separate and measure at fair value, a policyholder’s option to surrender an insurance
Insurance contracts (IFRS 17) 4457
contract for a fixed amount (or for an amount based on a fixed amount and an interest
rate), even if the exercise price differed from the carrying amount of the host insurance
liability. [IFRS 4.8]. Instead, the requirements of IFRS 9 decide whether an entity needs to
separate a surrender option. [IFRS 17.BC105(b)]. However, the value of a typical surrender
option and the host insurance contract are likely to be interdependent because the
component cannot be measured without the other. Therefore, in practice, this change
may not result in separation of the surrender option.
A derivative is a financial instrument within the scope of IFRS 9 with all three of the
following characteristics:
• its value changes in response to a change in a specified interest rate, financial
instrument price, commodity 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 the variable is not specific to the underlying of the contract;
• it requires no initial net investment or an initial net investment that would be
smaller than would be required for other types of contracts that would be expected
to have a similar response to changes in market factors; and
• it is settled at a future date. [IFRS 9 Appendix A].
An embedded derivative is a component of a hybrid contract that also includes a non-
derivative host with the effect that some of the cash flows of the combined instrument
vary in a way similar to a stand-alone derivative. An embedded derivative causes some or
all of the cash flows that otherwise would be required by the contract to be modified
according to a specified interest rate, financial instrument price, commodity 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 the variable is not specific to a party
to the contract. A derivative that is attached to a financial instrument but is contractually
transferable independently of that instrument, or has a different counterparty, is not an
embedded derivative, but a separate financial instrument. [IFRS 9.4.3.1].
The following are examples of embedded derivatives that may be found in insurance
contracts:
• benefits, such as death benefits, linked to equity prices or an equity index;
• options to take life-contingent annuities at guaranteed rates;
• guarantees of minimum interest rates in determining surrender or maturity values;
• guarantees of minimum annuity payments where the annuity payments are linked
to investment returns or asset prices;
• a put option for the policyholder to surrender a contract. These can be specified
in a schedule, based on the fair value of a pool of interest-bearing securities or
based on an equity or commodity price index;
• an option to receive a persistency bonus (an enhancement to policyholder benefits
for policies that remain in-force for a certain period);
• an industry loss warranty where the loss trigger is an industry loss as opposed to
an entity specific loss;
• a catastrophe trigger where a trigger is defined as a financial variable such as a drop
in a designated stock market;
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• an inflation index affecting policy deductibles;
• contracts where the currency of claims settlement differs from the currency of loss; and
• contracts with fixed foreign currency rates.
The following example illustrates an embedded derivative in an insurance contract that
is not required to be separated and accounted for under IFRS 9.
Example 52.13: Death or annuitisation benefit linked to equity prices or index
A contract has a death benefit linked to equity prices or an equity index and is payable only on death or when
annuity payments begin and not on surrender or maturity.
The equity-index feature meets the definition of an insurance contract (unless the life-contingent payments
are insignificant) because the policyholder benefits from it only when the insured event occurs and therefore
the derivative and the host insurance contract are interdependent. The embedded derivative is not required to
be separated and will be accounted for under IFRS 17. [IFRS 9.B4.3.8(h)].
The following example illustrates an embedded derivative in an insurance contract that
is required to be separated and accounted for under IFRS 9.
Example 52.14: Policyholder option to surrender contract for value based on a
market index
An insurance contract gives the policyholder the option to surrender the contract for a surrender value based
on an equity or commodity price or index.
The option is not closely related to the host insurance contract because the surrender value is derived from an
index and is therefore not interdependent with the insurance contract. Therefore the surrender option is
required to be accounted for under IFRS 9. [IFRS 9.B4.3.5(c)-(d)].
The meaning of ‘closely related’ is discussed more generally in Chapter 42 at 5.
A unit-linking feature (i.e. a contractual term that requires payments denominated in
units of an internal or external investment fund) embedded in a host financial instrument
or host insurance contract is closely related to the host instrument or host contract if
the unit-denominated payments are measured at current unit values that reflect the fair
values of the assets of the fund. [IFRS 9.B4.3.8(g)].
IFRS 9 also considers that unit-linked investment liabilities should normally be regarded
as puttable instruments that can be put back to the issuer at any time for cash equal to a
proportionate share of the net asset value of an entity, i.e. they are not closely related.
Nevertheless, the effect of separating an embedded derivative and accounting for each
component is to measure the hybrid contract at the redemption amount that is payable
at the reporting date if the unit holder had exercised its right to put the instrument back
to the issuer. [IFRS 9.B4.3.7]. This seems somewhat to contradict the fact that the unit-
linked feature is regarded as closely related (which means no separation of the feature
is required) but the accounting treatment is substantially the same.
4.2
Separating investment components from an insurance contract
IFRS 4 referred to the notion of a deposit component, [IFRS 4.10-12]. IFRS 17 does not refer
to a deposit component but, instead, introduces the new concept of an investment
component. An investment component is the amounts that an insurance contract
requires the entity to repay to a policyholder even if an insured event does not occur.
[IFRS 17 Appendix A]. An example of an investment component is an insurance contract
Insurance contracts (IFRS 17) 4459
where premiums are paid into an account balance and that balance (or a portion thereof)
is guaranteed to be repaid to the policyholder on maturity or surrender of the contract
(i.e. even if an insured event such as death does not occur – see Example 52.15 below).
Many insurance contracts have an implicit or explicit investment component that
would, if it were a separable financial instrument, be within the scope of IFRS 9.
However, the Board decided that it would be difficult to routinely separate such
investment components from insurance contracts. [IFRS 17.BC108].
Accordingly, IFRS 17 requires an entity to separate from a host insurance contract an
investment component if, and only if, that investment component is distinct from the
host insurance contract. [IFRS 17.11(b)]. The Board concluded that, in all cases, entities
would be able to measure the stand-alone value for a separated investment component
by applying IFRS 9. [IFRS 17.BC109].
The words ‘if, and only if’ mean that voluntary separation of investment components which
are not distinct is prohibited. This is a change from IFRS 4, which permitted voluntary
unbundling of deposit components if the deposit component could be measured
separately. The Board considered whether to permit an entity to separate a non-insurance
component when not required to do so by IFRS 17; for example, some investment
components with interrelated cash flows, such as policy loans. Such components may have
been separated when applying previous accounting practices. However, the Board
concluded that it would not be possible to separate in a non-arbitrary way a component
that is not distinct from the insurance contract nor would such a result be desirable. The
Board also noted that when separation ignores interdependencies between insurance and
non-insurance components, the sum of the values of the components may not always equal
the value of the contract as a whole, even on initial recognition. That would reduce the
comparability of the financial statements across entities. [IFRS 17.BC114].
An investment component is distinct if, and only if, both the following conditions are
met: [IFRS 17.B31]
• the investment component and the insurance component are not highly
interrelated; and
• a contract with equivalent terms is sold, or could be sold, separately in the same
market or the same jurisdiction, either by entities that issue insurance contracts or
by other parties. The entity should take into account all information reasonably
available in making this determination. The entity is not required to undertake an
exhaustive search to identify whether an investment component is sold separately.
An investment component and an insurance component are highly interrelated if, and
only if: [IFRS 17.B32]
• the entity is unable to measure one component without considering the other. Thus, if
the value of one component varies according to the value of the other, an entity should
apply IFRS 17 to account for the combined investment and insurance component; or
• the policyholder is unable to benefit from one component unless the other is also
present. Thus, if the lapse or maturity of one component in a contract causes the
lapse or maturity of the other, the entity should apply IFRS 17 to account for the
combined investment component and insurance component.
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In addition to the example of a contract with a repayable account balance, another
example of an investment component is a no-claims bonus (NCB) whereby the
policyholder is guaranteed a refund of the premium if no claims are paid on the contract
(this guaranteed amount might be withheld and never be actually paid to the (re)insurer).
The word ‘even’ in the definition is important here as it implies that an entity would have
to consider if an event does not occur in addition to what happens if an event does occur.
Although an entity applies IFRS 17 to account for both the combined investment and
insurance components of an insurance contract if those components are highly
interrelated, insurance revenue and insurance service expenses presented in profit or
loss must exclude any non-separated investment component. [IFRS 17.85, BC108(b)].
The following example, taken from Example 4 accompanying IFRS 17, illustrates the
requirements for separating non-insurance components from insurance contracts for a
contract with an account balance. [IFRS 17.IE43-51].
Example 52.15: Separating components from a life insurance contract with an
account balance
An entity issues a life insurance contract with an account balance. The entity receives a premium of $1,000
when the contract is issued. The account balance is increased annually by voluntary amounts paid by the
policyholder, increased or decreased by amounts calculated using the returns from specified assets and
decreased by fees charged by the entity (e.g. asset management fees).
The contract promises to pay the following:
• a death benefit of $5,000 plus the amount of the account balance if the insured person dies during the
coverage period; and
• the account balance, if the contract is cancelled (i.e. there are no surrender charges).
The entity has a claims processing department to process the claims received and an asset management
department to manage investments. An investment product that has equivalent terms to the account balance,
but without the insurance coverage, is sold by another financial institution.
Analysis
The existence of an investment product with equivalent terms indicates that the components may be distinct.
However, if the right to provide death benefits provided by the insurance coverage either lapses or matures
at the same time as the account balance, the insurance and investment components are highly interrelated and
are therefore not distinct. Consequently, the account balance would not be separated from the insurance
contract and would be accounted for by applying IFRS 17. However, any revenue and expenses related to the
investment component would not be presented as insurance revenue or insurance service expenses.
Claims processing activities are part of the activities the entity must undertake to fulfil the contract and the
entity does not transfer a good or service to the policyholder because the entity performs those activities.
Thus, the entity would not separate the claims processing component from the insurance contract.
The asset management activities, similarly to claims processing activities, are part of the activities the entity
must undertake to fulfil the contract and the entity does not transfer a good or service to the policyholder
because the entity performs those activities. Thus, the entity would not separate the asset management
component from the insurance contract.
The requirements in IFRS 17 for separating investment components do not specifically
address the issue of contracts artificially separated through the use of side letters, the
separate components of which should be considered together. However, IFRS 17 does
state that it may be necessary to treat a 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
Insurance contracts (IFRS 17) 4461
contract entered into at the same time with the same counterparty, the combined effect
is that no rights or obligations exist (see 3.2.2 above). [IFRS 17.9].
4.3
Separating a promise to provide distinct goods and non-
insurance services from insurance contracts
component from a host insurance contract, an entity is required to separate from the host
insurance contract any promise to transfer distinct goods or services to a policyholder by
applying the requirements of IFRS 15 for a contract that is partially within the scope of
IFRS 15 and partially within the scope of other standards. [IFRS 17.12]. See Chapter 28 at 3.4.
This means that, on initial recognition, an entity should: [IFRS 17.13]
• apply IFRS 15 to attribute the cash inflows between the insurance component and
any promises to provide distinct goods or non-insurance services; and
• attribute the cash inflows between the insurance component and any promised
goods and non-insurance services accounted for by applying IFRS 15 so that:
• cash inflows that relate directly to each component are attributed to that
component; and
• any remaining cash inflows are attributed on a systematic and rational basis,
reflecting the cash outflows the entity would expect to arise if that component
were a separate contract.
The allocation of the cash flows between the host insurance contract and the distinct good
or non-insurance service should be based on the stand-alone selling price of the
components. The Board believes that in most cases entities would be able to determine
an observable stand-alone selling price for the bundled goods or services if those
components meet the separation criteria. [IFRS 17.BC111]. If the stand-alone selling price is
not directly observable, an entity would need to estimate the stand-alone selling price of
each component to allocate the transaction price. This stand-alone selling price might not
be directly observable if the entity does not sell the insurance and the goods or
components separately, or if the consideration charged for the two components together
differs from the stand-alone selling prices for each component. In this case, applying
IFRS 15 results in any discounts and cross-subsidies being allocated to components
proportionately or on the basis of observable evidence. [IFRS 17.BC112]. IFRS 17 requires that
cash outflows should be allocated to their related component, and that cash outflows not
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