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Background
IFRS 4=
is
the first guidance from the IASB on accounting for insurance contracts
– but not the last. A Second Phase of the =
IASB's Insurance Project is under way. The Bo=
ard
issued IFRS 4 because it saw an urgent need for improved disclosures for
insurance contracts, and modest improvements to recognition and measure=
ment
practices, in time for the adoption of IFRS by listed companies through=
out Europe and elsewhere in 2005. The improvements =
to
recognition and measurement are ones that will not likely have to be
reversed when the IASB completes the second phase of the project. =
Summary of IFRS 4
Sco=
pe. IFRS 4 applies=
to
virtually all insurance contracts (including reinsurance contracts) tha=
t an
entity issues and to reinsurance contracts that it holds. It does not a=
pply
to other assets and liabilities of an insurer, such as financial assets=
and
financial liabilities within the scope of IAS 39 Financial Instruments:
Recognition and Measurement. Furthermore, it does not address accountin=
g by
policyholders.
Def=
inition
of insurance contract. An insurance contract is a "contract under whi=
ch
one party (the insurer) accepts significant insurance risk from another
party (the policyholder) by agreeing to compensate the policyholder if a
specified uncertain future event (the insured event) adversely affects =
the
policyholder."
Acc=
ounting
policies. The IFRS exempts an insurer temporarily (until completion=
of Phase II of the I=
nsurance
Project) from some requirements of other IFRSs,
including the requirement to consider the IASB's
Framework in selecting accounting policies for insurance contracts.
However, the IFRS:
- Prohibits provisions f=
or
possible claims under contracts that are not in existence at the
reporting date (such as catastrophe and equal=
isation
provisions).
- Requires a test for the
adequacy of recognised insurance liabi=
lities
and an impairment test for reinsurance assets. <=
/li>
- Requires an insurer to=
keep
insurance liabilities in its balance sheet until they are discharg=
ed
or cancelled, or expire, and prohibits offsetting insurance
liabilities against related reinsurance assets. =
Cha=
nges
in accounting policies. IFRS 4 permits an insurer to change its accounting
policies for insurance contracts only if, as a result, its financial
statements present information that is more relevant and no less reliab=
le,
or more reliable and no less relevant. In particular, an insurer cannot
introduce any of the following practices, although it may continue using
accounting policies that involve them:
- Measuring insurance
liabilities on an undiscounted basis.
- Measuring contractual =
rights
to future investment management fees at an amount that exceeds the=
ir
fair value as implied by a comparison with current market-based fe=
es
for similar services.
- Using non-uniform acco=
unting
policies for the insurance liabilities of subsidiaries.
Remeasuring insurance liabilities. The IFRS permi=
ts the
introduction of an accounting policy that involves remeasuring
designated insurance liabilities consistently in each period to reflect
current market interest rates (and, if the insurer so elects, other cur=
rent
estimates and assumptions). Without this permission, an insurer would h=
ave
been required to apply the change in accounting policies consistently to
all similar liabilities.
Pru=
dence. An insurer nee=
d not
change its accounting policies for insurance contracts to eliminate
excessive prudence. However, if an insurer already measures its insuran=
ce
contracts with sufficient prudence, it should not introduce additional
prudence.
Fut=
ure
investment margins. There is a rebuttable
presumption that an insurer's financial statements will become less
relevant and reliable if it introduces an accounting policy that reflec=
ts
future investment margins in the measurement of insurance contracts.
Ass=
et
classifications. When an insurer changes its accounting policies for insur=
ance
liabilities, it may reclassify some or all financial assets as 'at fair
value through profit or loss'.
Oth=
er
issues. The IFRS:
- Clarifies that an insu=
rer
need not account for an embedded derivative separately at fair val=
ue
if the embedded derivative meets the definition of an insurance
contract.
- Requires an insurer to=
unbundle (that is, to account separately for)
deposit components of some insurance contracts, to avoid the omiss=
ion
of assets and liabilities from its balance sheet.
- Clarifies the applicab=
ility
of the practice sometimes known as 'shadow accounting'.
- Permits an expanded
presentation for insurance contracts acquired in a business
combination or portfolio transfer.
- Addresses limited aspe=
cts of
discretionary participation features contained in insurance contra=
cts
or financial instruments.
Dis=
closures. The IFRS requi=
res
disclosure of:
- Information that helps=
users
understand the amounts in the insurer's financial statements that
arise from insurance contracts:
- Accounting policies f=
or
insurance contracts and related assets, liabilities, income, and
expense.
- The recognised
assets, liabilities, income, expense, and cash flows arising from
insurance contracts.
- If the insurer is a <=
span
class=3DSpellE>cedant, certain additional disclosures are
required.
- Information about the
assumptions that have the greatest effect on the measurement of
assets, liabilities, income, and expense including, if practicabl=
e,
quantified disclosure of those assumptions.
- The effect of changes=
in
assumptions.
- Reconciliations of ch=
anges
in insurance liabilities, reinsurance assets, and, if any, related
deferred acquisition costs.
- Information that helps=
users
understand the amount, timing and uncertainty of future cash flows
from insurance contracts:
- Risk management objec=
tives
and policies.
- Those terms and condi=
tions
of insurance contracts that have a material effect on the amount,
timing, and uncertainty of the insurer's future cash flows.<=
/o:p>
- Information about ins=
urance
risk (both before and after risk mitigation by reinsurance),
including information about:
- The sensitivity of p=
rofit
or loss and equity to changes in variables that have a material
effect on them.
- Concentrations of
insurance risk.
- Actual claims compar=
ed
with previous estimates.
- The information about
interest rate risk and credit risk that IAS 32 would require if t=
he
insurance contracts were within the scope of IAS 32.
- Information about exp=
osures
to interest rate risk or market risk under embedded derivatives
contained in a host insurance contract if the insurer is not requ=
ired
to, and does not, measure the embedded derivatives at fair value.=
Eff=
ective
date.
Entities should apply the IFRS for annual periods beginning on or after=
1
January 2005, but earlier application is encouraged. An insurer need not
apply some aspects of the IFRS to comparative information that relates =
to
annual periods beginning before 1 January 2005.
August =
2005
Amendment to IAS 39 and IFRS 4 – Financial Guarantee Contracts
On 18 =
August
2005, the IASB has amended the scope of IAS 39 to include financial
guarantee contracts issued. However, if an issuer of financial guarantee
contracts has previously asserted explicitly that it regards such contr=
acts
as insurance contracts and has used accounting applicable to insurance
contracts, the issuer may elect to apply either IAS 39 or IFRS 4 Insur=
ance
Contracts to such financial guarantee contracts. =
A fina=
ncial
guarantee contract is a contract that requires the issuer to make speci=
fied
payments to reimburse the holder for a loss it incurs because a specifi=
ed
debtor fails to make payment when due.
Under =
IAS 39
as amended, financial guarantee contracts are initially recognised
at fair value and are subsequently measured at the greater of (a) the
amount determined in accordance with IAS 37 and (b) the amount initiall=
y recognised less, where appropriate, cumulative amortisation recognised in
accordance with IAS 18. The issuer may make that election contract by
contract, but the election for each contract is irrevocable.
The
amendments to IAS 39 and IFRS 4 are effective for annual periods beginn=
ing
on or after 1 January 2006, with earlier application encouraged. <=
/o:p>
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