were adjusted in
some other way, the contract might transfer insurance risk. [IFRS 4.IG2 E1.27].
4308 Chapter 51
4 EMBEDDED
DERIVATIVES
Insurance contracts may contain policyholder options or other clauses that meet the
definition of an embedded derivative under IAS 39 or IFRS 9. A derivative is a financial
instrument within the scope of IAS 39 or IFRS 9 with all three of the following characteristics:
• its value changes in response to a 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 the underlying of the contract;
• it requires no initial net investment or an initial net investment that would be
smaller than would be required for other types of contracts that would be expected
to have a similar response to changes in market factors; and
• it is settled at a future date. [IAS 39.9, IFRS 9 Appendix A].
An embedded derivative is a component of a hybrid (combined) instrument that also
includes a non-derivative host contract. An embedded derivative causes some or all of
the cash flows that would otherwise be required by the contract to be modified
according to 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 that in the case of a non-financial variable that the variable is not
specific to a party to the contract. [IAS 39.10, IFRS 9.4.3.1].
The following are examples of embedded derivatives that may be found in
insurance contracts:
• benefits, such as death benefits, linked to equity prices or an equity index;
• options to take life-contingent annuities at guaranteed rates;
• guarantees of minimum interest rates in determining surrender or maturity values;
• guarantees of minimum annuity payments where the annuity payments are linked
to investment returns or asset prices;
• a put option for the policyholder to surrender a contract. These can be specified
in a schedule, based on the fair value of a pool of interest-bearing securities or
based on an equity or commodity price index;
• an option to receive a persistency bonus (an enhancement to policyholder benefits
for policies that remain in-force for a certain period);
• an industry loss warranty where the loss trigger is an industry loss as opposed to
an entity specific loss;
• a catastrophe trigger where a trigger is defined as a financial variable such as a drop
in a designated stock market;
• an inflation index affecting policy deductibles;
• contracts where the currency of claims settlement differs from the currency of loss; and
• contracts with fixed foreign currency rates.
Insurance contracts (IFRS 4) 4309
IAS 39 requires that an embedded derivative is separated from its host contract and
measured at fair value with changes in fair value included in profit or loss if:
• its economic characteristics and risks are not closely related to the economic
characteristics and risks of the host contract;
• it meets the definition of a derivative; and
• the combined instrument is not measured at fair value through profit or loss.
[IAS 39.11].
IFRS 9 has identical requirements, although they do not apply to contracts that are
financial assets. [IFRS 9.4.3.3].
The IASB considered and rejected arguments that insurers should be exempt from the
requirement to separate embedded derivatives contained in a host insurance contract
under IAS 39 or IFRS 9 because, in the IASB’s opinion, fair value is the only relevant
measure for derivatives. [IFRS 4.BC190].
However, the IASB decided to exclude derivatives embedded in an insurance contract
from the IAS 39 or IFRS 9 measurement requirements if the embedded derivative is
itself an insurance contract. [IFRS 4.7].
The IASB determined that it would be contradictory to require the measurement at fair
value of an embedded derivative that met the definition of an insurance contract when
such accounting is not required for a stand-alone insurance contract. Similarly, the IASB
concluded that an embedded derivative is closely related to the host insurance contract
if the embedded derivative and the host insurance contract are so interdependent that
an entity cannot measure the embedded derivative separately. Without this conclusion
IAS 39 or IFRS 9 would have required an insurer to measure the entire insurance
contract at fair value. [IFRS 4.BC193].
This means that derivatives embedded within insurance contracts do not have to be
separated and accounted for under IAS 39 or IFRS 9 if the policyholder benefits from
the embedded derivative only when the insured event occurs.
IFRS 4 also states that an insurer need not (but may) 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 and an interest rate) even if the exercise price differs
from the carrying amount of the host insurance liability. This appears to overrule the
requirement in IAS 39 or IFRS 9 that a call, put or prepayment option embedded in a
host insurance contract must be separated from the host insurance contract unless the
option’s exercise price is approximately equal on each exercise date to the carrying
amount of the host insurance contract. [IAS 39.AG30(g), IFRS 9.B4.3.5(e)]. Because surrender
values of insurance contracts often do not equal their amortised cost, without this
concession in IFRS 4 fair value measurement of the surrender option would be required.
[IFRS 4.8]. This relief also applies to investment contracts with a discretionary
participation feature. [IFRS 4.9].
4310 Chapter 51
The diagram below illustrates an embedded derivative decision tree.
Separation Criteria:
1. Is the embedded feature a derivative?
2. Is the embedded feature “not closely related” to host?
3. Is the host instrument not already at fair value?
Yes (to all three)
Is it Insurance?
No
or
Fixed/cash surrender
No
Yes
Separate the
Separation not
&
nbsp; embedded feature and
required
fair value
The example below illustrates an embedded derivative in an insurance contract that is
not required to be separated and accounted for under IAS 39 or IFRS 9.
Example 51.20: Death or annuitisation benefit linked to equity prices or index
A contract has a death benefit linked to equity prices or an equity index and is payable only on death or when
annuity payments begin and not on surrender or maturity.
The equity-index feature meets the definition of an insurance contract (unless the life-contingent payments
are insignificant) because the policyholder benefits from it only when the insured event occurs. The embedded
derivative is not required to be separated for accounting purposes. [IFRS 4.IG4 E2.1].
The following two examples illustrate the application of the concession that IFRS 4
gives from the requirements in IAS 39 or IFRS 9 to separate and measure at fair value
surrender options for which the exercise price is not amortised cost as discussed above.
Example 51.21: Life contingent annuity option
An insurance contract gives the policyholder the option to take a life-contingent annuity at a guaranteed rate
i.e. a combined guarantee of interest rates and mortality changes.
The embedded option is an insurance contract (unless the life-contingent payments are insignificant) because
the option is derived from mortality changes. Fair value measurement is not required but not prohibited even
though the guaranteed rate may differ from the carrying amount of the insurance liability. [IFRS 4.IG4 E2.3].
Example 51.22: Policyholder option to surrender contract for cash surrender value
An insurance contract gives the policyholder the option to surrender the contract for a cash surrender value
specified in a schedule i.e. not indexed and does not accumulate interest.
Fair value measurement is not required (but not prohibited) because the surrender option is for a fixed amount
even though that fixed amount may differ from the carrying amount of the insurance liability. The surrender
value may be viewed as a deposit component, but IFRS 4 does not require an insurer to unbundle a contract
if it recognises all its obligations arising under the deposit component (see 5 below).
If this was an investment contract measured at amortised cost then fair value measurement of the option would
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 853
