1. INSTITUTE OF CHARTERED ACCOUNTANTS OF NIGERIA
IFRS CERTIFICATION TRAINING PROGRAMME
Insurance Contracts IFRS 4
Segun Ilori FCA
2. Contents
• IFRS 4 Background
– Major issues covered in the first phase
• Scope
• Insurance Contracts new definition
• Contracts not recognised as Insurance contracts
• Income recognition
• Changes in Accounting policies
• Waivers under IFRS 4
• Acquisition of Insurance entities
3. Contents
• Deferred acquisition cost
• Liability adequacy test
– Loss reserving
– Actuary’s role
– Discounted cash-flows
• Phase II overview
• Disclosures
• Case Studies and Reference materials
– IFRS FAQs
• References
5. IFRS 4 Background
• The IASB issued the first standard on insurance contracts in 2005. Prior to
now, insurance accounting practices follow the provisions of the local
GAAP, SAS 16 (in Nigeria) and other applicable SORPs in other
jurisdictions, particularly, The Association of British Insurers(ABI) SORPs.
Some of the provisions of SAS 16 are in tandem with the ABI SORPs.
• The standard seeks to make limited improvements to insurance
accounting practices and also provides users with an insight into the grey
areas in accounting for insurance contracts such as liability estimation.
• The standard also applies to financial instruments with discretionary
participating features.
6. Scope
• Entities that issue policies that fit into the new
definition of insurance and reinsurance contracts are to
apply IFRS4.
• The standard also applies to financial instruments with
discretionary participating features, IFRS 7 also applies
to such financial instruments.
• IFRS 4 does not cover other assets and liabilities of an
insurance entities, such as financial assets and
liabilities which are more specifically covered under IAS
39.
• There are new disclosure requirements for insurance
contracts, including profiles of future cash-flows.
8. What is insurance contract ?
• “An insurance contract is signified by acceptance of 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. “
– Key phrases
Significant
insurance risk
Compensation
Uncertain
future event
Adverse
effects on
policyholder
9. Insurance and Financial risks
differentiated
• In contrast to insurance risk, financial risk is the risk of
possible change in one or more of the following:
– Interest rate
– Foreign exchange rate
– Commodity price
– Price index
– Credit rating
– Credit index
– Financial instrument rate; and
– Other variable
Provided in the case of nonfinancial variable that the variable is not
specific to a party to the contract.
10. Insurance and Financial risks
differentiated
• IAS 39 covers policies that transfer no
significant insurance risks and the principal
risk components are financial risks as stated
above.
11. Some examples of Insurance
Contracts
• Property or material damage
• Business interruption consequent upon material
damage
• Product liability, professional indemnity, third party
liability and legal expenses or legal protection
insurance
• Life insurance, life-contingent annuities or pensions
• Product warranties, provided the warranty is issued by
another party for goods sold by a manufacturer,
otherwise, IAS 18 and IAS 37 will apply.
• Reinsurance contracts
13. Contracts not classified as insurance
Contracts
• Investment contracts with no significant
insurance risk (for example, life policies with
no significant mortality risk)
• Credit guarantee that engages Insurer’s
liability if a debtor defaults notwithstanding
whether the policyholder has incurred a loss.
15. Changes in income recognition??
• Income recognition bases have not changed for
insurance contracts. However, reclassification
(unbundling) of contracts will impact revenue for
both short-term and long-term insurance
contracts
• Annual accounting is still the recommended
accounting treatment for all kinds of insurance
business, deferred annual accounting has been
outlawed in some jurisdictions, while the funded
basis became acceptable for 2, 3 or 4 year funds:
only in restricted circumstances.
16. Insurance and deposit components
• Unbundling the components:
– Scenarios
• Compulsory unbundling
• Permitted but not compulsory
• Prohibited
17. Unbundling scenarios
Insurer can
measure
deposit
component
Insurer’s accounting
policies do not
otherwise require it
to recognise all rights
and Obligations
arising from deposit
component
Compulsory
Unbundling
18. Unbundling scenarios
Insurer can
measure
deposit
component
Insurer’s accounting
policies require it to
recognise all rights and
obligations arising from
deposit components
regardless of the basis
used to measure the
rights and obligations
Unbundling
permitted
but not
compulsory
21. Concessions
• IFRS 4 permits temporary waiver of full compliance with
the criteria for selecting accounting policies (where no
specific IFRS is available) relating to insurance contracts. IAS
8 specifies the criteria but the overarching principle is that
of reliability and relevance of the financial statements.
• IFRS 4 forbids an insurer to introduce the following
accounting practices but can continue using policies that
involve them:
– Measuring insurance liabilities on a non-discounted basis;
– Measuring contractual rights to future investment management
fees at an amount that exceeds their fair value; and
– Using non-uniform accounting policies for the insurance
liabilities of a subsidiary
22. Concessions cont’d
• Key learning points
– Insurers can apply current market rate as against risk-free
rate to value liabilities, thus the liabilities at par with
movements in attaching assets that are interest sensitive;
– The above treatment may not generally apply to all
liabilities except those liabilities with assets that are
sensitive to market interest rate;
– Insurers can neither eliminate excessive prudence nor
introduce additional prudence where current practice is
sufficiently prudent;
– Insurers cannot adjust for future investment margins in
liabilities estimation except there is a switch to a
comprehensive investor-based accounting
23. Concessions cont’d
• Not withstanding the temporary waiver in the application of IAS 8,
an Insurer:
– shall not recognise as a liability any provisions for possible future
claims, if those claims arise under insurance contracts that are not in
existence at the end of the reporting period (such as catastrophe
provisions and equalisation provisions).
– shall carry out the liability adequacy test as prescribed by the standard
– shall not remove an insurance liability (or a part of an insurance
liability) from its statement of financial position until it is extinguished,
that is when the obligation specified in the contract is discharged or
cancelled or expires.
– Shall not offset reinsurance assets against insurance liabilities or
income or expense of reinsurance contracts against related income or
expense of insurance contracts; and
– Shall test for impairment of reinsurance assets
25. Business combinations
• An insurer entity may acquire another entity in part or whole, or the
portfolio of another insurance entity such as a composite company
acquiring the life portfolio of another insurer.
• The standard provides for the assets and liabilities to be measured at fair
value,
• An insurer may adopt split accounting which measures liabilities in line
with current accounting policies and the attaching insurance assets on fair
value.
• Insurers can recognise intangible asset, that is the difference between the
fair value and book value of liabilities assumed by the acquiring entity.
Such intangible asset is excluded from the scope of IAS 36 ( impairment of
Assets) and IAS 38 (Intangible Assets)
27. Deferred Acquisition cost
Commission and
acquisition cost
on New
Business,
excluding
renewals
Deferred
acquisition
cost
Incentives and
Bonuses on
New Business
Remuneration
of sales staff in
relation to New
Business
Administrative
cost relating to
issuance of
policies, e.g.
Risk survey and
medical fees.
•To be deferred against future revenue or investment margin
•Insurer is required to test for recoverability annually
28. Cost not allowed for deferment
• Recurring commission except for renewal
contracts.
• Recruitment of sales staff and agents
• Advertising cost
• Training and conferences
• Product design cost
29. Deferred cost amortisation bases
• Expense immediately
• Gross premium
• Estimated gross profits over contracts life
• Projection of fees collected over contract life
31. Liability adequacy
• An insurance entity is required under IFRS4.15 to assess
adequacy of its liabilities at the end of each reporting date.
The import is to test whether its obligations to policy
holders, excluding any attaching deferred acquisition cost
and intangibles is adequate based on the estimated future
cash-flows (including claims handling cost and embedded
options and guarantees)
• If the test reveals a deficiency, such is charged to Profit and
loss.
• Application of the test is at portfolio level provided the
Insurance entity’s accounting policy meets the minimum
requirements
32. Liability Adequacy
Best Estimate Claim Liability
Type of claim
Claim reserve
required
Common name of
reserve
Paid None None
Reported, not yet
paid IBNR reserve
Case reserve Case reserve
IBNER reserve
Not yet reported True IBNR reserve
(company-wide
reserve calculated by
actuary)
Ultimate loss
• IBNER = Incurred but not enough reported; global adjustment
to company-wide case reserves
• IBNR = Incurred but not reported
Adapted from paper presented at Loss Reserving Seminar, by Chye Pang-Hsiang
F.I.A., M.A.A.A. 16 January 2009
33. Liability adequacy
• Loss reserving
Premium written during
the year
PROFIT AND LOS S ACCOUNT
Earned Premium Claims incurred
Reported and Paid
Reported not yet paid
(movement)
Not yet reported (IBNR)
(movement)
BALANCE SHEET
Unearned Premium Outstanding Claims
34. Liability adequacy
• Actuary’s role
– The Actuary’s primary role is to determine the impact of reserve
studies on the balance sheet. Actuary estimates future claims and
expenses
– Expenses include claims related expenses
– In theory, also maintenance expenses
The Actuary applies a basic three building block approach to obtain fair
value of insurance liabilities.
35. Liability adequacy
• Discounted cash-flows
– The Building block approach
• Explicit, unbiased, market-consistent, probability-weighted
and current estimates of contractual casf
flows, (BLOCK 1)
• Current market discount rates that adjust the estimated
future cash flows for the time value of money, (BLOCK2)
and
• An explicit and unbiased estimate of margin that
market participants require for bearing risk( a risk
margin) and for providing other services, if any (service
margin) (BLOCK 3)
36. Overview of Phase II
• Discussions have centered on the move to fair values (also known as
prospective provisioning). This will bring an end to the deferral of
acquisition costs and the spreading of premiums over the duration of the
contract.
• Both premiums and expenses will be recognized immediately as a contract
is signed, with the accounting focused on the present value of expected
future cash flows. For example, on writing a new policy, all present and
future expected cash flows will be recorded. The net present value (NPV)
of relevant contractual premiums will be recorded as assets (and as
premium income) whilst the future expected cashflows for claims and
expenses will be discounted to their NPV and recorded as liabilities (and
claims/expenses)
37. Overview of Phase II
• In addition to reserving for the best estimate of the present value of
future cash flows, it is expected that insurers will also have to include a
market value margin (MVM) on top. This margin aims to take total
reserves to the level that would be sufficient to encourage a third party to
accept the relevant liabilities and therefore represent a proxy for fair value
in the absence of a liquid market.
38. Overview of Phase II
• Conceptually straightforward in the case of non-life contracts where a single
premium is paid at the start of the contract.
• The concept is more complex for policies where premiums may be received over a
long period (e.g. life assurance policies). The IASB has indicated that future
premiums will be able to be recognized if policyholders have “non-cancellable
continuation or renewal rights that significantly constrain the insurer’s ability to
re-price the contract to rates that would apply for new policyholders whose
characteristics are similar to those of the existing policyholder” and that “those
rights will lapse if the policyholders stop paying premiums.” For example, insurers
would typically charge lower premium rates on an existing life assurance policy
compared with a new policy for an individual of the same age. Assuming that the
definitions included above are met, the insurer would recognize the expected cash
flows (including premium and payments) allowing for projected lapse experience
40. Disclosures
• Detail information about insurance risk exposures, possible risk
concentration and the impact of changes in key variables on the key
assumptions used;
• Information about amount, timing and uncertainty of future cash-flows
• Terms and conditions of contracts that have material; effect on the
timing, amount and uncertainty of future cash-flows
• Information about actual claims compared to previous estimates
• Information about interest and credit rate risks in line with IAS 32,
Financial instruments Presentation;
• Disclosure of gains and losses from purchasing reinsurance
contracts such as Profit commission.
• Disclosure is not required of the fair value of their contracts for now
(see phaseII)
41. PRACTICAL INSIGHT
A typical insurer's statement of financial position might comprise these assets and liabilities and
be covered by the following IFRS:
Assets IAS/IFRS
Investments IAS 39
Property IAS 16/40
Investments contracts IAS 18
Insurance contracts IFRS 4
Other assets Various
Liabilities
Equity IAS 32/39
Insurance liabilities IFRS 4
Investment contract liabilities IAS 39
Other liabilities Various
42. Case Study
CASE STUDY
Facts
Entity A writes a single policy for a N1,000,000 premium and expects claims to be
made of N600,000 in year 4. At the time of writing the policy, there are
commission costs paid of N200,000. Assume a discount rate of 3% risk-free. The
entity says that if a provision for risk and uncertainty were to be made, it would
amount to N250,000 and that this risk would expire evenly over years 2, 3, and 4.
Under existing policies, the entity would spread the net premiums, the claims
expense, and the commissioning costs over the first two years of the policy.
Investment returns in years 1 and 2 are N20,000 and N40,000respectively.
Required
Show the treatment of this policy using a deferral and matching approach in
years 1 and 2 that would be acceptable under IFRS 4.
How would the treatment differ if a "fair value" approach were used?
43. References
• Understanding IFRS Fundamentals, Nandakumar Ankarath, Kalpesh J. Mehta,Dr. T.P. Ghosh and
Dr. Yass A. Alkafaji, wiley 2010
• Practical Implementation Guide and Workbook for IFRS, Third Edition, Abbas Ali Mirza
and Graham J. Holt, Wiley 2011
• International Financial Reporting Standards. A practical guide, 5th Edition, Hennie Van
Greuning, International Bank for Reconstruction and Development and the world Bank, 2010
• Loss Reserving Seminar, by Chye Pang-Hsiang F.I.A., M.A.A.A. 16 January 2009
• Excerpts from Fitch Ratings view on IFRS Phase I and II
43
Editor's Notes
Paragraphs 10-12 for waivers
Paragraphs 15-19 of IFRS 4 liability adequacy test
Paragraphs 20, impairment of reinsurance assets
