International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards
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Insurance contracts (IFRS 17) 4441
such as banks and service companies, applied guidance from other standards, such as
IFRS 9 and IFRS 15, to recognise and measure insurance contracts. This is no longer
possible since IFRS 17 has specific recognition, measurement and presentation
requirements for financial statements. In May 2018, the IASB staff agreed to perform
outreach on three categories of contracts typically issued by non-insurance entities to
better understand the nature of the contracts and how they are accounted for today (i.e.
pre-IFRS 17). The three categories of contracts are:
• loan contracts that may waive some or all of the payments due under the contract
in specific circumstances;
• service contracts including a form of EBITDA guarantee; and
• credit card contracts providing coverage for a supplier failure.
An entity should consider its substantive rights and obligations, whether they arise from
a contract, law or regulation, when applying IFRS 17. A contract is an agreement
between two or more parties that creates enforceable rights and obligations.
Enforceability of the rights and obligations in a contract is a matter of law. Contracts can
be written, oral or implied by an entity’s customary business practices. Contractual
terms include all terms in a contract, explicit or implied, but an entity should disregard
terms that have no commercial substance (i.e. no discernible effect on the economics of
the contract). Implied terms in a contract include those imposed by law or regulation.
The practices and processes for establishing contracts with customers vary across legal
jurisdictions, industries and entities. In addition, they may vary within an entity (for
example, they may depend on the class of customer or the nature of the promised goods
or services). [IFRS 17.2]. The Basis for Conclusions observes that these considerations are
consistent with IFRS 15 and apply when an entity classifies a contract and when
assessing the substantive rights and obligations for determining the boundary of a
contract. [IFRS 17.BC69].
The rest of this section discusses the definition of an insurance contract in more detail
as follows:
• significant insurance risk (see 3.2 below);
• changes in the level of insurance risk (see 3.3 below);
• uncertain future events (see 3.4 below);
• payments in kind (see 3.5 below);
• the distinction between insurance risk and other risks (see 3.6 below); and
• examples of insurance and non-insurance contracts (see 3.7 below).
3.2 Significant
insurance
risk
A contract is an insurance contract only if it transfers ‘significant insurance risk’.
[IFRS 17.B17].
Insurance risk is ‘significant’ if, and only if, an insured event could cause an insurer to
pay significant additional amounts in any scenario, excluding scenarios that lack
commercial substance (i.e. have no discernible effect on the economics of the
transaction). If an insured event could mean significant additional amounts would be
payable in scenarios that have commercial substance, this condition may be met even if
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the insured event is extremely unlikely or even if the expected (i.e. probability-
weighted) present value of contingent cash flows is a small proportion of the expected
present value of all the remaining contractual cash flows. [IFRS 17.B18].
In addition, a contract transfers significant insurance risk only if there is a scenario that
has commercial substance in which the issuer has a possibility of a loss on a present
value basis. However, even if a reinsurance contract does not expose the issuer to the
possibility of a significant loss, that contract is deemed to transfer significant insurance
risk if it transfers to the reinsurer substantially all the insurance risk relating to the
reinsured portions of the underlying insurance contracts. [IFRS 17.B19].
The additional amounts described above are determined on a present value basis. If an
insurance contract requires payment when an event with uncertain timing occurs and if
the payment is not adjusted for the time value of money, there may be scenarios in
which the present value of the payment increases, even if its nominal value is fixed. An
example is insurance that provides a fixed death benefit when the policyholder dies,
with no expiry date for the cover (often referred to as whole-life insurance for a fixed
amount). It is certain that the policyholder will die, but the date of death is uncertain.
Payments may be made when an individual policyholder dies earlier than expected.
Because those payments are not adjusted for the time value of money, significant
insurance risk could exist even if there is no overall loss on the portfolio of contracts.
Similarly, contractual terms that delay timely reimbursement to the policyholder can
eliminate significant insurance risk. An entity should use the discount rates required as
discussed at 8.3 below to determine the present value of the additional amounts.
[IFRS 17.B20].
IFRS 17 does not prohibit a contract from being an insurance contract if there are
restrictions on the timing of payments or receipts. However, the existence of
restrictions on the timing of payments may mean that the policy does not transfer
significant insurance risk if it results in the lack of a scenario that has commercial
substance in which the issuer has a possibility of a loss on a present value basis.
3.2.1
Quantity of insurance risk
No quantitative guidance supports the determination of ‘significant’ in IFRS 17. This was
a deliberate decision because the IASB considered that if quantitative guidance was
provided it would create an arbitrary dividing line that would result in different
accounting treatments for similar transactions that fall marginally on different sides of
that line and would therefore create opportunities for accounting arbitrage. [IFRS 17.BC78].
The IASB also rejected defining the significance of insurance risk by reference to the
definition of materiality within the Conceptual Framework for Financial Reporting
because, in its opinion, a single contract, or even a single book of similar contracts,
would rarely generate a loss that would be material to the financial statements as a
whole. Consequently, IFRS 17 defines the significance of insurance risk in relation to
individual contracts (see 3.2.2 below). [IFRS 17.BC79].
The IASB also rejected the notion of defining significance of insurance risk by
expressing the expected (probability weighted) average of the present values of the
adverse outcomes as a proportion of the expected present value of all outcomes, or as
a proportion of the premium. This definition would mean that a contract could start as
Insurance contracts (IFRS 17) 4443
a financial liability and become an insurance contract as time passes or probabilities are
reassessed. This idea would have required the constant monitoring of contracts over
their life to see whether they continued to transfer insurance risk. The IASB considered
that it would be too burdensome to require an entity to continuously monitor whether
a contracts meets the definition of an insurance contr
act over its duration.
Consequently, as discussed at 3.3 below, an assessment of whether significant insurance
risk has been transferred is normally required only at the inception of a contract.
[IFRS 17.BC80].
IFRS 4 contained an illustrative example which implied insured benefits must be greater
than 101% of the benefits payable if the insured event did not occur for there to be
insurance risk in an insurance contract. [IFRS 4.IG2.E1.3]. However, no equivalent example
has been included in IFRS 17.
Some jurisdictions have their own guidance as to what constitutes significant insurance
risk. However, other jurisdictions offer no quantitative guidance. Some US GAAP
practitioners apply a guideline that a reasonable possibility of a significant loss is a 10%
probability of a 10% loss although this guideline does not appear in US GAAP itself.
[IFRS 17.BC77]. It is not disputed in the Basis for Conclusions that a 10% chance of a 10% loss
results in a transfer of significant insurance risk and, indeed, the words ‘extremely unlikely’
and ‘a small proportion’ (see 3.2 above) suggests that the IASB envisages that significant
insurance risk could exist at a different threshold than a 10% probability of a 10% loss.
This lack of a quantitative definition means that insurers must apply their own
judgement as to what constitutes significant insurance risk. Although the IASB did not
want to create an ‘arbitrary dividing line’, the practical impact of this lack of guidance is
that insurers have to apply their own criteria to what constitutes significant insurance
risk and there will probably be inconsistency in practice as to what these dividing lines
are, at least at the margins.
There is no specific requirement under IFRS 17 for insurers to disclose any thresholds
used in determining whether a contract contains significant insurance risk. However,
IFRS 17 requires an entity to disclose the significant judgements made in applying
IFRS 17 (see 16.2 below) whilst IAS 1 – Presentation of Financial Statements – requires
an entity to disclose the judgements that management has made in the process of
applying the entity’s accounting policies that have the most significant effect on the
amounts recognised in the financial statements (see Chapter 3 at 5.1.1.B).
3.2.2
The level at which significant insurance risk is assessed
Significant insurance risk must be assessed by individual contract, rather than by
portfolios or groups of contracts or by reference to materiality to the financial
statements. Thus, insurance risk may be significant even if there is a minimal probability
of significant losses for a portfolio or group of contracts. [IFRS 17.B22]. There is no
exception to the requirement for assessment at an individual contract level, unlike
IFRS 4 which permitted an insurer to make an assessment based on a small book of
contracts if those contracts were relatively homogeneous.
The IASB decided to define significant insurance risk in relation to a single contract rather
than at a higher level of aggregation because, although contracts are usually managed on
a portfolio basis, the contractual rights and obligations arise from individual contracts.
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Materiality by reference to the financial statements was considered an inappropriate basis
to define significant insurance risk because a single contract, or even a single book of
similar contracts, would rarely generate a material loss in relation to the financial
statements as a whole. [IFRS 17.BC79].
A set or series of insurance contracts with the same or a related counterparty may
achieve, or be designed to achieve, an overall commercial effect. In those
circumstances, it may be necessary to treat the set or series of contracts as a whole in
order to report the substance of such contracts. For example, if the rights or obligations
in one contract do nothing other than entirely negate the rights or obligations of another
contract entered into at the same time with the same counterparty, the combined effect
is that no rights or obligations exist. [IFRS 17.9]. 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).
If an insurance contract is separated into non-insurance components and insurance
components (see 4 below) the significance of insurance risk transferred is assessed by
reference only to the remaining components of the host insurance contract. [IFRS 17.13].
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 with
a third party. [IFRS 17.B27(c)]. 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 17 applies to those contracts. [IFRS 17.B16].
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 17 from the viewpoint of the consolidated financial
statements of a non-insurer because policyholder accounting is excluded from IFRS 17
as discussed at 2.3.1.G above.
Insurance contracts (IFRS 17) 4445
3.2.3 Significant
additional
amounts
The ‘significant additional amounts’ described at 3.2 above refer to the present value of
amounts that exceed those that would be payable if no insured event occurred
(excluding scenarios that lack commercial substance). These additional amounts include
claims handling and claims assessment costs, but exclude: [IFRS 17.B21]
(a) the loss of the ability to charge the policyholder for future service. For example,
in an investment-linked life contract, the death of the policyholder means that
the entity can no longer perform investment management services and collect a
; fee for doing so. However, the economic loss for the entity does not result from
insurance risk. Consequently, the potential loss or future investment
management fees is not relevant when 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, their waiver 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 £1m if an asset
suffers physical damage causing an insignificant economic loss of £1 to the
holder. The holder in this case has transferred to the insurer the insignificant
insurance risk of losing £1. At the same time the contract creates non-insurance
risk that the issuer will need to pay an additional £999,999 if the specified event
occurs. Because there is no scenario in which an insured event causes a
significant loss to the holder of the contract, the issuer does not accept
significant insurance risk from the holder and this contract is not an insurance
contract; and
(d) possible reinsurance recoveries. The insurer will account for these separately.
It follows from this that if a contract pays a death benefit exceeding the amount payable
on survival (excluding any waiver or surrender charges as per (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 portfolio 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 17.B23].
3.3
Changes in the level of insurance risk
IFRS 17 requires the assessment of whether a contract transfers significant insurance