premium should not be included in profit or loss. However, it concluded that requiring
each incoming premium on a contract with a DPF to be split between liability and equity
would requires systems changes beyond the scope of Phase I. Therefore, it decided that
an issuer could recognise the entire premium as revenue without separating the portion
that relates to the equity component. [IFRS 4.BC164]. This conclusion is inconsistent with
those discussed at 4 and 5 above where IFRS 4 requires the separation of embedded
derivatives and deposit elements of contracts in certain circumstances regardless of the
‘systems changes’ that may be required as a result.
Subsequent changes in the measurement of the guaranteed element and in the portion
of the DPF classified as a liability must be recognised in profit or loss. If part or all of the
DPF is classified in equity, that portion of profit or loss may be attributable to that
feature (in the same way that a portion may be attributable to a non-controlling interest).
The insurer must recognise the portion of profit or loss attributable to any equity
component of a DPF as an allocation of profit or loss, not as expense or income.
[IFRS 4.34(c)].
Insurance contracts (IFRS 4) 4321
IFRS 4 also requires an insurer to:
(a) apply IAS 39 or IFRS 9 to a derivative embedded within an insurance contract
containing a DPF if it is within the scope of IAS 39 or IFRS 9 (see 4 above); and
(b) continue its existing accounting policies for such contracts, unless it changes those
accounting policies in a way that complies with IFRS 4 (subject to the constraints
noted above and those discussed at 8 below). [IFRS 4.34(d)-(e)].
AMP provide the following detail as to how DPF contracts have been allocated in their
income statement and statement of financial position.
Extract 51.2: AMP Limited (2016)
Notes to the financial statements
for the year ended 31 December 2016 [extract]
Section 4: Life insurance and investment contracts
4.1
Accounting for life insurance contracts and investment contracts [extract]
Allocation of operating profit and unvested policyholder benefits
The operating profit arising from discretionary participating contracts is allocated between shareholders and
participating policyholders by applying the MoS principles in accordance with the Life Insurance Act 1995 (Cth)
(Life Act) and the Participating Business Management Framework applying to NMLA.
Once profit is allocated to participating policyholders it can only be distributed to these policyholders.
Profit allocated to participating policyholders is recognised in the Income statement as an increase in policy liabilities.
The policy liabilities include profit that has not yet been allocated to specific policyholders (i.e. unvested) and that
which has been allocated to specific policyholders by way of bonus distributions (i.e. vested).
Bonus distributions to participating policyholders do not alter the amount of profit attributable to shareholders. These
are merely changes to the nature of the liability from unvested to vested.
The principles of allocation of the profit arising from discretionary participating business are as follows:
(i) investment income (net of tax and investment expenses) on retained earnings in respect of discretionary participating business is allocated between policyholders and shareholders in proportion to the balances of policyholders’ and
shareholders’ retained earnings. This proportion is, mostly, 80% to policyholders and 20% to shareholders;
(ii) other MoS profits arising from discretionary participating business are allocated 80% to policyholders and 20%
to shareholders, with the following exceptions:
– the profit arising from New Zealand corporate superannuation business is apportioned such that shareholders are
allocated 15% of the profit allocated to policyholders;
– the profit arising in respect of preservation superannuation account business is allocated 92.5% to policyholders
and 7.5% to shareholders;
– the profits arising from NMLA’s discretionary participating investment account business where 100% of
investment profit is allocated to policyholders and 100% of any other profit or loss is allocated to shareholders,
with the over-riding provision being that at least 80% of any profit and not more than 80% of any loss be allocated
to policyholders’ retained profits of the relevant statutory fund;
– the underwriting profit arising in respect of NMLA’s participating super risk business is allocated 90% to
policyholders and 10% to shareholders.
6.2
Discretionary participation features in financial instruments
As discussed at 2.2.2 above, a financial instrument containing a DPF is also within the
scope of IFRS 4, not IAS 39 or IFRS 9, and issuers of these contracts are permitted to
4322 Chapter 51
continue applying their existing accounting policies to them rather than apply the rules
in IAS 39 or IFRS 9.
The requirements discussed at 6.1 above apply equally to financial instruments that
contain a DPF. However, in addition:
(a) if the issuer classifies the entire DPF as a liability, it must apply the liability adequacy
test discussed at 7.2.2 below to the whole contract, i.e. to both the guaranteed
element and the DPF. The issuer need not determine separately the amount that
would result from applying IAS 39 or IFRS 9 to the guaranteed element;
(b) if the issuer classifies part or all of the DPF of that instrument as a separate
component of equity, the liability recognised for the whole contract should not be
less than the amount that would result from applying IAS 39 or IFRS 9 to the
guaranteed element. That amount should include the intrinsic value of an option
to surrender the contract, but need not include its time value if IFRS 4 exempts
that option from fair value measurement (see 4 above). The issuer need not
disclose the amount that would result from applying IAS 39 or IFRS 9 to the
guaranteed element, nor need it present the guaranteed amount separately.
Furthermore, it need not determine the guaranteed amount if the total liability
recognised for whole contract is clearly higher; and
(c) the issuer may continue to recognise all premiums (including the premiums from
the guaranteed element) as revenue and recognise as an expense the resulting
increase in the carrying amount of the liability even though these contracts are
financial instruments.
The IASB has admitted that, conceptually, the premium for the guaranteed element of
these investment contracts is not revenue but believes that the treatment of the
discretionary element could depend on matters that will not be resolved until Phase II.
It has also decided to avoid requiring entities to make systems changes in order to split
the premium between the guaranteed and discretionary elements which might later
become redundant. Therefore, entities can continue to present premiums or deposits
received from investment contracts with a DPF as revenue, with an expense
representing the corresponding change in the liability. [IFRS 4.BC163].
AXA’s accounting policy for revenue recognition gives an example of an accounting
policy that includes premiums from investment contracts with a DPF as revenue.
Extr
act 51.3: AXA SA (2016)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS [extract]
1.19. REVENUE
RECOGNITION
[extract]
1.19.1. Gross written premiums
Gross written premiums correspond to the amount of premiums written by insurance and reinsurance companies on
business incepted in the year with respect to both insurance contracts and investment contracts with discretionary
participating features, net of cancellations and gross of reinsurance ceded. For reinsurance, premiums are recorded
on the basis of declarations made by the ceding company, and may include estimates of gross written premiums.
The disclosure requirements of IFRS 7 and IFRS 13 apply to financial instruments
containing a DPF even though they are accounted for under IFRS 4. [IFRS 4.2(b)].
Insurance contracts (IFRS 4) 4323
However, disclosure of the fair value of a contract containing a DPF (as described in
IFRS 4) is not required if the fair value of that DPF cannot be measured reliably.
[IFRS 7.29(c)]. Further, IFRS 4 allows the disclosed amount of interest expense for such
contracts to be calculated on a basis other than the effective interest method.
[IFRS 4.35(d)]. All of the other disclosure requirements of IFRS 7 and IFRS 13 apply to
investment contracts with a DPF without modification, for example the contractual
maturity analysis showing undiscounted cash flows and the fair value hierarchy
categorisation if the contracts are measured at fair value.
6.3 Practical
issues
6.3.1
Unallocated DPF liabilities which are negative
Cumulative unallocated realised and unrealised returns on investments backing
insurance and investment contracts with a DPF may become negative and result in an
unallocated amount that is negative (a cumulative unallocated loss).
Negative DPF is not addressed in IFRS 4 and does not appear to have been
contemplated by the IASB at the time the standard was issued.
Assuming an insurer normally classifies contracts with a DPF as a liability, where such
amounts become negative we believe that the insurer is prohibited from recognising an
asset or debiting the contract liability related to the cumulative unallocated losses
(realised or unrealised) on the investments backing contracts that include DPF features
except to the extent that:
• the insurer is contractually entitled to pass those losses to the contract holders; or
• the insurer’s previous local GAAP accounting for insurance or investment
contracts with a DPF permitted the recognition of such an asset or the debiting of
the contract liability when the unallocated investment results of the investments
backing a DPF contract were negative.
An insurer is permitted to continue existing GAAP accounting for insurance contracts and
investment contracts with a DPF as discussed at 7 below. If an existing GAAP accounting
policy specifically allows the recognition of an asset or the reduction of contract liabilities
related to cumulative unallocated DPF losses then in our view continuation of that policy
is permitted because IFRS 4 specifically excludes accounting policies for insurance
contracts from paragraphs 10-12 of IAS 8. If the existing GAAP accounting policy does not
permit the recognition of an asset or the reduction of contract liabilities in such
circumstances then the introduction of such a policy would need to satisfy the relevance
and reliability criteria discussed at 8.1 below to be permissible.
Examples of situations in which an insurer is contractually entitled to (partially) recover losses
can include contracts with a fixed surrender charge or a market value adjustment feature.
6.3.2
Contracts with switching features
Some contracts may contain options for the counterparty to switch between terms that
would, prima facie, result in classification as an investment contract without DPF
features (accounted for under IAS 39 or IFRS 9) and terms that would result in a
classification as an investment contract with DPF features (accounted for under IFRS 4).
4324 Chapter 51
We believe that the fact that this switch option makes these contracts investment
contracts with a DPF means that the issuer should continuously be able to demonstrate
that the DPF feature still exists and also be able to demonstrate actual switching to a DPF
in order to classify these contracts as investment contracts with a DPF under IFRS 4.
7
SELECTION OF ACCOUNTING POLICIES
IFRS 4 provides very little guidance on accounting policies that should be used by an
entity that issues insurance contracts or investment contracts with a DPF (hereafter for
convenience, at 7 and 8 below, referred to as ‘insurance contracts’).
Instead of providing detailed guidance, the standard:
(a) creates an exemption from applying the hierarchy in IAS 8 (the ‘hierarchy
exemption’) that specifies the criteria an entity should use in developing an
accounting policy if no IFRS applies specifically to an item (see 7.1 below);
(b) limits the impact of the hierarchy exemption by imposing five specific
requirements relating to catastrophe provisions, liability adequacy, derecognition,
offsetting and impairment of reinsurance assets (see 7.2 below); and
(c) permits some existing practices to continue but prohibits their introduction
(see 8.2.1 below).
The importance of the hierarchy exemption is that without it certain existing accounting
practices would be unlikely to be acceptable under IFRS as they would conflict with the
Framework or other standards such as IAS 37, IAS 39 or IFRS 9 or IFRS 15. For example,
the deferral of acquisition costs that are not incremental or directly attributable to the
issue of an insurance contract are unlikely to meet the Framework’s definition of an asset.
Similarly, a basis of liability measurement, such as the gross premium valuation, which
includes explicit estimates of future periods’ cash inflows in respect of policies which are
cancellable at the policyholder’s discretion would be unlikely to be acceptable.
The IASB considered that, without the hierarchy exemption, establishing acceptable
accounting policies for insurance contracts could have been costly and that some
insurers might have made major changes to their policies on adoption of IFRS followed
by further significant changes in what became IFRS 17. [IFRS 4.BC77].
The practical result of the hierarchy exemption is that an insurer is permitted to
continue applying the accounting policies that it was using when it first applied IFRS 4,
subject to the exceptions noted at 7.2 below. [IFRS 4.BC83].
Usually, but not exclusively, these existing accounting policies will be the insurer’s
previous GAAP, but IFRS 4 does not specifically require an insurer to follow its local
accounting pronouncements. This is mainly because of the problems in defining local
GAAP. Additionally, some insurers, such as non-US insurers with a US listing, apply
US GAAP to their insurance contracts rather than the GAAP of their own country which
would have given rise to further definitional problems. [IFRS 4.BC81]. The IASB also
wanted to give insurers the opportunity to improve their accounting policies even if
there was no change to their lo
cal GAAP. [IFRS 4.BC82].
Insurance contracts (IFRS 4) 4325
The practical result of this is a continuation of the diversity in accounting practices
whose elimination was one of the primary objectives of the IASC’s project on insurance
contracts originally initiated in 1997.
To illustrate this point, below are extracts from the financial statements of Prudential
and Münchener Rück (Munich Re), both of which apply IFRS. Prudential is a UK
insurance group which applies previously extant UK GAAP to its UK insurance
contracts whereas Munich Re is a German insurance group that applies US GAAP (as at
1 January 2005) to its insurance contracts.
Extract 51.4: Prudential plc (2016)
Notes to Primary statements [extract]
Section A: Background and critical accounting policies [extract]
A3.1 Critical accounting policies, estimates and judgements [extract]
Measurement of policyholder liabilities and unallocated surplus of with-profits [extract]
IFRS 4 permits the continued usage of previously applied Generally Accepted Accounting Practices (GAAP) for
insurance contracts and investment contracts with discretionary participating features.
A modified statutory basis of reporting was adopted by the Group on first-time adoption of IFRS in 2005. This was
set out in the Statement of Recommended Practice issued by the Association of British Insurers (ABI SORP). An
exception was for UK regulated with-profits funds which were measured under FRS 27 as discussed below.
FRS 27 and the ABI SORP were withdrawn in the UK for the accounting periods beginning in or after 2015. As used
in these consolidated financial statements, the terns ‘FRS 27’ and the ‘ABI SORP’ refer to the requirements of these
pronouncements prior to their withdrawal.
Extract 51.5: Allianz SE (2016)
Notes to the consolidated financial statements [extract]
GENERAL INFORMATION [extract]
1 – Nature of operations and basis of presentation [extract]
In accordance with the provisions of IFRS 4 insurance contracts are recognized and measured on the basis of
accounting principles generally accepted in the United States of America (US GAAP) as at first-time adoption of
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 856
