Insurance Contracts - Phase I

Date recorded:


In May, the IASB agreed to split the insurance contracts project into two phases, so that some components of the project can be put in place by 2005 without delaying the rest of the project. The first phase will address the application of existing IFRSs to companies that issue insurance contracts. Phase II is a comprehensive project on accounting for insurance contracts addressing all issues afresh. Click for information about the Insurance Contracts - Phase II (Comprehensive) Project.

The Board's goal for Phase I is to publish an Exposure Draft promptly so that a final Standard can be in place and effective by 2005. The current timetable is for the ED to be issued in first quarter of 2003 and a final IFRS in 2004.

At today's meeting, the Board discussed the following Phase I issues:

  • Unbundling of an investment contract component of an insurance contract.
  • Application of IAS 39, Financial Instruments: Recognition and Measurement, to investment contracts (contracts that do not transfer enough insurance risk to qualify as insurance contracts).
  • Measurement of financial assets backing investment contracts and insurance contracts.
  • Embedded derivatives.


The Board tentatively decided that, to the extent that the cash flows in an insurance contract are not affected by an insured risk, the contract contains an investment contract component (sometimes called the 'deposit component') that must be 'unbundled' and accounted for separately as a financial instrument.

Application of IAS 39

Under IAS 39 as it currently stands, the issuer generally treats the investment contract component of an insurance contract as a held-to-maturity investment carried at amortised cost. Under IAS 39 as it is proposed to be Amended, however, the issuer will have a choice of measuring investment contracts either at amortised cost or at fair value.

The Board agreed that investment contracts should be treated the same as other financial instruments under IAS 39, including related transaction costs. A proposed amendment to IAS 39 would restrict the amount of transaction cost included in the cost of a financial asset to external transaction costs. Internal transaction costs would be expensed. In the case of a company that issues insurance contracts, internal transaction costs would include the costs of sales agents on the issuer's own staff.

The Board generally agreed with the staff's recommendation that the IFRS that results from Phase I should provide guidance on applying IAS 39 in the following situations:

  • Whether costs of administering an investment contract over its life (including overheads) are included in the future cash flows used to determine amortised cost or estimate fair value.
  • Payouts denominated in units of a pool of reference assets or linked to an index.
  • Clarification that future cash flows from assets should not be considered in determining the amortised cost or fair value of investment contract liabilities (except for performance-linked contracts, which will be addressed at a later meeting).
  • Whether there is a need for a loss recognition test, analogous to an asset impairment test. The test would identify whether, and when, the amortised cost of a financial liability should be increased if future cash flows differ from previous estimates because of variations in lapses or changes in administrative costs.
  • Clarification that the amortised cost of a financial liability is not increased when market interest rates increase, even if the return on available assets is below the effective interest rate on the liability.
  • Whether an insurer should measure the portion of separate account assets representing contract holder funds at fair value and report it in the insurer's financial statements as a summary total, with an equivalent summary total for related liabilities (also measured at fair value).

Measurement of Financial Assets

A new category of financial asset (financial assets held to back insurance liabilities) will not be created. IAS 39 should be applied.

Embedded Derivatives

The Board tentatively decided that a derivative embedded in an insurance contract (such as an equity-indexed return or a guaranteed interest rate in a life contract) should be accounted for as a separate derivative under IAS 39 if either (a) it is 'out of the money' at issuance or (b) it is leveraged. The cash surrender value of a life insurance contract is an embedded derivative (a put) whose risks are closely related to those of the host insurance contract and, therefore, is not an embedded derivative that must be separated.

Other Issues

While the Phase I IFRS will not establish new accounting standards for insurance contracts, in the basis for conclusions appendix the Board plans to indicate the direction in which it has been leaning in its deliberations on Phase II, to provide guidance regarding adoption of new accounting policies, and changes to existing accounting policies, by companies that issue insurance contracts. The Board's main leanings have been:

  • Insurance contracts should be measured at entity-specific value.
  • The deferred and fund methods of accounting for insurance contracts should not be used.

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