International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards
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features (accounted for under IFRS 17). As these options are included in the terms of the
contract, their exercise is not a contract modification as discussed at 12.1 below.
IFRS 17 states that once a contract is within its scope then it is not subsequently
reassessed even if, at a later date, it is no longer a contract within its scope. Therefore,
investment contracts with discretionary participation features that subsequently lose
their ‘discretionary feature’ as the result of the exercise of a policyholder option will
remain within the scope of IFRS 17.
12
MODIFICATION AND DERECOGNITION
IFRS 17 states that a contract which qualifies as an insurance contract remains an
insurance contract until all rights and obligations are extinguished (i.e. discharged,
cancelled or expired) unless the contract is derecognised because of a contract
modification. [IFRS 17.B25].
IFRS 4 contained no guidance on when or whether a modification of an insurance
contract might cause derecognition of that contract. Therefore, prior to IFRS 17, most
insurers would have applied the requirements, if any, contained in local GAAP.
12.1 Modification of an insurance contract
An insurance contract can be modified either by agreement between the parties or as
result of regulation. If the terms of an insurance contract are modified, an entity should
derecognise the original insurance contract and recognise the modified contract as a
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new contract, if and only if, any of the conditions listed below are satisfied. The
conditions are that: [IFRS 17.72]
• if the modified terms had been included at contract inception:
• the modified contract would have been excluded from the scope of IFRS 17;
• an entity would have separated different components from the host insurance
contract (see 4 above) resulting in a different insurance contract to which
IFRS 17 would have applied;
• the modified contract would have had a substantially different contract
boundary; or
• the modified contract would have been included in a different group of
contracts at initial recognition (e.g. the contracts would have been onerous at
initial recognition rather than had no significant possibility of being onerous
subsequently – see 5 above);
• the original contract met the definition of an insurance contract with direct
participation features but the modified contract no longer meets that definition or
vice versa; or
• the entity applied the premium allocation approach (see 9 above) to the original
contract but the modifications mean that the contract no longer meets the
eligibility criteria for that approach.
In summary, any contract modification which changes the accounting model or the
accounting standards measuring the components of the insurance contract is likely to
result in derecognition. This is probably a different treatment compared to current
practices applied under IFRS 4.
However, the exercise of a right included in the terms of a contract is not a modification.
[IFRS 17.72].
If a contract modification meets none of the conditions above for derecognition, the
entity should treat any changes in cash flows caused by the modification as changes in
the estimates of the fulfilment cash flows. [IFRS 17.73]. See 8.6 and 11.2.3 above for the
accounting for changes in the fulfilment cash flows.
Accounting for derecognition of a modified contract is discussed at 12.3 below.
12.2 Derecognition of an insurance contract
An insurance contract is derecognised when, and only when [IFRS 17.74]
• it is extinguished, i.e. when the obligation specified in the insurance contract
expires or is discharged or cancelled; or
• any of the conditions for modifications which result in derecognition – see 12.1
above – are met.
The treatment of contract derecognition differs depending on which of the two
scenarios above applies. See 12.3 below.
When an insurance contract is extinguished, the entity is no longer at risk and is
therefore no longer required to transfer any economic resources to satisfy the insurance
contract. Therefore, the settlement of the last claim outstanding on a contract does not
Insurance contracts (IFRS 17) 4557
necessarily result in derecognition of the contract per se although it may result in the
remaining fulfilment cash flows under a contract being immaterial. For derecognition to
occur all obligations must be discharged or cancelled. When an entity purchases
reinsurance, it should derecognise the underlying insurance contracts only when those
underlying insurance contracts are extinguished. [IFRS 17.75].
12.3 Accounting for derecognition
There are three different ways to treat the derecognition of a contract, depending on
the circumstances discussed at 12.3.1 to 12.3.3 below.
12.3.1
Derecognition resulting from extinguishment
An entity derecognises an insurance contract from within a group of insurance contracts
by applying the following requirements: [IFRS 17.76]
• the fulfilment cash flows allocated to the group for both the liability for remaining
coverage and the liability for incurred claims are adjusted to eliminate the present
value of the future cash flows and risk adjustment for non-financial risk relating to
the rights and obligations that have been derecognised from the group;
• the contractual service margin of the group is adjusted for the change in fulfilment
cash flows described above, to the extent required by the general model as
discussed at 8.6.2 above (for contracts without direct participation features)
and 11.2.2 above (for contracts with direct participation features); and
• the number of coverage units for expected remaining coverage is adjusted to
reflect the coverage units derecognised from the group, and the amount of the
contractual service margin recognised in profit or loss in the period is based on that
adjusted number to reflect services provided in the period (see 8.7 above).
In practice, derecognition as a result of extinguishment will occur mostly on contracts
where a contractual service margin (or liability for remaining coverage) no longer exists.
In these circumstances, extinguishment will result in the elimination of any fulfilment
cash flows for the liability for incurred claims with a corresponding adjustment to profit
or loss. The Board observes in the Basis for Conclusions that an entity might not know
whether a liability has been extinguished because claims are sometimes reported years
after the end of the coverage period. It also considered concerns that an entity might be
unable to derecognise those liabilities. In the Board’s view, ignoring contractual
obligations that remain in existence and can generate valid claims would not give a
faithful representation of an entity’s financial position. However, it is expected that
when the entity has no information to suggest there are unasserted claims on a contract
with an expired coverage period, the entity would measure the insurance contract
liability at a very low amount. Accordingly, there may be little practical difference
between recognising an insuranc
e liability measured at a very low amount and
derecognising the liability. [IFRS 17.BC322].
When an entity transfers a group of insurance contracts or derecognises an insurance
contract because it either transfers that contract to a third party or derecognises the
insurance contract and recognises a new insurance contract (see 12.3.2 and 12.3.3 below)
it should: [IFRS 17.91]
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• for insurance contracts without direct participation features, reclassify to profit or
loss as a reclassification adjustment any remaining amounts for the group (or
contract) that were previously recognised in other comprehensive income as a
result of its accounting policy choice, if any, to disaggregate the finance income or
expenses of a group of insurance contracts (see 15.3.1 below); or
• for insurance contracts with direct participation features, not reclassify to profit or
loss as a reclassification adjustment any remaining amounts for the group (or
contract) that were previously recognised in other comprehensive income as a
result of its accounting policy choice, if any, to disaggregate the finance income or
expenses of a group of insurance contracts (see 15.3.1 below).
12.3.2
Derecognition resulting from transfer
When an entity derecognises an insurance contract because it transfers the contract to
a third party the entity should: [IFRS 17.77]
• adjust the fulfilment cash flows allocated to the group relating to the rights and
obligations that have been derecognised as discussed at 12.3.1 above; and
• adjust the contractual service margin of the group from which the contract has
been derecognised for the difference between the change in the contractual cash
flows resulting from derecognition and the premium charged by the third party
(unless the decrease in fulfilment cash flows are allocated to the loss component
of the liability for remaining coverage).
If there is no contractual service margin to be adjusted then the difference between the
fulfilment cash flows derecognised and the premium charged by the third party are
recognised in profit or loss.
12.3.3
Derecognition resulting from modification
When an entity derecognises an insurance contract and recognises a new insurance
contract as a result of a modification described at 12.1 above the entity should: [IFRS 17.77]
• adjust the fulfilment cash flows allocated to the group relating to the rights and
obligations that have been derecognised as discussed at 12.3.1 above;
• adjust the contractual service margin of the group from which the contract has
been derecognised for the difference between the change in the contractual
cash flows resulting from derecognition and the hypothetical premium the entity
would have charged had it entered into a contract with equivalent terms as the
new contract at the date of the contract modification, less any additional
premium charged for the modification (unless the decrease in fulfilment cash
flows are allocated to the loss component of the liability for remaining
coverage); and
• measure the new contract recognised assuming that the entity received the
hypothetical premium that the entity would have charged had it entered into the
modified contract at the date of the contract modification.
This can be illustrated by the following example.
Insurance contracts (IFRS 17) 4559
Example 52.46: Contract derecognition resulting from modification
An entity modifies an insurance contract issued such that there is a substantial change in the contract boundary
and, applying the guidance in IFRS 17, determines that the contract should be derecognised and replaced by
a new contract. The modified contract was part of a group of insurance contracts that were not onerous.
At the date of modification the fulfilment cash flows in respect of the contract were £100 and the present
value of the additional premium received for the contract modification is £10. The entity estimates that a
hypothetical premium that it would have charged had it entered into the modified contract at the date of the
contract modification was £105.
This gives rise to the following accounting entries:
DR CR
£ £
Cash 10
Derecognition of original contract fulfilment cash flows
100
Initial recognition of new contract at hypothetical premium
105
Contractual service margin
5
Determining any hypothetical premium will require the exercise of judgement by the
reporting entity.
12.3.4
Contracts applying the premium allocation approach that are
derecognised
IFRS 17 does not contain guidance on how contracts accounted for under the premium
allocation approach (see 9 above) should apply the requirements at 12.3.1 to 12.3.3 above
in circumstances in which the derecognised contracts are part of a group which has a
liability for remaining coverage but no separate contractual service margin (as a contractual
service margin is not recognised separately under the premium allocation approach).
13
ACQUISITIONS OF INSURANCE CONTRACTS
Insurance contracts may be acquired in a transfer (often referred to as a portfolio
transfer) or in a business combination as defined in IFRS 3.
In summary, insurance contracts acquired in a transfer or a business combination
are measured in the same way as insurance contracts issued by the entity except
that the fulfilment cash flows are recognised at date of the combination or transfer.
IFRS 3 requires a group of insurance contracts acquired in a business combination
to be measured at the acquisition date under IFRS 17 rather than at fair value.
[IFRS 3.31A].
This results in the following key differences for insurance contracts acquired in a
business combination compared with the accounting used previously under IFRS 4:
• contracts are classified and grouped based on the contractual terms, economic
conditions, operating or accounting policies and other pertinent factors and
conditions as they exist at the acquisition date. [IFRS 3.15]. Previously, when IFRS 4
applied, IFRS 3 had an exception for insurance contracts from this requirement
and stated that insurance contracts acquired in a business combination within its
scope should be classified on the basis of the contractual terms and other factors
at the inception of the contract rather than at the date of acquisition. In June 2018,
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the IASB discussed and tentatively agreed a proposed amendment to IFRS 3 which
clarifies that this exception is withdrawn prospectively from the date of initial
application of IFRS 17;37 and
• contracts are measured under the requirements of IFRS 17 rather than at fair value.
Consequently no option is available to split the value of the acquired insurance
contracts into two components (i.e. between a liability in according with the insurer’s
accounting policies and an intangible asset representing the difference between fair
value and the value of that liability under the IFRS 17 measurement model).
IFRS 17 does not explicitly state that contracts acquired in a business combination<
br />
should be classified based on the contractual terms and conditions as they exist at the
acquisition date. However, neither do other standards in similar circumstances. The
amendments to IFRS 3 are clear that, in a business combination, an entity is required to
classify contracts (i.e. assess whether a contract transfers significant insurance risk or
contains a discretionary participation feature) based on the contractual terms and other
factors at the date of acquisition rather than the original inception date of the contract.38
At the time of writing this chapter, the proposed narrow-scope amendments clarifying
that these amendments to IFRS 3 would apply prospectively to business combinations
after the date of initial application of IFRS 17 have not been issued.
As IFRS 3 also refers to ‘groupings’ and ‘operating and accounting policies’, this implies
also that other assessments like the eligibility for the variable fee approach for direct
participation contracts or the premium allocation approach (see 9.1 and 11.2 above) should
be based on the contractual terms and conditions at the date of acquisition rather than at
the date of the original inception of the contract. This approach may result in, for example,
contracts that are insurance contracts of the acquiree being investment contracts of the
acquirer and consequently there will be a different accounting treatment between the
consolidated financial statements that include the acquiree and the separate financial
statements of the acquiree. However, this would reflect the substance that the acquirer
has purchased investment contracts rather than insurance contracts.
When insurance contracts or reinsurance contracts held are acquired in a transfer that
is not a business combination, an entity should apply the aggregation requirements for
the identification of portfolios of insurance contracts and divide those into groupings as
explained at 5 above as if it had entered into the contracts on the date of acquisition.
[IFRS 17.B93]. In our view, this also implies that these contracts should be classified (i.e.
assessed for significant insurance risk and eligibility for the variable fee approach and
the premium allocation approach) based on the terms and conditions at the transfer