International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards
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not only changes in market prices for similar aircraft but also the condition of the specific asset held.
However, if the contract compensated B only for changes in market prices and not for changes in the condition
of B’s asset, the contract would be a derivative and within the scope of IAS 39 or IFRS 9. [IFRS 4.IG2 E1.15].
Contracts that expose the issuer to both financial risk and significant insurance risk can
be insurance contracts. [IFRS 4.B10].
Example 51.5: Contract with insurance and financial risk
Entity A issues a catastrophe bond to Entity B under which principal, interest payments or both are reduced
significantly if a specified triggering event occurs and the triggering event includes a condition that B has
suffered a loss.
The contract is an insurance contract because the triggering event includes a condition that B has suffered a
loss, and contains an insurance component (with the issuer as policyholder and the holder as the insurer) and
a deposit component. A discussion of the separation of these two components is set out at 5 below.
[IFRS 4.IG2 E1.20].
Contracts where an insured event triggers the payment of an amount linked to a price
index are insurance contracts provided the payment that is contingent on the insured
event is significant.
Insurance contracts (IFRS 4) 4301
An example would be a life contingent annuity linked to a cost of living index. Such a
contract transfers insurance risk because payment is triggered by an uncertain future
event, the survival of the annuitant. The link to the price index is an embedded
derivative but it also transfers insurance risk. If the insurance risk transferred is
significant the embedded derivative meets the definition of an insurance contract
(see 4 below for a discussion of derivatives embedded within insurance contracts).
[IFRS 4.B11].
3.7
Adverse effect on the policyholder
For a contract to be an insurance contract the insured event must have an adverse effect
on the policyholder. In other words, there must be an insurable interest.
Without the notion of insurable interest the definition of an insurance contract would
have encompassed gambling. The IASB believed that without this notion the definition
of an insurance contract might have captured any prepaid contract to provide services
whose cost is uncertain and that would have extended the scope of the term ‘insurance
contract’ too far beyond its traditional meaning. [IFRS 4.BC26-28]. In the IASB’s opinion the
retention of insurable interest gives a principle-based distinction, particularly between
insurance contracts and other contracts that happen to be used for hedging and they
preferred to base the distinction on a type of contract rather than the way an entity
manages a contract or group of contracts. [IFRS 4.BC29].
The adverse effect on the policyholder is not limited to an amount equal to the financial
impact of the adverse event. So, the definition includes ‘new for old’ coverage that
replaces a damaged or lost asset with a new asset. Similarly, the definition does not limit
payment under a term life insurance contract to the financial loss suffered by a
deceased’s dependents nor does it preclude the payment of predetermined amounts to
quantify the loss caused by a death or accident. [IFRS 4.B13].
A contract that requires a payment if a specified uncertain event occurs which does not
require an adverse effect on the policyholder as a precondition for payment is not an
insurance contract. Such contracts are not insurance contracts even if the holder uses
the contract to mitigate an underlying risk exposure. Conversely, the definition of an
insurance contract refers to an uncertain event for which an adverse effect on the
policyholder is a contractual precondition for payment. This contractual precondition
does not require the insurer to investigate whether the uncertain event actually caused
an adverse effect, but permits the insurer to deny payment if it is not satisfied that the
event caused an adverse effect. [IFRS 4.B14].
The following example illustrates the concept of insurable interest.
Example 51.6: Reinsurance contract with ‘original loss warranty’ clause
Entity A agrees to provide reinsurance cover to airline insurer B for $5m against losses suffered. The claims
are subject to an original loss warranty of $50m meaning that only losses suffered by B up to $5m from events
exceeding a cost of $50m in total can be recovered under the contract. This is an insurance contract as B can
only recover its own losses arising from those events.
If the contract allowed B to claim up to $5m every time there was an event with a cost exceeding $50m
regardless of whether B had suffered a loss from that event then this would not be an insurance contract
because there would be no insurable interest in this arrangement.
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3.7.1
Lapse, persistency and expense risk
Lapse or persistency risk (the risk that the policyholder will cancel the contract earlier
or later than the issuer had expected in pricing the contract) is not insurance risk
because, although this can have an adverse effect on the issuer, the cancellation is not
contingent on an uncertain future event that adversely affects the policyholder.
[IFRS 4.B15].
Similarly, expense risk (the risk of unexpected increases in the administrative costs
incurred by the issuer associated with the serving of a contract, rather than the costs
associated with insured events) is not insurance risk because an unexpected increase in
expenses does not adversely affect the policyholder. [IFRS 4.B15].
Therefore, a contract that exposes the issuer to lapse risk, persistency risk or expense risk
is not an insurance contract unless it also exposes the issuer to significant insurance risk.
3.7.2
Insurance of non-insurance risks
If the issuer of a contract which does not contain significant insurance risk mitigates the
risk of that contract by using a second contract to transfer part of that first contract’s
risk to another party, this second contract exposes that other party to insurance risk
because the policyholder of the second contract (the issuer of the first contract) is
subject to an uncertain event that adversely affects it and thus it meets the definition of
an insurance contract. [IFRS 4.B16]. This is illustrated by the following example.
Example 51.7: Insurance of non-insurance risks
Entity A agrees to compensate Entity B for losses on a series of contracts issued by B that do not transfer
significant insurance risk. These could be investment contracts or, for example, a contract to provide services.
The contract is an insurance contract if it transfers significant insurance risk from B to A, even if some or all
of the underlying individual contracts do not transfer significant insurance risk to B. The contract is a
reinsurance contract if any of the contracts issued by B are insurance contracts. Otherwise, the contract is a
direct insurance contract. [IFRS 4.IG2 E1.29].
3.8
Accounting differences between insurance and non-insurance
contracts
Making a distinction between insurance and non-insurance contracts is important
because the accounting treatment will usually
differ.
Insurance contracts under IFRS 4 will normally be accounted for under local GAAP
(see 7 below). Typically, local GAAP (see 1.4 above) will recognise funds received or due
from a policyholder as premiums (revenue) and amounts due to a policyholder as claims
(an expense). However, if a contract does not transfer significant insurance risk and is
therefore not an insurance contract under IFRS 4 it will probably be accounted for as
an investment contract under IAS 39 or IFRS 9. Under IAS 39 or IFRS 9 the receipt of
funds relating to financial assets or financial liabilities will result in the creation of a
liability for the value of the remittance rather than a credit to profit or loss. This
accounting treatment is sometimes called ‘deposit accounting’. [IFRS 4.B20].
A financial liability within the scope of IAS 39 or IFRS 9 is measured at either amortised
cost or fair value or possibly a mixture (e.g. if the instrument contains an embedded
derivative). However, under IFRS 4, an insurance liability is measured under the entity’s
Insurance contracts (IFRS 4) 4303
previous local GAAP accounting policies, unless these have been subsequently changed
as discussed at 8 below. These may well result in the measurement of a liability that is
different from that obtained by applying IAS 39 or IFRS 9.
Additionally, the capitalisation of any acquisition costs related to the issuance of a
contract is also likely to be different for insurance and investment contracts. IFRS 15
permits only incremental costs associated with obtaining an investment management
contract to be capitalised. IAS 39 or IFRS 9 requires transaction costs directly
attributable to a financial asset or financial liability not at fair value through profit or loss
to be included in its initial measurement. Transaction costs relating to financial assets
and financial liabilities held at fair value through profit or loss are required to be
expensed immediately. IFRS 4 does not provide any guidance as to what acquisition
costs can be capitalised so reference to existing local accounting policies should apply
(see 7.2.6.D below). In most cases, these will differ from the requirements outlined in
IFRS 15 and IAS 39 or IFRS 9.
If non-insurance contracts (see 3.9.2 below) do not create financial assets or financial
liabilities then IFRS 15 applies to the recognition of associated revenue. The principle
outlined in IFRS 15 is to recognise revenue associated with a transaction involving the
rendering of services when (or as) an entity satisfies a performance obligation by
transferring the promised service to a customer in an amount that reflects the
consideration to which the entity expects to be entitled. [IFRS 4.B21]. This could differ
from revenue recognition for insurance contracts measured under local GAAP.
3.9
Examples of insurance and non-insurance contracts
The section contains examples given in IFRS 4 of insurance and non-insurance contracts.
3.9.1
Examples of insurance contracts
The following are examples of contracts that are insurance contracts, if the transfer of
insurance risk is significant:
(a) insurance against theft or damage to property;
(b) insurance against product liability, professional liability, civil liability or legal expenses;
(c) life insurance and prepaid funeral plans (although death is certain, it is uncertain
when death will occur or, for some types of life insurance, whether death will
occur within the period covered by the insurance);
(d) life-contingent annuities and pensions (contracts that provide compensation for
the uncertain future event – the survival of the annuitant or pensioner – to assist
the annuitant or pensioner in maintaining a given standard of living, which would
otherwise be adversely affected by his or her survival);
(e) disability and medical cover;
(f) surety
bonds,
fidelity bonds, performance bonds and bid bonds (i.e. contracts that
provide compensation if another party fails to perform a contractual obligation, for
example an obligation to construct a building);
(g) credit insurance that provides for specified payments to be made to reimburse the
holder for a loss it incurs because a specified debtor fails to make payment when
due under the original or modified terms of a debt instrument. These contracts
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could have various legal forms, such as that of a guarantee, some types of letter of
credit, a credit derivative default contract or an insurance contract. Although these
contracts meet the definition of an insurance contract they also meet the definition
of a financial guarantee contract and are within the scope of IAS 39 or IFRS 9 and
IFRS 7 and not IFRS 4 unless the issuer has previously asserted explicitly that it
regards such contracts as insurance contracts and has used accounting applicable
to such contracts (see 2.2.3.D above);
(h) product warranties issued by another party for goods sold by a manufacturer,
dealer or retailer are within the scope of IFRS 4. However, as discussed at 2.2.3.A
above, product warranties issued directly by a manufacturer, dealer or retailer are
outside the scope of IFRS 4;
(i) title insurance (insurance against the discovery of defects in title to land that were
not apparent when the contract was written). In this case, the insured event is the
discovery of a defect in the title, not the title itself;
(j) travel assistance (compensation in cash or in kind to policyholders for losses
suffered while they are travelling);
(k) catastrophe bonds that provide for reduced payments of principal, interest or both
if a specified event adversely affects the issuer of the bond (unless the specified
event does not create significant insurance risk, for example if the event is a change
in an interest rate or a foreign exchange rate);
(l) insurance swaps and other contracts that require a payment based on changes in
climatic, geological and other physical variables that are specific to a party to the
contract; and
(m) reinsurance contracts. [IFRS 4.B18].
These examples are not intended to be an exhaustive list.
The following illustrative examples provide further guidance on situations where there
is significant insurance risk:
Example 51.8: Deferred annuity with guaranteed rates
Entity A issues a contract to a policyholder who will receive, or can elect to receive, a life-contingent annuity
at rates guaranteed at inception.
This is an insurance contract unless the transfer of insurance risk is not significant. The contract transfers
mortality risk to the insurer at inception, because the insurer might have to pay significant additional benefits
for an individual contract if the annuitant elects to take the life-contingent annuity and survives longer than
expected. [IFRS 4.IG2 E1.6].
This example contrasts with Example 51.3 above where the rates were not set at the inception of the policy
and therefore that was not an insurance contract at inception.
Example 51.9: Guarantee fund established by contract
A guarantee fund is established by contract. The contract requires all participants to pay contributions to the
fund so that it can m
eet obligations incurred by participants (and, perhaps, others). Participants would
typically be from a single industry, e.g. insurance, banking or travel.
The contract that establishes the guarantee fund is an insurance contract. [IFRS 4.IG2 E1.13].
This example contrasts with Example 51.15 below where a guarantee fund has been established by law and
not by contract.
Insurance contracts (IFRS 4) 4305
Example 51.10: Insurance contract issued to employees related to a defined
contribution pension plan
An insurance contract is issued by an insurer to its employees as a result of a defined contribution pension
plan. The contractual benefits for employee service in the current and prior periods are not contingent on
future service. The insurer also issues similar contracts on the same terms to third parties.
This is an insurance contract. However, if the insurer pays part or all of its employee’s premiums, the payment
by an insurer is an employee benefit within the scope of IAS 19 and is not accounted for under IFRS 4 because
the insurer is the employer and would be paying its own insurance premiums. [IFRS 4.IG2 E1.22].
Defined benefit pension liabilities are outside the scope of IFRS 4 as discussed at 2.2.3.B above.
Example 51.11: No market value adjustment for maturity benefits
A contract permits the issuer to deduct a market value adjustment (MVA), a charge which varies depending
on a market index, from surrender values or death benefits to reflect current market prices for the underlying
assets. It does not permit an MVA for maturity benefits.
The policyholder obtains an additional survival benefit because no MVA is applied at maturity. That benefit
is a pure endowment because the insured person receives a payment on survival to a specified date but
beneficiaries receive nothing if the insured person dies before then. If the risk transferred by that benefit is
significant, the contract is an insurance contract. [IFRS 4.IG2 E1.25].
Example 51.12: No market value adjustment for death benefits
A contract permits the issuer to deduct a market value adjustment (MVA) from surrender values or
maturity payments to reflect current market prices for the underlying assets. It does not permit an MVA
for death benefits.
The policyholder obtains an additional death benefit because no MVA is applied on death. If the risk