The IASB’s reasons for defining significant insurance risk in relation to a single contract
were that:
(a) although contracts are often managed and measured on a portfolio basis, the
contractual rights and obligations arise from individual contracts; and
(b) an assessment contract by contract is likely to increase the proportion of contracts
that qualify as insurance contracts. The IASB intended to make it easier, not
harder, for a contract previously regarded as an insurance contract under local
GAAP to meet the IFRS 4 definition. [IFRS 4.BC34].
However, where a relatively homogeneous book of small contracts is known to consist
of contracts that all transfer insurance risk, the standard does not require that an insurer
examine each contract within that book to identify a few non-derivative contracts that
transfer insignificant insurance risk. [IFRS 4.B25].
Multiple, mutually linked contracts entered into with a single counterparty (or contracts
that are otherwise interdependent) should be considered a single contract for the
purposes of assessing whether significant insurance risk is transferred. [IFRS 4.B25fn7]. This
requirement is intended to prevent entities entering into contracts that individually
transfer significant insurance risk but collectively do not and accounting for part(s) of
what is effectively a single arrangement as (an) insurance contract(s).
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If an insurance contract is unbundled (see 5 below) into a deposit component and an
insurance component, the significance of insurance risk transferred is assessed by
reference only to the insurance component. The significance of insurance risk
transferred by an embedded derivative is assessed by reference only to the embedded
derivative (see 4 below). [IFRS 4.B28].
3.2.2.A Self
insurance
An insurer can accept significant insurance risk from a policyholder only if it issues an
insurance contract to an entity separate from itself. Therefore, ‘self insurance’, such as
a self-insured deductible where the insured cannot claim for losses below the excess
limit of an insurance policy, is not insurance because there is no insurance contract.
Accounting for self insurance and related provisions is covered by IAS 37 which requires
that a provision is recognised only if there is a present obligation as a result of a past
event, if it is probable that an outflow of resources will occur and a reliable estimate can
be determined. [IAS 37.14].
3.2.2.B Insurance
mutuals
A mutual insurer accepts risk from each policyholder and pools that risk. Although
policyholders bear the pooled risk collectively in their capacity as owners, the mutual
has still accepted the risk that is the essence of an insurance contract and therefore
IFRS 4 applies to those contracts. [IFRS 4.B17].
3.2.2.C
Intragroup insurance contracts
Where there are insurance contracts between entities in the same group these would
be eliminated in the consolidated financial statements as required by IFRS 10 –
Consolidated Financial Statements. If any intragroup insurance contract is reinsured
with a third party that is not part of the group this third party reinsurance contract
should be accounted for as a direct insurance contract in the consolidated financial
statements of a non-insurer because the intragroup contract will be eliminated on
consolidation. This residual direct insurance contract (i.e. the policy with the third
party) is outside the scope of IFRS 4 from the viewpoint of the consolidated financial
statements of a non-insurer because policyholder accounting is excluded from IFRS 4
as discussed at 2.2.3.F above.
3.2.3 Significant
additional
benefits
The ‘significant additional benefits’ described at 3.2 above refer to amounts that exceed
those that would be payable if no insured event occurred. These additional amounts
include claims handling and claims assessment costs, but exclude:
(a) the loss of the ability to charge the policyholder for future services, for example
where the ability to collect fees from a policyholder for performing future
investment management services ceases if the policyholder of an investment-
linked life insurance contract dies. This economic loss does not reflect insurance
risk and the future investment management fees are not relevant in assessing how
much insurance risk is transferred by a contract;
(b) the waiver on death of charges that would be made on cancellation or surrender
of the contract. Because the contract brought these charges into existence, the
Insurance contracts (IFRS 4) 4297
waiver of them does not compensate the policyholder for a pre-existing risk.
Hence, they are not relevant in determining how much insurance risk is transferred
by a contract;
(c) a payment conditional on an event that does not cause a significant loss to the
holder of the contract, for example where the issuer must pay one million currency
units if an asset suffers physical damage causing an insignificant economic loss of
one currency unit to the holder. The holder in this case has transferred to the
insurer the insignificant insurance risk of losing one currency unit. However, at the
same time the contract creates non-insurance risk that the issuer will need to pay
999,999 additional currency units if the specified event occurs;
(d) possible reinsurance recoveries. The insurer will account for these separately;
[IFRS 4.B24] and
(e) the original policy premium (but not additional premiums payable in the event of
claims experience – see Example 51.26 below).
The definition of insurance risk refers to risk that the insurer accepts from the
policyholder. Consequently, insurance risk must be a pre-existing risk transferred from
the policyholder to the insurer. A new risk, such as the inability to charge the policyholder
for future services, is not insurance risk. [IFRS 4.B12]. The following example illustrates this.
Example 51.2: Loan contract with prepayment fee
A loan contract contains a prepayment fee that is waived if the prepayment results from the borrower’s death.
This is not an insurance contract since before entering into the contract the borrower faced no risk
corresponding to the prepayment fee. Hence, although the loan contract exposes the lender to mortality risk,
it does not transfer a pre-existing risk from the borrower. Thus, the risk associated with the possible waiver
on death of the prepayment fee is not insurance risk. [IFRS 4.IG2 E1.23].
It follows from this that if a contract pays a death benefit exceeding the amount payable on
survival (excluding waivers under (b) above), the contract is an insurance contract unless
the additional death benefit is insignificant (judged by reference to the contract rather than
to an entire book of contracts). Similarly, an annuity contract that pays out regular sums for
the rest of a policyholder’s life is an insurance contract, unless the aggregate life-contingent
payments are insignificant. In this case, the insurer could suffer a significant loss on an
individual contract if the annuitant survives longer than expected. [IFRS 4.B26].
Additional benefits could include a requirement to
pay benefits earlier than expected if
the insured event occurs earlier provided the payment is not adjusted for the time value
of money. An example could be whole life insurance cover that provides a fixed death
benefit whenever a policyholder dies. Whilst it is certain that the policyholder will die,
the timing of death is uncertain and the insurer will suffer a loss on individual contracts
when policyholders die early, even if there is no overall expected loss on the whole
book of contracts. [IFRS 4.B27].
3.3
Changes in the level of insurance risk
It is implicit within IFRS 4 that an assessment of whether a contract transfers significant
insurance risk should be made at the inception of a contract. [IFRS 4.B29]. Further, a contract
that qualifies as an insurance contract at inception remains an insurance contract until all
rights and obligations are extinguished or expire. [IFRS 4.B30]. This applies even if
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circumstances have changed such that insurance contingent rights and obligations have
expired. The IASB considered that requiring insurers to set up systems to continually assess
whether contracts continue to transfer significant insurance risk imposed a cost that far
outweighed the benefit that would be gained from going through the exercise. [IFRS 4.BC38].
Conversely, contracts that do not transfer insurance risk at inception may become
insurance contracts if they transfer insurance risk at a later time, as explained in the
following example. This is because IFRS 4 imposes no limitations on when contracts
can be assessed for significant insurance risk. The reclassification of contracts as
insurance contracts occurs based on changing facts and circumstances, although there
is no guidance on accounting for the reclassification.
Example 51.3: Deferred annuity with policyholder election
Entity A issues a deferred annuity contract whereby the policyholder will receive, or can elect to receive, a
life-contingent annuity at rates prevailing when the annuity begins.
This is not an insurance contract at inception if the insurer can reprice the mortality risk without constraints.
However, it will become an insurance contract when the annuity rate is fixed (unless the contingent amount
is insignificant in all scenarios that have commercial substance). [IFRS 4.IG2 E1.7].
In practice, in the accumulation phase of an annuity, there are other guaranteed benefits such as premium
refunds that might still make this an insurance contract prior to the date when the annuity rate is fixed.
Some respondents to ED 5 suggested that a contract should not be regarded as an
insurance contract if the insurance-contingent rights and obligations expire after a very
short time. The IASB considered that the requirement to ignore scenarios that lack
commercial substance in assessing significant insurance risk and the fact that there is no
significant transfer of pre-existing risk in some contracts that waive surrender penalties
on death is sufficient to cover this issue. [IFRS 4.BC39].
IFRS 3 – Business Combinations – confirms that there should be no reassessment of
the classification of contracts previously classified as insurance contracts under IFRS 4
which are acquired as a part of a business combination. [IFRS 3.17(b)].
3.4
Uncertain future events
Uncertainty (or risk) is the essence of an insurance contract. Accordingly, IFRS 4
requires at least one of the following to be uncertain at the inception of an insurance
contract:
(a) whether an insured event will occur;
(b) when it will occur; or
(c) how much the insurer will need to pay if it occurs. [IFRS 4.B2].
An insured event will be one of the following:
• the discovery of a loss during the term of the contract, even if the loss arises from
an event that occurred before the inception of the contract;
• a loss that occurs during the term of the contract, even if the resulting loss is
discovered after the end of the contract term; [IFRS 4.B3] or
• the discovery of the ultimate cost of a claim which has already occurred but whose
financial effect is uncertain. [IFRS 4.B4].
Insurance contracts (IFRS 4) 4299
This last type of insured event arises from ‘retroactive’ contracts, i.e. those providing
insurance against events which have occurred prior to the policy inception date. An
example is a reinsurance contract that covers a direct policyholder against adverse
development of claims already reported by policyholders. In this case the insured event
is the discovery of the ultimate cost of those claims.
Local GAAP in some jurisdictions, including the US, prohibits the recognition of gains
on inception of retroactive reinsurance contracts. IFRS 4 contains no such prohibition.
Therefore, such gains would be recognised if that was required by an insurer’s existing
accounting policies. However, as discussed at 11.1.3 below, the amount of any such gains
recognised should be disclosed.
3.5
Payments in kind
Insurance contracts that require or permit payments to be made in kind are treated the
same way as contracts where payment is made directly to the policyholder. For
example, some insurers replace an article directly rather than compensating the
policyholder. Others use their own employees, such as medical staff, to provide services
covered by the contract. [IFRS 4.B5].
3.5.1 Service
contracts
Some fixed-fee service contracts in which the level of service depends on an uncertain
event may meet the definition of an insurance contract. However, in some jurisdictions
these are not regulated as insurance contracts. For example, a service provider could enter
into a maintenance contract in which it agrees to repair specified equipment after a
malfunction. The fixed service fee is based on the expected number of malfunctions but it
is uncertain whether a particular machine will break down. Similarly, a contract for car
breakdown services in which the provider agrees, for a fixed annual fee, to provide roadside
assistance or tow the car to a nearby garage could meet the definition of an insurance
contract even if the provider does not agree to carry out repairs or replace parts. [IFRS 4.B6].
In respect of the type of service contracts described above, their inclusion within IFRS 4
seems an unintended consequence of the definition of an insurance contract. However,
the IASB stresses that applying IFRS 4 to these contracts should be no more
burdensome than applying other IFRSs since:
(a) there are unlikely to be material liabilities for malfunctions and breakdowns that
have already occurred;
(b) if the service provider applied accounting policies consistent with IFRS 15, this
would be acceptable either as an existing accounting policy or, possibly, an
improvement of existing policies (see 8 below);
(c) whilst the service provider would be required to apply the liability adequacy test
discussed at 7.2.2 below if the cost of meeting its contractual obligation to provide
services exceeded the revenue received in advance, it would have been required
to apply IAS 37 to determine whether its contracts were onerous if IFRS 4 did not
apply; and
(d) th
e disclosure requirements in IFRS 4 are unlikely to add significantly to the
disclosures required by other IFRSs. [IFRS 4.B7].
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3.6
The distinction between insurance risk and financial risk
The definition of an insurance contract refers to ‘insurance risk’ which is defined as
‘risk, other than financial risk, transferred from the holder of a contract to the issuer’.
[IFRS 4 Appendix A].
A contract that exposes the reporting entity to financial risk without significant
insurance risk is not an insurance contract. [IFRS 4.B8]. ‘Financial risk’ is defined as ‘the
risk of a possible future change in one or more of a specified interest rate, financial
instrument price, foreign exchange rate, index of prices or rates, credit rating or credit
index or other variable, provided in the case of a non-financial variable that variable is
not specific to a party to the contract’. [IFRS 4 Appendix A].
An example of a non-financial variable that is not specific to a party to the contract is
an index of earthquake losses in a particular region or an index of temperature in a
particular city. An example of a non-financial variable that is specific to a party to the
contract is the occurrence or non-occurrence of a fire that damages or destroys an asset
of that party.
The risk of changes in the fair value of a non-financial asset is not a financial risk if the
fair value reflects not only changes in the market prices for such assets (a financial
variable) but also the condition of a specific non-financial asset held by a party to the
contract (a non-financial variable). For example if a guarantee of the residual value of a
specific car exposes the guarantor to the risk of changes in that car’s condition, that risk
is insurance risk. [IFRS 4.B9].
Example 51.4: Residual value insurance
Entity A issues a contract to Entity B that provides a guarantee of the fair value at the future date of an aircraft
(a non-financial asset) held by B. A is not the lessee of the aircraft (residual value guarantees given by a lessee
under a lease within the scope of IAS 17 or IFRS 16).
This is an insurance contract (unless changes in the condition of the asset have an insignificant effect on its
value). The risk of changes in the fair value of the aircraft is not a financial risk because the fair value reflects
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