Insurance Contracts

Date recorded:


Board discussions began by noting that, conceptually, there are two sorts of insurance contracts: year-to-year and long-duration contracts. The view among the Board members was unanimous that premiums on year-to-year contracts should be recognised as income for the period. The Board was less clear on how to treat premiums received on long-duration contracts.

The Board considered an example known as a 'term-to-100' contract, under which the policyholder pays a fixed premium annually until age 100. If the policyholder dies before age 100 or lives to age 100, the policy will pay $100,000. However, if at any point the policyholder decides not to pay the annual premiums any more, the insurer will not be obliged to pay anything.

The Board considered two possible ways of analysing the issue:

1. The premium received is accounted for the same way as under a year-to-year contract, that is, as current income. No further asset and no further liability is recognised. The rationale is that, since there is no enforceable right to receive future premiums, and thus no asset, there cannot be a liability beyond the current period either. This view was rejected by the Board.

2. Under the second view, a liability covering the 'standing ready to pay' would be assumed. During the discussion an issue emerged as to whether there are in fact two liabilities: a liability covering the mortality risk, and a second liability which is similar to a written (continuation) option. The project manager pointed out that, if this route were to be followed, it would deviate from the princples on which IAS 37, Provisions, Contingent Liabilities and Contingent Assets is based.

There was considerable debate over several issues under the second view. Firstly, some Board members raised doubts as to whether the 'standby' constitutes a liability in terms of the Framework. Under the contract, the insurer does not have an obligation to pay unless the policyholder pays the annual premium. Nevertheless, the insurer does have an obligation to provide a service. After some discussion, the Board agreed that a liability exists.

A second issue arose on whether in setting up a liability to cover the continuation risk an asset embodying the expected future premiums would have to be recognised as well. One Board member pointed out that the insurer had no enforceable right to receive future cash flows, since it would be left to the discretion of the policyholder if the contract continues. Thus, it would not be justified to recognise an asset for the premiums to be received in future periods. On the other hand, there may well be an asset in terms of an internally generated intangible asset (such as a customer list). A majority of Board members seemed to agree that (a) an asset existed, (b) the asset was linked to the liability incurred, and (c) once the liability is recognised, the asset should simultaneously be recognised. There also seemed to be a consensus that the asset and liability should be presented net. The Board members were less clear about income statement presentation (gross or net).

However, when asked to vote formally on the proposals, several Board members said that they would not have enough information to decide on whether the route proposed was the one to follow. Two issues were of primary concern: the distinction between insurance and non-insurance contracts and the differentiation between certain types of insurance contracts. It was suggested that typical contracts be exemplified and brought before the Board to see whether the proposals could be sustained as a working basis.

The Board tentatively decided that further research be needed and directed to project manager to devote resources to the following points:

  • Whether the measurement objective of the DSOP should be retained (that is, a risk-adjusted cash flow-based measurement technique).
  • The relation between insurance and non-insurance contracts (the outcome of the research could well lead to major changes in accounting for other types of contfracts involving future promises, such as airline loyalty programs).
  • The dividing line within the population of insurance contracts (at which point a liability would have to be recognised).
  • Whether an instant gain or loss would have to be recognised on initial recognition.
  • Possible alternatives to the approach suggested.

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