IFRS 4 — Insurance Contracts
IFRS 4 Insurance Contracts applies, with limited exceptions, to all insurance contracts (including reinsurance contracts) that an entity issues and to reinsurance contracts that it holds. In light of the IASB's comprehensive project on insurance contracts, the standard provides a temporary exemption from the requirements of some other IFRSs, including the requirement to consider IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors when selecting accounting policies for insurance contracts.
IFRS 4 was issued in March 2004 and applies to annual periods beginning on or after 1 January 2005.
History of IFRS 4
|1 April 2001||Comprehensive insurance contracts project carried over from IASC to new IASB||History of the comprehensive project|
|May 2002||Short-term insurance contracts project split off from comprehensive project||History of the short-term project|
|31 July 2003||Exposure Draft ED 5 Insurance Contracts published||Comment deadline 31 October 2003|
|31 March 2004||IFRS 4 Insurance Contracts issued||Effective for annual periods beginning on or after 1 January 2005|
|18 August 2005||Amended by Financial Guarantee Contracts (Amendments to IAS 39 and IFRS 4)||Effective for annual periods beginning on or after 1 January 2006|
|12 September 2016||Amended by Applying IFRS 9 'Financial Instruments' with IFRS 4 'Insurance Contracts'||An entity choosing to apply the overlay approach retrospectively to qualifying financial assets does so when it first applies IFRS 9. An entity choosing to apply the deferral approach does so for annual periods beginning on or after 1 January 2018.|
Amendments under consideration by IASB
Summary of IFRS 4
IFRS 4 is the first guidance from the IASB on accounting for insurance contracts – but not the last. A comprehensive project on insurance contracts is under way. The Board issued IFRS 4 because it saw an urgent need for improved disclosures for insurance contracts, and some improvements to recognition and measurement practices, in time for the adoption of IFRS by listed companies throughout Europe and elsewhere in 2005.
IFRS 4 applies to virtually all insurance contracts (including reinsurance contracts) that an entity issues and to reinsurance contracts that it holds. [IFRS 4.2] It does not apply 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. [IFRS 4.3] Furthermore, it does not address accounting by policyholders. [IFRS 4.4(f)]
In 2005, the IASB 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 contracts as insurance contracts and has used accounting applicable to insurance contracts, the issuer may elect to apply either IAS 39 or IFRS 4 to such financial guarantee contracts. [IFRS 4.4(d)]
Definition of insurance contract
An insurance contract is 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 affects the policyholder." [IFRS 4.Appendix A]
The IFRS exempts an insurer temporarily (until completion of Phase II of the Insurance Project) from some requirements of other IFRSs, including the requirement to consider IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors in selecting accounting policies for insurance contracts. However, the standard: [IFRS 4.14]
- prohibits provisions for possible claims under contracts that are not in existence at the reporting date (such as catastrophe and equalisation provisions)
- requires a test for the adequacy of recognised insurance liabilities and an impairment test for reinsurance assets
- requires an insurer to keep insurance liabilities in its balance sheet until they are discharged or cancelled, or expire, and prohibits offsetting insurance liabilities against related reinsurance assets and income or expense from reinsurance contracts against the expense or income from the related insurance contract.
Changes 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 reliable, or more reliable and no less relevant. [IFRS 4.22] In particular, an insurer cannot introduce any of the following practices, although it may continue using accounting policies that involve them: [IFRS 4.25]
- measuring insurance liabilities on an undiscounted basis
- measuring contractual rights to future investment management fees at an amount that exceeds their fair value as implied by a comparison with current market-based fees for similar services
- using non-uniform accounting policies for the insurance liabilities of subsidiaries.
Remeasuring insurance liabilities
The IFRS permits 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 current estimates and assumptions). Without this permission, an insurer would have been required to apply the change in accounting policies consistently to all similar liabilities. [IFRS 4.24]
An insurer need not change its accounting policies for insurance contracts to eliminate excessive prudence. However, if an insurer already measures its insurance contracts with sufficient prudence, it should not introduce additional prudence. [IFRS 4.26]
Future 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 reflects future investment margins in the measurement of insurance contracts. [IFRS 4.27]
When an insurer changes its accounting policies for insurance liabilities, it may reclassify some or all financial assets as 'at fair value through profit or loss'. [IFRS 4.45]
- clarifies that an insurer need not account for an embedded derivative separately at fair value if the embedded derivative meets the definition of an insurance contract [IFRS 4.7-8]
- requires an insurer to unbundle (that is, to account separately for) deposit components of some insurance contracts, to avoid the omission of assets and liabilities from its balance sheet [IFRS 4.10]
- clarifies the applicability of the practice sometimes known as 'shadow accounting' [IFRS 4.30]
- permits an expanded presentation for insurance contracts acquired in a business combination or portfolio transfer [IFRS 4.31-33]
- addresses limited aspects of discretionary participation features contained in insurance contracts or financial instruments. [IFRS 4.34-35]
The standard requires disclosure of:
- information that helps users understand the amounts in the insurer's financial statements that arise from insurance contracts: [IFRS 4.36-37]
- accounting policies for 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 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 practicable, quantified disclosure of those assumptions
- the effect of changes in assumptions
- reconciliations of changes in insurance liabilities, reinsurance assets, and, if any, related deferred acquisition costs
- Information that helps users to evaluate the nature and extent of risks arising from insurance contracts: [IFRS 4.38-39]
- risk management objectives and policies
- those terms and conditions of insurance contracts that have a material effect on the amount, timing, and uncertainty of the insurer's future cash flows
- information about insurance risk (both before and after risk mitigation by reinsurance), including information about:
- the sensitivity to insurance risk
- concentrations of insurance risk
- actual claims compared with previous estimates
- the 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
- information about exposures to market risk arising from embedded derivatives contained in a host insurance contract if the insurer is not required to, and does not, measure the embedded derivatives at fair value.
Interaction with IFRS 9
On 12 September 2016, the IASB issued amendments to IFRS 4 providing two options for entities that issue insurance contracts within the scope of IFRS 4:
- an option that permits entities to reclassify, from profit or loss to other comprehensive income, some of the income or expenses arising from designated financial assets; this is the so-called overlay approach;
- an optional temporary exemption from applying IFRS 9 for entities whose predominant activity is issuing contracts within the scope of IFRS 4; this is the so-called deferral approach.
An entity choosing to apply the overlay approach retrospectively to qualifying financial assets does so when it first applies IFRS 9. An entity choosing to apply the deferral approach does so for annual periods beginning on or after 1 January 2018. The application of both approaches is optional and an entity is permitted to stop applying them before the new insurance contracts standard is applied.
Rating agency analysis of IFRS 4
Fitch Ratings – a leading global fixed income rating agency – has analysed the implications of IFRS 4 Insurance Contracts and has concluded that Fitch "does not expect any rating actions as a direct result of the move to IFRS. However, Fitch cannot rule out the possibility that the additional disclosure and information contained in the accounts could lead to rating changes due to an improved perception of risk based on the enhanced information available." The special report Mind the GAAP: Fitch's View on Insurance IFRS provides an overview of IFRS 4 and the issues being addressed in Phase II of the IASB's insurance project; assesses the implications including increased volatility, greater use of discounting and fair values, changes to income recognition, and enhanced disclosures; and discusses how the changes affect ratings analysis. An excerpt:
|Fitch welcomes the progress made by the IASB towards standards that will be more transparent and comparable across regions. The agency recognises the significant limitations of phase 1 but believes that the enhanced disclosure and greater consistency at phase 1 of the insurance accounting project (set out in IFRS 4) will aid in the analysis of insurers and is a useful stepping stone to the more valuable phase 2.|
We are grateful to Fitch Ratings for allowing us to post their copyrighted report: Click to Download (PDF 209k).