Company Valuation Under IFRS : Interpreting and Forecasting ...

Chapter Six – The awkward squad
Issue 2: Claims and provisions
There are a number of different components to this line in the income statement:
• Claims paid
This represents all of the claims settled during the period. It includes all
related expenses (e.g. legal costs). Naturally if any of the risk on a policy has
been ceded the claims paid by the reinsurance company shall be netted
against the expense.
• Claims incurred
An insurance company cannot wait for claims to be paid prior to recognition.
This would mean that real liabilities and costs were not included in the
income statement. An insurance company will be well aware of claims that
have been made but not yet actually settled. In this case a provision, or
reserve as insurance professionals tend to call it, is established. Like all
provisions it is movement in the reserve that goes through the income
statement. The balance of the claim will be recognised in the balance sheet.
It is worth noting that insurance companies also provide for those claims that
have not yet been reported but have been incurred. These are often referred
to as ‘IBNR’ as described above.
It will only be the balance of claims made, and not settled, in addition to IBNR
that will be recognised on the balance sheet. Provisions for catastrophes have
been prohibited by IFRS 4 and therefore will no longer be allowed. The
prevalence of these provisions had started to fade over the years and so it was no
surprise that they were eventually eliminated. The main rationale for not
recognising such provisions is that they did not satisfy the recognition criteria in
IAS 37 Provisions as there was no past event – these provisions were established
for future unknown events.
Issue 3: Commissions
As mentioned above insurance companies often incur substantial costs upfront in
order to acquire customers. If we apply the matching system then there is an
argument for deferring some of these costs as the benefit will also be recognised
(earned premiums) in future years. Therefore, if such an approach were to be
followed the ‘DAC’ or deferred acquisition costs would be capitalised as an
intangible asset and amortised over the duration of the policy.
Accounting standards have tried to standardise this practice as there were widely
divergent approaches in the industry. Both US GAAP and IFRS (via IFRS 4
Insurance Contracts) provide that DAC can only be capitalised if:
1. They are costs that relate directly to the acquisition of insurance premiums,
such as commissions to agents and brokers, are deferred and amortised over
the related policy period, generally one year
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