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Discuss how the reinsurance contract should be accounted for in the financial statements 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 receive $1,600 at the end of year ten, which is 80% of the cumulative premiums of $2,000. IFRS 4 basically says that the policyholder
has made a loan that the reinsurer will repay in one installment in year ten. If current policies of the reinsurer are that it should recognize 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 require the reinsurer
to unbundle the contract. If the contract is unbundled, each payment by the policyholder has two components: a loan advance payment and a payment for
insurance cover. IAS 39 will be used to value the deposit element—the loan—and it will be measured initially at fair value. The fair value of the deposit
element would be calculated by discounting back the future loan repayment in year ten using an annuity method. If the policyholder makes a claim, then
this in itself will be unbundled into a claim of $X and a loan of $Y, which will be repaid in installments over the life of the policy.
DISCLOSURES
IFRS 4 adopts the so-called principles-based approach to disclosure. Information should be disclosed that helps the user to understand the amounts in the insurer’s
financial statements that arise from insurance contracts.
Insurers also need to give details about the insurance risk to which they are exposed, including any concentration of risk and the impact of changes in variables on
the key assumptions that are used.
Information that helps users understand the amount, timing, and uncertainty of future cash flows is required. The terms and conditions of insurance contracts that
have a material affect on the amount, timing, and uncertainty of the insurer’s future cash flows also have to be disclosed.
Information about the actual claims as compared with previous estimates needs disclosure, and information about interest rate risk and credit rate risk that IAS 32
would require should be shown.
Information about exposures to interest rate risk or market risk under embedded derivatives contained in a host insurance contract should be shown if the insurer
does not show the embedded derivatives at fair value. However, insurers do not need to disclose the fair value of their insurance contracts at present but need to
disclose the gains and losses from purchasing reinsurance contracts.
PRACTICAL INSIGHT
A typical insurer’s statement of financial position might comprise these assets and liabilities and be covered by the following IFRS:
Assets IAS/IFRS
Investments IAS 39
Property IAS 16/40
Investments contracts IAS 18
Insurance contracts IFRS 4
Other assets Various
Liabilities
Equity IAS 32/39
Insurance liabilities IFRS 4
Investment contract liabilities IAS 39
Other liabilities Various