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IFRS 4 Insurance Contracts

IFRS 4 Insurance Contracts

IFRS 4 Insurance Contracts: The Board decided to develop an International Financial Reporting Standard (IFRS) on insurance contracts because:
(a) there was no IFRS on insurance contracts, and insurance contracts were excluded from the scope of existing IFRSs that would otherwise have been relevant (eg IFRSs on provisions, financial instruments and
intangible assets).
(b) accounting practices for insurance contracts were diverse, and also often differed from practices in other sectors.

The Board’s predecessor organisation, the International Accounting Standards Committee (IASC), set up a Steering Committee in 1997 to carry out the initial work on this project. In December 1999, the Steering Committee published an Issues Paper, which attracted 138 comment letters. The Steering Committee reviewed the comment letters and concluded its work by developing a report to the Board in the form of a Draft Statement of Principles (DSOP). The Board started discussing the DSOP in November 2001. The Board did not approve the DSOP or invite formal comments on it, but made it available to the public on the IASB’s Website

Few insurers report using IFRSs at present, although many more are expected to do so from 2005. Because it was not feasible to complete this project for implementation in 2005, the Board split the project into two phases so that insurers could implement some aspects in 2005. The Board published its proposals for phase I in July 2003 as ED 5 Insurance Contracts. The deadline for comments was 31 October 2003 and the Board received 135 responses. After reviewing the responses, the Board issued IFRS 4 in March 2004.

IFRS 4 Insurance Contracts

IFRS 4 Insurance Contracts : The Board’s objectives for phase I were:
(a) to make limited improvements to accounting practices for insurancecontracts, without requiring major changes that may need to be reversedin phase II.
(b) to require disclosure that (i) identifies and explains the amounts in an insurer’s financial statements arising from insurance contracts and
(ii) helps users of those financial statements understand the amount, timing and uncertainty of future cash flows from insurance contracts.

The Board sees phase I as a stepping stone to phase II and is committed to completing phase II without delay once it has investigated all relevant conceptual and practical questions and completed its due process. In January 2003, the Board reached the following tentative conclusions for phase II:
(a) The approach should be an asset-and-liability approach that would require an entity to identify and measure directly the contractual rights and obligations arising from insurance contracts, rather than create
deferrals of inflows and outflows.
(b) Assets and liabilities arising from insurance contracts should be measured at their fair value, with the following two caveats:
(i) Recognising the lack of market transactions, an entity may use entity-specific assumptions and information when market-based information is not available without undue cost and effort.
(ii) In the absence of market evidence to the contrary, the estimated fair value of an insurance liability shall not be less, but may be more, than the entity would charge to accept new contracts with identical contractual terms and remaining maturity from new policyholders. It follows that an insurer would not recognise a net gain at inception of an insurance contract, unless such market evidence is available.

(c) As implied by the definition of fair value:1
(i) an undiscounted measure is inconsistent with fair value.
(ii) expectations about the performance of assets should not be incorporated into the measurement of an insurance contract, directly or indirectly (unless the amounts payable to a policyholder depend on the performance of specific assets).
(iii) the measurement of fair value should include an adjustment for the premium that marketplace participants would demand for risks and mark-up in addition to the expected cash flows.
(iv) fair value measurement of an insurance contract should reflect the credit characteristics of that contract, including the effect of policyholder protections and insurance provided by governmental bodies or other guarantors.
(d) The measurement of contractual rights and obligations associated with the closed book of insurance contracts should include future premiums specified in the contracts (and claims, benefits, expenses, and other additional cash flows resulting from those premiums) if, and only if:

(i) policyholders hold non-cancellable continuation or renewal rights that significantly constrain the insurer’s ability to reprice the contract to rates that would apply for new policyholders whose characteristics are similar to those of the existing policyholders; and
(ii) those rights will lapse if the policyholders stop paying premiums.
(e) Acquisition costs should be recognised as an expense when incurred.
(f) The Board will consider two more questions later in phase II:
(i) Should the measurement model unbundle the individual elements of an insurance contract and measure them individually?
(ii) How should an insurer measure its liability to holders of participating contracts?

In two areas, those tentative conclusions differ from the IASC Steering
Committee’s recommendations in the DSOP:
(a) the use of a fair value measurement objective rather than entity-specific value. However, that change is not as significant as it might seem because entity-specific value as described in the DSOP is
indistinguishable in most respects from estimates of fair value determined using measurement guidance that the Board has tentatively adopted in phase II of its project on business combinations.2
(b) the criteria used to determine whether measurement should reflect future premiums and related cash flows

IFRS 4 Insurance Contracts

IFRS 4 Insurance Contracts : Some argued that the IFRS should deal with all aspects of financial reporting by insurers, to ensure that the financial reporting for insurers is internally consistent. They noted that regulatory requirements, and some national accounting requirements, often cover all aspects of an insurer’s business. However, for the following reasons, the IFRS deals with insurance contracts of all entities and does not address other aspects of accounting by insurers:
(a) It would be difficult, and perhaps impossible, to create a robust definition of an insurer that could be applied consistently from country to country. Among other things, an increasing number of entities have major activities in both insurance and other areas.
(b) It would be undesirable for an insurer to account for a transaction in one way and for a non-insurer to account in a different way for the same transaction.
(c) The project should not reopen issues addressed by other IFRSs, unless specific features of insurance contracts justify a different treatment. Paragraphs BC166–BC180 discuss the treatment of assets backing insurance contracts.

IFRS 4 Insurance Contracts

IFRS 4 Insurance Contracts : The definition of an insurance contract determines which contracts are within the scope of IFRS 4 rather than other IFRSs. Some argued that phase I should use existing national definitions of insurance contracts, on the following grounds:
(a) Before phase II gives guidance on applying IAS 39 Financial Instruments: Recognition and Measurement4 to difficult areas such as discretionary participation features and cancellation and renewal rights, it would be premature to require insurers to apply IAS 39 to contracts that contain these features and rights.
(b) The definition adopted for phase I may need to be amended again for phase II. This could compel insurers to make extensive changes twice in a short time.

However, in the Board’s view, it is unsatisfactory to base the definition used in IFRSs on local definitions that may vary from country to country and may not be most relevant for deciding which IFRS ought to apply to a particular type of

IFRS 4 Insurance Contracts

IFRS 4 Insurance Contracts : Some contracts have the legal form of insurance contracts but do not transfer significant insurance risk to the issuer. Some argue that all such contracts
should be treated as insurance contracts, for the following reasons:
(a) These contracts are traditionally described as insurance contracts and are generall subject to regulation by insurance supervisors.
(b) Phase I will not achieve great comparability between insurers because it will permit a diverse range of treatments for insurance contracts. It would be preferable to ensure consistency at least within a single

(c) Accounting for some contracts under IAS 397 and others under local GAAP is unhelpful to users. Moreover, some argued that IAS 39 contains insufficient, and possibly inappropriate, guidance for investment contracts.8
(d) The guidance proposed in ED 5 on significant insurance risk was too vague, would be applied inconsistently and relied on actuarial resources in short supply in many countries

IFRS 4 Insurance Contracts

IFRS 4 Insurance Contracts : However, as explained in the Framework, financial statements should reflect economic substance and not merely legal form. Furthermore, accounting arbitrage could occur if the addition of an insignificant amount of insurance risk made a significant difference to the accounting. Therefore, the Board decided that contracts described in the previous paragraph should not be treated as insurance contracts for financial reporting.

IFRS 4 Insurance Contracts

IFRS 4 Insurance Contracts : In some countries, the legal definition of insurance requires that the policyholder or other beneficiary should have an insurable interest in the insured event. For the following reasons, the definition proposed in 1999 by the former IASC Steering Committee in the Issues Paper did not refer to insurable interest:
(a) Insurable interest is defined in different ways in different countries. Also, it is difficult to find a simple definition of insurable interest that is adequate for such different types of insurance as insurance against fire, term life insurance and annuities.
(b) Contracts that require payment if a specified uncertain future event occurs cause similar types of economic exposure, whether or not the other party has an insurable interest.

IFRS 4 Insurance Contracts

IFRS 4 Insurance Contracts : Quantitative guidance creates an arbitrary dividing line that results in different accounting treatments for similar transactions that fall marginally on different sides of the line. It also creates opportunities for accounting arbitrage by encouraging transactions that fall marginally on one side or the other of the line. For these reasons, the IFRS does not include quantitative guidance.

To reduce the need for guidance on the definition of an insurance contract, some argue that an insurer should ‘unbundle’ the deposit component from the insurance component. Unbundling has the following consequences:
(a) The insurance component is measured as an insurance contract.
(b) The deposit component is measured under IAS 39 at either amortised cost or fair value. This might not be consistent with the basis used for insurance contracts.

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