IFRS 4

1. IFRS 4

2. WELCOME

3. AGENDA
 Insurance type
 Introduction and Overview
 Definition of an Insurance Contract
 Accounting for Insurance Contracts
 Financial Components and investment contracts
 Disclosures

4. INSURANCE QUOTES
Going to work at 7am this morning I drove out of my drive straight into a bus. The bus
was 5 minutes early."
“Q: Could either driver have done anything to avoid the accident? A: Travelled by bus?
“
"I didn't think the speed limit applied after midnight“
"I knew the dog was possessive about the car but I would not have asked her to drive
it if I had thought there was any risk."
"The car in front hit the pedestrian but he got up so I hit him again“
"An invisible car came out of nowhere, struck my car and vanished."
"In an attempt to kill a fly, I drove into a telephone pole."
"My car was legally parked as it backed into another vehicle."

5. LIFE VS GENERAL
Life insurance
•Payments received on death of insured or upon continuous disability
(‘income protection’)
•Annuity or lump sum payment payable to nominee (e.g. estate,
dependent, policyholder etc.)
•Protection/Saving/Income
Property and Casualty / General / Non-life Insurance
•Insurance that is not over the life or well-being of insured
•Covers property, liability or personal injury (‘medical expenses’)

6. Categories of business
Short-tail business - less than one year to settle claim.
Losses identified / reported shortly after loss
Losses easily quantified
Typically physical damage
E.g. Motor, Home
Long-tail business – more than one year to settle claim.
Losses not reported and settled for a number of years
Losses not easily quantified
E.g. Personal injury, Professional indemnity

7. PROTECTION VS. INVESTMENT - THE SPECTRUM OF
LIFE PRODUCTS
Term
assurance
Protection
products
Savings /
investment
products
Permanent
health
insurance
Whole life
cover and
annuities
Endowments
Pensions
Maximum
investment

8. SPECTRUM OF LIFE AND PENSIONS PRODUCTS
Tax Advantages
Pensions
Protection
Term
assurance
Critical illness/
PHIGuaranteed
returns
Guaranteed
bonds
Annuities
equity release

9. NEED FOR AN INTERNATIONAL STANDARD ON INSURANCE
 Diversity in accounting practice for insurance contracts internationally (Grand
Father Concept)
 Accounting practices for insurance contracts differ from practices in other sectors
 Other IFRSs do not address accounting for insurance contracts

10. OVERVIEW OF IASB & FASB JOINT INSURANCE PROJECT
Phase I
 Objective was to:
 Make limited improvements to accounting for insurance contacts
 Provide disclosures that identify and explain amounts in an insurer’s financial
statements arising from insurance contracts and provide information about the
amount, timing and uncertainty of future cash flows from insurance contracts until
the board completes phase II
 Resulted in IFRS 4 Insurance contracts, an interim standard that permits a wide
variety of accounting practices for insurance contracts.

11. OVERVIEW OF IASB & FASB INSURANCE PROJECT(CONT’D)
Phase II
 Currently ongoing
 Objective is to develop a standard to replace the interim insurance standard and
to provide a basis for consistent accounting for insurance contracts in the longer
term
 Joint project with FASB
 DP Preliminary view on insurance contracts published in May 2007
 ED expected in near future
 Solvency II

12. OVERVIEW OF IFRS 4
 Defines an insurance contract and focuses on types of contracts rather than
types of entities
 Applies to:
 Insurance contracts, including reinsurance contracts, that an entity issues
 Reinsurance contracts that an entity holds
 Financial instruments issued with a discretionary participation features
 Does not address accounting by policy holders
 Does not apply to other assets and other liabilities of an insurer, such as financial
assets and financial liabilities within the scope of IAS 39/ IFRS 9

13. OVERVIEW OF IFRS 4 (CONT’D)
 Generally insurers are required to continue their existing accounting policies with
respect to insurance contracts except where the standard requires or permits
changes in accounting policies
 Requires some embedded derivatives and some deposit components to be
separated from insurance contracts
 Requires a minimum liability adequacy test to be applied to recognized insurance
liabilities
 Requires significant disclosures of the terms, conditions and risk related to
insurance contracts, consistent in principle with those required for financial
assets and liabilities

14. INSURANCE CONTRACTS – SCOPE EXEMPTION
 Product warranties issued directly by a manufacturer, dealer or retailer
 Employers assets and liabilities under employee benefit plans
 Contractual right and obligations contingent on future use or right to use a non-
financial item (e.g. some royalties) and lessee’s residual value guarantee
embedded in a finance lease
 Financial guarantee contracts, except for contracts previously accounted for as
insurance contracts in respect of which issuer may choose to apply IAS 39/IFRS 9
 Contingent consideration payable or receivable in a business combination
 Direct insurance contracts held by policyholder

15. DEFINITION OF INSURANCE CONTRACTS
 The definition of IFRS 4 refers to some traditional features of insurance contracts,
distinguishing them from financial instruments.
 IFRS 4 definition:
“ a contract under which 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 affect the policyholder”

16. INSURANCE RISK VS FINANCIAL RISK
INSURANCE RISK FINANCIAL RISK
 Risk, other than financial risk,
transferred from the holder of a
contract to the issuer.
 Risk of a potential future change in one or
more of:
 Interest rate
 Security price
 Commodity price
 Foreign exchange risk
 Index of prices or rates
 Credit rating
 Credit index
 Other variables, such as a non-financial
variable, that is not specific to a party to
the contract
Some insurance contracts expose the issuer to both insurance risk and financial risk. If insurance risk is
significant, such contracts are insurance contracts.

17. SIGNIFICANT INSURANCE RISK
 Insurance risk is significant if, and only if, an insured even could cause an insurer
to
 Pay significant additional benefits
 In any scenario
 Excluding scenarios that lack commercial substance
 The condition may be met even if the insured event is extremely unlikely or even if
the expected (i.e. probability weighted) present value of contingent cash flows is a
small portion of expected present value of contractual cash flows
 ‘Additional benefits’ are amounts in excess of those that would be payable if no
insured event occurred

18. SIGNIFICANT INSURANCE RISK (CONT’D)
 Significance of insurance risk is to be assessed on a contract by contract basis
 If a relatively homogenous book of small contracts is known to consist of
contracts that all transfer insurance risk, an insurer need not examine each
contract within that book to identify a few non – derivative contracts that transfer
insignificant insurance risk

19. UNCERTAIN FUTURE EVENTS
 Uncertainty (or risk) is the essence of an insurance contract
 At least one of the following should be uncertain at the inception of an insurance
contract
 Whether an insured event will occur
 When it will occur
 How much the insurer will need to pay if it occurs

20. CONTRACT CLASSIFICATION
Yes
No
IFRS investment
contracts
With DPF?
Continue traditional
UK GAAP/local
GAAP accounting
Investment
accounting under
IAS 39
No
Yes
IFRS insurance
contracts
Insurance contracts
Significant insurance risk?
Eg UK with
profits

21. CASE STUDY 1
 Saving contract – investor pays in stream of money which insurer invests in bonds
 At the end of the fixed term contract, investor receives amount paid to insurer
plus interest linked to the return on bonds
 Contract contains a clause that if the investor dies during the term of contract,
110% of balance outstanding ( principal + interest accrued) would be paid out of
the investor’s beneficiary

22. CASE STUDY 2
 Unit – linked savings contract containing guaranteed minimum death or survival
benefits.
 Benefit payable either upon the death of policy holder or upon maturity of the
contract, if the guaranteed minimum benefit is higher than the unit value at the
time a claim is made
 If the contract is surrendered, then the policy holder receives cash for the value
of the units surrendered (less surrender penalties)

23. ACCOUNTING OF INSURANCE CONTRACTS
Temporary exemption from the IAS 8 hierarchy
 IFRS 4 exempts an insurer from applying IAS 8 hierarchy (Para 10-12) for
developing accounting policies for insurance contracts
 The implication of this temporary exemption is that accounting policies
for insurance contracts are generally retained during phase I, with some
exceptions
 The objective of this exemption in phase I of the insurance project was to
avoid, for insurers transitioning to IFRSs, changes in accounting for
insurance contracts ahead of Phase II of the project

24. LIMITATIONS OF IAS 8 EXEMPTION
 The IAS 8 exemption does not exempt an insurer from some implications of para 10-12
of IAS 8; specifically an insurer should
 Not recognize as a liability any provisions for possible future claims under insurance
contracts that are not in existence at the end of the reporting period, such as
catastrophe and equalization provisions
 Carry out a liability adequacy test
 Remove an insurance liability from its statement of financial position only when the
obligation specified in the contract is extinguished
 An insurer should
 Not offset
 Reinsurance assets against the related insurance liabilities, or
 Reinsurance income and expenses against expenses or income from the related
insurance contracts
 Consider whether its reinsurance assets are impaired

25. LIABILITY ADEQUACY TEST
 An insurer should assess at the end of each reporting period whether its
recognized insurance liabilities are adequate, using current estimates of future
cash flows under its insurance contracts
 IFRS 4 only specifies minimum requirements for conducting the liability adequacy
test
 The test considers current estimates of all contractual cash flows, and of related
cash flows such as claims handling cost, as well as cash flows resulting from
embedded options and guarantees
 If liability is inadequate, entire deficiency is recognized in profit or loss

26. LIABILITY ADEQUACY TEST (CONT’D)
If existing accounting policies include an
assessment that meets the specified
minimum requirements, no further action
required
If current policy is not sufficient to comply
with IFRS 4, then the carrying amount of
the liability should be tested against the
requirements of IAS 37 and, if necessary
increased ( DR PL, CR liability)
If
not?

27. IMPAIRMENT OF REINSURANCE ASSETS
 A cedant should consider at each reporting date whether its reinsurance assets
are impaired
 A reinsurance asset is impaired if, any only if
 There is a objective evidence, as a result of an event that occurred after initial
recognition of the reinsurance asset, that the cedant may not receive all amounts
due to it under the terms of the contract; and
 That event has a reliably measurable impact on the amounts that the cedant will
receive from the reinsurer

28. CHANGE IN ACCOUNTING POLICIES
 An insurer may change its accounting policies for insurance contracts if, and only
if, the changes make the financial statements
 More relevant for decision making and no less reliable; or
 More reliable and no less relevant
 An insurer judges relevance and reliability using the criteria in IAS 8
 This guidance applies to both changes made by an insurer applying IFRSs and to
changes made by insurers adopting IFRSs for the first time

29. CHANGE IN ACCOUNTING POLICIES ( CONT’D)
 Current market interest rates
 An insurer is permitted, but not required, to change its accounting policies so that
it remeasures designated insurance liabilities to reflect current market interest
rates and recognizes changes in those liabilities in profit and loss
 Shadow accounting
 An insurer may apply “shadow accounting” to remeasure insurance liabilities to
reflect recognized but unrealized gains and losses on related financial assets in
the same way as realized gain and losses.
 Adjustments to the insurance liabilities are recognized in other comprehensive
income only if the unrealized gains and losses on the related assets are
recognized in other comprehensive income

30. CHANGE IN ACCOUNTING POLICIES ( CONT’D)
 An insurer may continue the following practices, but not introduce them:
 Measuring insurance liabilities on an undiscounted basis
 Using non – uniform accounting policies for insurance contracts ( and related
deferred acquisition costs and related intangible assets, if any) of subsidiaries
 Insurer need not change accounting policy to eliminate excessive prudence but
cannot introduce additional prudence if insurance contracts are already
measured with sufficient prudence

31. CHANGE IN ACCOUNTING POLICIES ( CONT’D)
 An insurer is permitted to continue applying and permitted to introduce following
accounting policies
 Using shadow accounting
 Remeasure designated insurance liabilities to reflect current market interest rates
/ other assumptions and recognize changes in those liabilities in profit and loss

32. INSURANCE AND INVESTMENT CONTRACTS
Unbundling of deposit component
 Some insurance contracts contain both an insurance component and a
deposit component. For such contracts
 Unbundling of a deposit component is permitted if
 The deposit component can be measured separately; and
 Insurer’s accounting policies require it to recognize all rights and
obligations arising from the deposit component, regardless of the basis
used to measure those rights and obligations
 Unbundling of a deposit component is required if:
 The deposit component can be measured separately; and
 Insurer’s accounting policies do not otherwise require it to recognize all
rights and obligations arising from the deposit component

33. Unbundling of deposit component ( cont’d)
 Unbundling of a deposit component is prohibited if:
 An insurer cannot measure the deposit component separately

34. EMBEDDED DERIVATIVES
 A embedded derivative is a component of a hybrid (combined) contract that
includes both the derivative and a host contract
 Components of insurance contracts that meet the definition of a derivative are
within the scope of IAS 39 / IFRS 9 and are therefore subject to the general
requirements for embedded derivatives under IAS 39 / IFRS 9:
 However, there are two exceptions:
 Components that meet the definition of an insurance contract ( e.g.; components
that transfer significant insurance risk); and
 Surrender options with fixed terms

35. EMBEDDED DERIVATIVES (CONT’D)
 As insurance contracts are not within the scope of IFRS 9, the requirements in
that standard to separate embedded derivatives are not applicable to insurance
contracts embedded in a host contract. A component meeting the definition of an
insurance contract does not need to be separated from its host contract
 For example, an option to take a life-contingent annuity contract would not be
separated from a host insurance contract

36. EMBEDDED DERIVATIVES (CONT’D)
 Surrender option with fixed terms
 A policyholder option to surrender an insurance contract
 For a fixed amount
 Or for an amount based on a fixed amount and an interest rate
 Even if the exercise price differs from the carrying amount of the host insurance
liability
need not be separated from the host insurance contract

37. DISCRETIONARY PARTICIPATION FEATURES
 Definition
 A contractual right to receive, as a supplement to guaranteed benefits, additional
benefits
 That are likely to be a significant portion of the total contractual benefits;
 Whose amounts or timing is contractually at the discretion of the issuer; and
 That are contractually based on, the performance of a specified pool of contracts,
or investment returns on a specified pool of assets owned by the issuer, or the
profit or loss of the issuer of the contract
 IFRS 4 addresses limited aspects of DPFs contained in insurance contracts or in
financial instruments

38. DISCLOSURES
 Disclosures comprise
 Explanation of recognized amounts
 Nature and extent of risks arising from insurance contracts
 Explanation of recognized amounts
 Accounting policies for insurance contracts and related assets, liabilities, income and
expense
 Amounts of recognized assets, liabilities, income and expense arising from insurance
contracts, as well as gains/ losses recognized on reinsurance by the cedant
 How the most significant assumptions used to measure recognized amounts are
determined, and if practicable, quantified disclosure of assumptions
 Effect of changes in assumptions used to measure insurance assets and liabilities

39. DISCLOSURES (CONT’D)
 Nature and extent of risks
 Risk management objectives, policies and processes, and method used for
managing risk from insurance contracts
 Sensitivity of insurance risk
 Concentrations of insurance risk
 Actual claims compared with previous estimates, i.e. claims development
 Information about credit risk, liquidity risk and market risk that IFRS 7 would
require if the insurance contracts were within the scope of IFRS 7, with certain
exceptions