International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards
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Insurers often make investments on behalf of policyholders as well as on behalf of
shareholders. In some cases, this can result in the insurer holding an interest in an entity
which, either on its own, or when combined with the interest of the policyholder, gives
the insurer control of that entity (as defined by IFRS 10).
8
CHANGES IN ACCOUNTING POLICIES
IFRS 4 imposes a number of constraints that apply whenever an insurer wishes to
change its accounting policies for insurance contracts. These requirements apply both
to changes made by an insurer that already applies IFRS and to changes made by an
insurer adopting IFRS for the first time. [IFRS 4.21].
They reflect the IASB’s concern that insurers might change their existing policies to
ones that are less relevant or reliable contrary to the requirements of IAS 8. One option
would have been for the IASB to prohibit any changes in accounting policies to prevent
lack of comparability (especially within a country) and management discretion to make
arbitrary changes. However, it decided to permit changes in accounting policies for
insurance contracts provided they can be justified, as is required for any change in
accounting policy under IFRS. [IFRS 4.BC123, 125].
The general and specific requirements relating to changes in accounting policies are
discussed below.
8.1
Criteria for accounting policy changes
An insurer may change its accounting policies for insurance contracts 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.
Relevance and reliability should be judged by the criteria in IAS 8. [IFRS 4.22].
Relevance relates to the economic decision-making needs of users and reliability, in
reference to the financial statements, relates to faithful representation, the economic
substance of transactions and not merely their legal form, freedom from bias, prudence
and completion in all material respects. [IAS 8.10]. In making judgements regarding
relevance and reliability management should refer to the requirements in IFRSs dealing
with similar and related issues and the definitions, recognition criteria and measurement
concepts in the IASB Framework. Management may also consider the most recent
pronouncements of other standard-setting bodies that use a similar conceptual
framework to develop accounting standards, other accounting literature and accepted
industry practices to the extent that they do not conflict with IFRS. [IAS 8.11-12].
The Board also considered that, as what became IFRS 17 developed, the expected
requirements of the new standard would give insurers further context for judgements
about whether a change in accounting policy would make the financial statements more
relevant and reliable (i.e. in determining whether a new accounting policy was more
relevant an entity could look to what became IFRS 17). [IFRS 4.BC123]. Any such change in
an insurer’s accounting policies should have brought the insurer’s financial statements
closer to meeting the relevance and reliability criteria in IAS 8, but did not need to
Insurance contracts (IFRS 4) 4337
achieve full compliance with those criteria. [IFRS 4.23]. Now that IFRS 17 has been issued
it is possible that some insurers, whilst still applying IFRS 4, will consider changing their
accounting policies to better align them with the requirements of IFRS 17.
IAS 8 requires changes in accounting policies for which there are no specific transitional
provisions to be applied retrospectively. As IFRS 4 does not contain any transitional
provisions for changes in accounting policies for insurance contracts, any such changes
will have to be retrospective, unless impracticable. [IAS 8.19].
8.2 Specific
issues
In addition to the more general criteria considered at 8.1 above, certain changes of
accounting policy are specifically addressed in IFRS 4. The need for the IASB to
establish requirements in respect of these issues perhaps indicates that the criteria
above are not as clear-cut on certain matters as the IASB would like.
The following are discussed below:
• continuation of existing practices;
• current market interest rates;
• prudence; and
• future investment margins. [IFRS 4.23].
Shadow accounting is discussed separately at 8.3 below.
8.2.1
Continuation of existing practices
An insurer may continue the following practices but the introduction of any of them
after IFRS has been adopted is not permitted because the IASB believes that they do
not satisfy the criteria discussed at 8.1 above. [IFRS 4.25].
8.2.1.A
Measuring insurance liabilities on an undiscounted basis
Under many bodies of local GAAP, non-life insurance liabilities are not discounted to reflect
the time value of money. In the IASB’s view, discounting of insurance liabilities results in
financial statements that are more relevant and reliable. Hence, a change from a policy of
discounting to not discounting liabilities is not permitted. [IFRS 4.25(a)]. The IASB decided
against requiring insurance liabilities to be discounted in IFRS 4 because it had not addressed
the issue of the discount rate(s) to be used and the basis for any risk adjustments. [IFRS 4.BC126].
8.2.1.B
Measuring contractual rights to future investment management fees in
excess of their fair value
It is not uncommon to find insurance contracts that give the insurer an entitlement to
receive a periodic investment management fee. Some local GAAP accounting policies
permit the insurer, in determining the value of its contractual rights and obligations
under the insurance contract, to discount the estimated cash flows related to those fees
at a discount rate that reflects the risks associated with the cash flows. This approach is
found in some embedded value methodologies. [IFRS 4.BC128].
In the IASB’s opinion, however, this approach can lead to results that are not consistent
with fair value measurement. The IASB considers that if the insurer’s contractual asset
management fee is in line with the fee charged by other insurers and asset managers for
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comparable asset management services, the fair value of the contractual right to that fee
would be approximately equal to what it would cost insurers and asset managers to
acquire similar contractual rights. This approach is considered by the IASB to be
consistent with how to account for servicing rights and obligations in IAS 39 or IFRS 9.
Therefore, IFRS 4 does not permit an insurer to introduce an accounting policy that
measures those contractual rights at more than their fair value as implied by fees
charged by others for comparable services. [IFRS 4.BC129].
The reasoning behind this requirement is that the fair value at inception of such
contractual rights will equal the origination costs paid, unless future investment
management fees and related costs are out of line with market comparables. [IFRS 4.25(b)].
8.2.1.C Introducing
non-uniform
accounting policies for the insurance contracts
; of subsidiaries
IFRS 10 requires consolidated financial statements to be prepared using uniform
accounting policies for like transactions. [IFRS 10.19]. However, under current local
requirements, some insurers consolidate subsidiaries without using the parent company’s
accounting policies for the measurement of the subsidiaries’ insurance liabilities (and
related deferred acquisition costs and intangible assets) which continue to be measured
under the relevant local GAAP applying in each jurisdiction. [IFRS 4.BC131].
The use of non-uniform accounting policies in consolidated financial statements
reduces the relevance and reliability of financial statements and is not permitted by
IFRS 10. However, prohibiting this practice in IFRS 4 would have forced some insurers
to change their accounting policies for the insurance liabilities for some of their
subsidiaries, requiring systems changes now that might not be subsequently required
following what became IFRS 17. Therefore, the IASB decided that an insurer could
continue to use non-uniform accounting policies to account for insurance contracts. If
those accounting policies are not uniform, an insurer may change them if the change
does not make the accounting policies more diverse and also satisfies the criteria set out
at 8.1 above. [IFRS 4.25(c), BC132].
There is one exception to this requirement which is discussed at 8.2.2 below.
Old Mutual is an example of a company that applies non-uniform accounting policies
to the measurement of its insurance contract liabilities.
Extract 51.8: Old Mutual plc (2016)
Notes to the consolidated financial statements [extract]
G: Analysis of financial assets and liabilities [extract]
G6: Insurance and investment contracts [extract]
Insurance contract liabilities [extract]
Insurance contract liabilities for African businesses have been computed using a gross premium valuation method.
Provisions in respect of African business have been made in accordance with the Financial Soundness Valuation basis
as set out in the guidelines issued by the Actuarial Society of South Africa in Standard of Actuarial Practice (SAP)
104 (2012). Under this guideline, provisions are valued using realistic expectations of future experience, with margins
for prudence and deferral of profit emergence.
[...]
For other territories, the valuation bases adopted are in accordance with local actuarial practices and methodologies.
Insurance contracts (IFRS 4) 4339
8.2.2
Current market interest rates
An insurer is permitted, but not required, to change its accounting policies so that it
remeasures designated insurance liabilities (including related deferred acquisition costs
and related intangible assets) to reflect current market interest rates. Any changes in
these rates would need to be recognised in profit or loss. At that time, it may also
introduce accounting policies that require other current estimates and assumptions for
the designated liabilities. An insurer may change its accounting policies for designated
liabilities without applying those policies consistently to all similar liabilities as IAS 8
would otherwise require. If an insurer designates liabilities for this election, it should
apply current market interest rates (and, if applicable, the other current estimates and
assumptions) consistently in all periods to all those liabilities until they are extinguished.
[IFRS 4.24].
The purpose of this concession is to allow insurers to move, in whole or in part, towards
the use of fair value-based measures for insurance contracts.
AXA is an example of an insurance group which has used this option for some of its
insurance contracts.
Extract 51.9: AXA SA (2016)
5.6 Notes to the consolidated financial statements [extract]
1.14.2. Insurance contracts and investment contracts with discretionary participating features [extract]
Some guaranteed benefits such as Guaranteed Minimum Death or Income Benefits (GMDB or GMIB), or certain
guarantees on return proposed by reinsurance treaties, are covered by a Risk Management program using derivative
instruments. In order to minimize the accounting mismatch between liabilities and hedging derivatives, AXA has
chosen to use the option allowed under IFRS 4.24 to re-measure its provisions: this revaluation is carried out at each
accounts closing based on guarantee level projections and considers interest rates and other market assumptions. The
liabilities revaluation impact in the current period is recognized through income, symmetrically with the impact of
the change in value of hedging derivatives. This change in accounting principles was adopted on the first time
application of IFRS on January 1, 2004 for contracts portfolios covered by the Risk Management program at that
date. Any additional contract portfolios covered by the Risk Management program after this date are valued on the
same terms as those that applied on the date the program was first applied.
Our view is that, where an entity has elected to account for some, but not all, of its
insurance products using current market interest rates, or other current estimates and
assumptions, it cannot selectively disregard an input variable, such as a change in
interest rates, to determine the value of those liabilities. The input variable must be used
every time those insurance contracts are valued.
8.2.3 Prudence
In the IASB’s opinion, insurers sometimes measure insurance liabilities on what is
intended to be a highly prudent basis that lacks the neutrality required by the IASB’s
Framework. This may be particularly true for insurers who are required under local
GAAP to measure their liabilities on a regulatory basis. However, IFRS 4 does not define
how much prudence is ‘sufficient’ and therefore does not require the elimination of
‘excessive prudence’. [IFRS 4.BC133]. As a result, insurers are not required under IFRS 4 to
change their accounting policies to eliminate excessive prudence. However, if an
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insurer already measures its insurance contracts with sufficient prudence, it should not
introduce additional prudence. [IFRS 4.26].
The liability adequacy test requirements discussed at 7.2.2 above address the converse
issue of understated insurance liabilities.
8.2.4
Future investment margins
An insurer need not change its accounting policies for insurance contracts to eliminate
the recognition of future investment margins (which may occur under some forms of
embedded value accounting). However, IFRS 4 imposes a rebuttable presumption that
an insurer’s financial statements will become less relevant and reliable if it introduces
an accounting policy that reflects future investment margins in the measurement of
insurance contracts, unless those margins directly affect the contractual payments.
Two examples of accounting policies that reflect those margins are:
(a) using a discount rate that reflects the estimated return on the insurer’s assets; and
(b) projecting the returns on those assets at an estimated rate of return, discounting
those projected returns at a different rate and including the result in the
measurement of the liability. [IFRS 4.27].
Such accounting policies are used in some embedded
value methodologies. For
example, the European Insurance CFO Forum European Embedded Value (EEV)
Principles state that the value of future cash flows from in-force covered business
should be the present value of future shareholder cash flows projected to emerge from
the assets backing the liabilities of the in-force covered business reduced by the value
of financial options and guarantees.6 The EEV methodology is considered to be an
indirect method of measuring the insurance liability because the measurement of the
liability is derived from the related asset. In contrast, direct methods measure the
liability by discounting future cash flows arising from the book of insurance contracts
only. If the same assumptions are made in both direct and indirect methods, they can
produce the same results. [IFRS 4.BC138].
The IASB appears to have been concerned that insurers might take advantage of the
lack of specific accounting guidance for insurance contracts in IFRS 4 as an opportunity
to change their accounting policies to an embedded value basis on the grounds that this
was more relevant and no less reliable, or more reliable and no less relevant than their
existing accounting policies (possibly prepared on an ‘excessively prudent’ regulatory
basis). The use of embedded value measures by insurers is discussed at 1.3.3 above.
The IASB’s view is that the cash flows arising from an asset are irrelevant for the
measurement of a liability unless those cash flows affect (a) the cash flows arising from
the liability or (b) the credit characteristics of the liability. Therefore, the IASB considers
that the following two embedded value approaches involve practices that are
incompatible with IFRS, namely:
• applying an asset discount rate to insurance liabilities; and
• measuring contractual rights to investment management fees at an amount that
exceeds their fair value (see 8.2.1.B above).
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However, the IASB concluded that it could not eliminate these practices, where they
were existing accounting policies, until IFRS 17 gives guidance on the appropriate
discount rates and the basis for risk adjustments and therefore the use of asset-based
discount rates for the measurement of insurance liabilities is not prohibited.