IFRS 4: Insurance contracts
IFRS 4 is Phase I of the accounting standards on insurance accounting. In June 2010, IASB issued an exposure draft on phase II of the insurance accounting contract. Hence, IFRS 4 is not a comprehensive standard on insurance accounting.
Where insurance contracts contain a deposit component that may be separated, this Standard shall be applicable to the insurance component.
The key issue in applying the standard is the liability adequacy test. Para 15 provides that an insurer shall assess at the end of each reporting period whether its recognized insurance liabilities are adequate, using current estimates of future cash flows under its insurance contracts. If that assessment shows that the carrying amount of its insurance liabilities (less related deferred acquisition costs and related intangible assets – these arise commonly in case of portfolio acquisitions) is inadequate in the light of the estimated future cash flows, the entire deficiency shall be recognised in profit or loss.
The liability adequacy test is the key feature of the Standard. The test gives recognition to internal standards of the insurer. The liability adequacy test may be performed applying aggregation at a portfolio level. Portfolio for this purpose may be taken to mean portfolios of broadly similar risks and managed together as a single portfolio.
Para 21 pertains to changes in insurance accounting. Changes would be permitted if, and only if, the change makes the financial statements more relevant to the economic decision-making needs of users and no less reliable, or more reliable and no less relevant to those needs.
There are specific provisions about change of insurance accounting arising out of the following:
(a) current interest rates (paragraph 24): an insurer is permitted to recompute insurance liabilities based on changes in interest rates.
(b) continuation of existing practices (paragraph 25): insurers may continue existing practices of measuring insurance liabilities on undiscounted basis, etc.
(c) prudence (paragraph 26): insurers do not have to change their accounting policies if they are premised on excessive prudence; however, if insurers measure insurance contracts with sufficient prudence, more, that is, excessive prudence is not required.
(d) future investment margins (paragraphs 27–29): insurers do not have to introduce accounting changes to eliminate future investment margins.
(e) shadow accounting practices pertaining to unrealized gains on acquired portfolios. (paragraph 30).
Para 34 deals with discretionary participation features in insurance contracts. It is commonplace feature of insurance policies to have a guaranteed amount of policyholder benefit, and an amount which is discretionary, commonly caused “bonus”. The Standard permits an insurer to recognize the guaranteed element and the discretionary element separately – if the two are separated, then the guaranteed element shall be recognized as liability. There are several alternative approaches discussed in this para regarding the discretionary element.
There are important disclosures required regarding insurance risks. These are:
- the insurer’s objectives, policies and processes for managing risks arising from insurance contracts and the methods used to manage those risks.
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information about insurance risk (both before and after risk mitigation by reinsurance), including information about:
- sensitivity to insurance risk (see details below).
- concentrations of insurance risk, including a description of how management determines concentrations and a description of the shared characteristic that identifies each concentration (eg type of insured event, geographical area, or currency).
- actual claims compared with previous estimates (ie claims development). The disclosure about claims development shall go back to the period when the earliest material claim arose for which there is still uncertainty about the amount and timing of the claims payments, but need not go back more than ten years.
- information about credit risk, liquidity risk and market risk as if insurance contracts were akin to financial instruments under IFRS 7. However, maturity composition of insurance liabilities, and sensitivity to market conditions need not be provided in the manner required in case of financial instruments.
As regards sensitivity to insurance risk, the Standard requires an insurer to make the following disclosures:
- A sensitivity analysis that shows how profit or loss and equity would have been affected if changes in the relevant risk variable that were reasonably possible at the end of the reporting period had occurred; the methods and assumptions used in preparing the sensitivity analysis; and any changes from the previous period in the methods and assumptions used..
Qualitative information about sensitivity and information about those terms and conditions of insurance contracts that have a material effect on the amount, timing and uncertainty of the insurer’s future cash flows.