IFRS PRACTICAL IMPLEMENTATION GUIDE AND WORKBOOK

Chapter 36 / Insurance Contracts (IFRS 4)

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6.3 An example might be a p rofit- sh aring rein su ra nce contract where the cedent is g iven a guar– a ntee as to the minimum repaymen t of th e premium. As wi th embedded de rivatives, insurers need to identify any pol ic ies th at may require unbundling . Gen erall y speaki ng, any deposit com po ne nt is subject to lAS 39 and any in suran ce feat ure is subject to ex isting accounting poli ci es. Practical Insight An entity is required or permitted to unbundle the in surance and deposit compo nents of in surance contrac ts that conta in both. For a contrac t that is unbundled, th e entity is re quire d to apply lAS 39 to th e deposit compo ne nt. 6.4 IFRS 4 also clarifies the ap plicabi lity of a practice th at is often called shadow accounting. This practice allows ins urers to adjust the ir liab ilities for any c hanges that have arisen if any unre– a lize d ga ins and losses on assets have been realized. An insurer is permitted to c ha nge its accounting po licies suc h th at recognized , but unreal ized gai ns or lo sses, also adj ust the ir liab il ities. Any movements in the liabil ity may be recogn ized in eq uity only if unreal ized gai ns or lo sses are re cognized directl y in equity . Facts Entity A has a reinsurance contract that has these elements to it: A policyholder under a reinsurance contract pays premiums of $200 every year for 10 years. The entity sets up an experience acco unt equal to 80% of the cumulative premiums less 80% of the cumulative claims under the policy. If the ba lance in the experience account ever becomes negative, the policyholder has to pay an additional premium based on the balance on the experience account divided by the number of years the policy has left to run. At the end of the contract, if the balance on the experience account is positive, it is refunded to the polic y– holder. If the balance is negative, the policyholder has to pay the amou nt as an additional premi um. The policy is not able to be cancelled before the end of the contract, and the maximum loss that the policy– holder is required to pay in any year is $300 . Required Discuss how the reinsurance contract should be accoun ted for in the financial statemen ts of the insurer. Solution The contract is an insurance contract because it transfers a significant insurance risk to the reinsurer. Where there are no claims on the contract, the policyholder will rece ive $ 1,600 at the end of year 10, which is 80% of the cumulative premiums of $2,000. IFRS 4 basically says that the policyho lder has made a loan that the reinsurer will repay in one instalme nt in year 10. If curren t policies of the reinsurer are that it should recogn ize a liability under the contract, then unbundling is permitted but not required. However, if the reinsurer does not have such policies, then IFRS 4 would requi re the reinsurer to unbun– dle the contract. If the contract is unbundled, each payment by the policy holder has two components : a loan advance payment and a payment for insurance cover. lAS 39 will be used to value the deposit ele– ment-the loan- and it will be measured initially at fair value. The fair value of the deposit eleme nt would be calculated by discount ing back the future loan repayment in yea r lOusing an annuity method. If the policyholder makes a claim, then this in itself will be unbundl ed into a claim of $X and a loan of $Y, which will be repaid in installments over the life of the policy. 7. DISCLOSURES 7.1 IFRS 4 ado pts the so-calle d principles-based approach to d iscl o sure. In formation sho uld be disclos ed th at helps the user to understand the amounts in th e insurer's fi na ncial statements th at arise from ins ura nce contrac ts . 7.2 In surers also need to give de tai ls about the insurance risk to which they are exposed, including any concentratio n of risk and the impact of changes in variables on the key assumptions th at are used. Case Study 1