Concepts of IFRS 4 â Insurance Contracts & Implementation ...

Concepts of IFRS 4 – Insurance Contracts 

& Implementation Challenge 

IFRS Seminar, The Institute of Actuaries of India - Mumbai, 17 October 2011 

Presented by: Mr. Mayank Bathwal 

CFO - Birla Sun Life Insurance Co Ltd. 

•Copyright Birla Sun Life Insurance Company Limited 2008 

Copyright Aditya Birla Nuvo Limited 2008

Outline for Discussion 

A 

IFRS 4 : Insurance 

contracts - Phase I 

Definition 

Product 

Classification 

Unbundling 

/Embedded 

Derivatives 

Liability 

adequacy test 

Accounting 

policies/ 

Disclosures 

B 

IFRS 4 : Insurance 

contracts - Phase II 

Overview & 

Project 

timelines 

Measurement 

Models 

Accounting 

and 

Disclosure 

Gaps 

Presentation 

Major 

Implications 

Copyright Birla Sun Life Insurance Company Limited 2008

IFRS 4 : Insurance contracts - Phase I 


Definition 

IFRS 4 Phase I 

Insurance Contract 

A contract under which one party accepts significant insurance risk from another party 

by agreeing to compensate the policyholder if a specified uncertain future event 

adversely effects the policyholder. 

Significant insurance risk 

- Sufficient probability of occurrence & 

- Sufficient magnitude of effect 

Key Impact 

Significant changes will be required in IT systems and actuarial models to bifurcate & measure 

the products as insurance and investment contracts 


Product Classification flowchart 


Contract components 

Significant insurance 

risk 

Yes 

No 

Yes 

Financial risk 

No 

Insurance contract 

IFRS 4 

Investment contract 

Service contract 

Unbundling 

Accounting: 


Yes 

Any 

Discretionary 

Participating 

Features 

IAS 18 

Recognise 

Revenue as 

earned 

No 

Yes 

IFRS 4 Deposit element: IAS 39 

Insurance – IFRS 4 

IFRS 9 Fair value or 

Amortised cost 


Examples of Product Classification 


Invidual Life- Insurance 

Invidual Life- Investment 

Endowment 

Pension 

Term 

Group - Insurance 

Term 

Mortgage 

Group - Invesmtnets 

Fund 



Unbundling & Embedded Derivatives 

Unbundling 

Derivatives & Embedded Derivatives Defined 

Some insurance contracts contain both 

insurance and deposit components. 

Unbundling is required if both the 

following conditions are met: 

i. Insurer can measure the deposit component 

separately 

ii. Insurer‟s accounting policies do not otherwise 

require it to recognise all obligations and rights 

arising from the deposit component. 

If unbundled, IAS 39 will apply to the deposit 

component and IFRS 4 to the Insurance 

Component 

 

Embedded derivatives should be 

separated from host contract, 

measured at fair value and changes 

in fair value to be taken in profit and 

loss 

– This requirement applies to an 

insurance contract also, unless the 

embedded derivative itself is an 

insurance contract 

– An exception allowed when there is a 

policyholder option to surrender an 

insurance contract for a fixed amount 

• This will impact the top line of the 

company as deposit component will be 

reduced from the total premium and 

accounted under IAS 39 Financial 

Instruments 

• IT systems needs to be upgraded / 

modified to separately capture the 

deposit component and recognise front 

end fees as revenue 

• The life insurance products in India are 

designed in such a way that embedded 

derivative components cannot be 

separated from host contract 

• Unbundling of insurance contracts has 

also been prohibited in IRDA Report for 

IFRS 



Liability Adequacy Test 

 

An insurer shall assess at the end of each reporting period whether its recognised 

insurance liabilities are adequate, using current estimates of future cash flows under its 

insurance contracts. 

 

IFRS 4 requires to perform liability adequacy test by the Actuary 

 

The minimum requirements of test are the following: 

- The test considers current estimates of all contractual cash flows, and of related cash 

flows such as claims handling costs as well as cash flows resulting from embedded 

options and guarantees. 

- if the test shows that the liability is inadequate, the entire deficiency must be recognised 

in profit or loss 

The liability measurement principles are pretty stringent in India as negative reserves are 

not considered in valuation of policy liabilities 


Accounting policy 


Investment Contract; 

Deposit components to the extent invested in various fund/s are to be 

accounted as liability directly into the Balance sheet. 

Benefits and claims paid on investment contracts directly need to be adjusted 

against the liability. 

Deferred acquisition costs (DAC) needs to be deferred over contract period 

Deferred income (DOF) needs to be deferred and recognised as revenue 

over the contract period. 

• 

IFRS 4 permits to continue with current accounting 

policies except; 

Measuring insurance liability on undiscounted basis 

Measuring contractual rights to future investment management 

fees at an amount that exceeds its fair value – using non uniform 

accounting policies for the insurance liabilities of subsidiaries 

Catastrophe and equalisation provisions 

• Deposit accounting 

will reduce the top 

line of company 

• DAC and DOF 

accounting will 

reduce volatility in 

the bottom line by 

equalising the 

acquisition costs 

and Income over 

the contract period 

• Actuarial models & 

IT systems need to 

be upgraded to 

capture and track 

deposit 

component, DAC & 

DOF separately 

 



Additional Disclosures 

Areas 

Details 

Risk Management 

Framework 

 

 

 

Objectives & Policies 

Risk identification and classification 

Risk Mitigation Strategies & Review mechanism 

Impact and 

Sensitivity of 

various risks 

 

 

 

 

Insurance risk 

Interest rate risk 

Credit risk 

ALM risk 

Others 

 

 

Basis used for classification of contracts into 

insurance contracts and investment contracts 

Movement in Actuarial Liabilities 

System changes for capturing disclosures such as sensitivity analysis, credit risk, interest rate and 

maturity profile are required 



Impact : Balance sheet of an Indian Insurer 

Particulars 

ASSETS 

Non Current assets 

Financial Investments 

Current Assets 

Financial Investments 

Impact 

Negligible 

Negligible 

Other Financial Assets Below 15% 

EQUITY AND LIABILITIES 

Retained Earnings 

Other comprehensive income 

Negligible 

New item 

Non-Current Liabilities 

Other Financial Liabilities 

New item 

Current Liabilities 

Other Financial Liabilities Below 10% 

 

 

 

 

 

 

 

Transaction costs on FVTPL 

investments charged off. 

Investments Fair valued 

Impact on recognition of DAC 

and DOF on investment 

contracts 

Deferred lease expense 

charged off 

Notional interest income 

recognised on deposits given. 

Premium/(Discount) amortised 

on investments reversed. 

Gain/(loss) on AFS recognised 

in OCI 



Financial Impact: Profit & Loss Account 

Particulars 

Impact 

Income 

Premium 

Other income 

Depends on 

product mix 

 

Premium, Commission, 

investment income and claims 

on investment contracts are 

removed from Profit & Loss 

Account 

Expenses 

Commission 

Operating Expenses related to Insurance 

Business 

Benefits paid (Net) 

Change in investment liabilities 

Negligible 

Negligible 

Depends on 

product mix 

 

 

 

DAC and DOF amortised 

Notional interest income 

recognised on deposits given 

Premium and benefits and 

claims on investment contract 

impact adjusted in change in 

investment liability 

Profit/(loss) for the year 

Negligible 


IFRS 4 Insurance contracts - 

Phase II 


IFRS 4 Phase II 

Overview 

Current IFRS 4 definition of “Insurance” carried forward 

Single model for all types of insurance contracts 

– a „building block‟ approach to measure insurance liabilities 

– a margin approach to report performance (income statement) 

 

 

 

Measurement is current, i.e. no locking-in of assumptions (except for residual margin) 

and based on a “fulfillment of obligations” notion. 

Acquisition costs included in contractual cash flows, if incremental ; all other costs to 

be expensed. 

Implementation will be complex, but other projects can be leveraged 

– Economic capital 

Adoption of IFRS 9 

– a „big bang‟ change for insurers 



Project timelines 

Phase 1 Phase II Implementation 


Insurance 

contracts 

IASB – 

Discussion 

Paper 

issued 

FASB – 

Invitation 

to comment 

End of 

Comment 

Periods (IASB 

And FASB) 

FASB – 

Joined the 

project 

IASB and FASB 

Meetings to 

Develop 

Accounting 

standards 

IASB – 

Exposure 

Draft 

End of 

comment 

period 

Reissue of 

IASB 

Exposure draft 

Final 

Standard 

Implementation 

Date 

Jan 

May Aug Nov 

Oct Jan’09 to Jul’10 Jul Nov 

H2 2012 

TBD 

TBD 

2005 

2006 2007 

2008 2009 2010 

201 201 



Measurement Models - Building blocks 

Premium 

FASB: Composite margin 

Consequence: 

no gain at issue 

1 Expected 

future cash 

flows 

2 Discounting 

3 Risk 

adjustment 

4 Residual 

margin 

IASB 

5. Unallocated 

premium 

reserve for 

pre-claims 

liability short 

duration 

contracts 

(FASB not 

decided yet) 

Present value of fulfilment cash flows 

Concept: what happens as the 

insurer fulfils contracts with 

policyholders over time 



IFRS 4 Phase II model- How does it work 

Diagram 1: 

Profitable 

contract 

Shortduration 

pre-claims 

liability 

(net of 

incremental 

acquisition 

costs) 

Nil 

Diagram 2: 

Non profitable 

contract 

Shortduration 

pre-claims 

liability 

(net of 

incremental 

acquisition 

costs) 

Nil 

Liability 

adequacy test 

PV of 

future 

cash 

inflows 


future 

cash 

inflows 

PV of fulfilment cash flows 


future 

cash 

outflow 

Risk 

adjustment 

PV of fulfilment cash flows 


future 

cash 

outflow 

Risk 

adjustment 

Residual 

margin 

Loss on 

inception 

FASB: 

Composite 

margin 

Cash inflows 

o 

o 

Premiums, including initial 

premiums and future premiums 

within contract boundary 

Potential recoveries (e.g., salvage 

and subrogation) 

Cash outflows 

o 

o 

o 

o 

o 

o 

o 

Payments to (or on behalf of) 

policyholders, including payments 

in kind and Incurred but not 

reported (IBNR) 

Claim handling costs 

Cash flows that will result from 

options and guarantees embedded 

in the contract 

Payments to policyholders as a 

result of a contractual participation 

term 

Transaction-based taxes and 

levies (VAT, premium tax) 

Incremental costs of selling, 

underwriting, and initiating 

successful insurance contracts 

Policy administration and 

maintenance costs 



Phase II highlights- Key aspects of the ‘Building blocks’ 

1. Cash flows 2. Discounting 3. Risk margin 4. Residual margin 5. Unallocated 

premium 

Initial 

• Recognise 

when being “on 

risk” 

• Unbiased 

probability 

weighted cash 

flows 

• At 

contract/portfolio 

level 

• Reflect 

characteristics of 

contract 

• Exclude “own risk” 

• Risk free rate plus 

allowance for 

illiquidity 

premiums 

• Cost of capital, 

conditional tail 

expectation or 

confidence level 

methodologies 

• Portfolio level 

• No diversification 

benefit between 

portfolios 

• Eliminate day 1 

gain 

• Interest accretion 


(date of inception 

and life of policy) 

• Offset with 

incremental 

acquisition cash 

flows 

• Mandated contracts 

less than 1 year 

coverage 

• Amortise 

incremental 

acquisition costs 

• Onerous contract 

test on fulfilment 

cash flows 


Subsequent • Re-measured • Re-measured • Re -measured • Not re-measured 

• Release over 

“coverage period” 

• Release over 

“coverage period” 

• Onerous contract 

test 

Presentation 

and 

disclosure 

s 

• Reconcile 

opening to 

closing balance 

• Present 

separate 

changes in 

experience and 

estimates 

• Disclose 

• Need to disclose 

discount rate 

applied 

• Present changes 

in discount rate 

and interest 

accretion 

• Reconcile opening 

to closing balance 

• Present changes in 

risk adjustments 

• Disclose the 

methodology basis, 

inputs to calculate 

risk margin and the 

confidence level 

achieved 





including 

premiums, claims, 

expenses and 

amortisation of 

acquisition 

expenses 

• Disclosure of 

additional liabilities 

for onerous 

contracts 


Accounting and Disclosure Gaps 

Identify the data 

requirement needs from 

outsourced providers 

Data warehouse 

Outsourcing 

General ledger 

Source systems 

Front-end 

applications 

Identify the general 

ledger accounts to which 

gaps relate. 

Trace the general ledger 

transactions back to their source: 

- Directly to source systems 

- through the data warehouse(s). 

Trace the transactions back 

to the front-end application, 

when appropriate. 



Income Statement - Margin model 

Summarized margin- Overview 

(A 1) Risk adjustment 

(A 2) Residual Margin 

Underwriting Margin 

(B) Losses on initial recognition 

(C) Experience adjustment 

(D) Changes in estimates 

(E) Interest on insurance liability 

(F) Investment income 

Profit 

 

 

 

 

Change in estimates flow through 

income statement 

Premium and claims are deposit 

accounted 

Investment income included in 

income statement 

Premiums, claims and expenses 

can still be shown in the income 

statement 


IFRS 4 Phase II:-More than accounting impact 


 

Anticipation of changes to product features due 

to changes in profit signatures, regulatory capital 

A number of key areas 

need to be considered 

 

Significant changes to financial statement 

presentation and disclosures; new processes 

and controls 

Policies 

Process and 

controls 

 

 

Alignment of financial and management 

reporting metrics and processes 

Training and communication 

Governance 

and 

organisation 

PM, MI, 

KPIs 

 

Profound impact on processes, data and 

systems. The impact on closing processes 

and reporting 

People 

Systems 

and data 

 

Restructuring of the technology landscape is 

expected to be complex and costly. 


How do you prevent the accounting mismatch 

IFRS 4 phase II versus IFRS 9 

Assets 


Liabilities 

1. Fair value through P&L 

 

Insurance contracts BE+risk margin 

•at fair value (through P&L) 

2. Fair value in OCI (equity securities) 

 

Insurance contracts res./compos. 

•margin deferred profit – at cost 

3. Amortised cost (debt securities) 

 

Insurance contracts Unearned Premium Reserve 

(UPR)– at cost 

4. Hedge accounting (P&L or OCI) as variation to 

fair value option 


Business Implications 

 

 

 

 

Insurers may see greater discipline in their pricing processes as a result of the new 

model. 

To reduce volatility in reported results - Insurers may consider changes to their 

current product offerings, moving out of longer term products with embedded 

guarantee towards products in which more investment risk is borne by policyholders. 

Insurers may enter into outsourcing arrangements, restructure sales compensation 

arrangements with their employees and buy more reinsurance to mitigate the impact 

of proposed changes to the recognition of acquisition costs. 

Phase II will place significant demands on skilled actuarial and finance resources. 

Gaps are likely to be addressed by hiring additional resources, outsourcing to third 

parties, training and redeploying skilled resource to focus on Phase II. 


Challenges for insurers 

 

 

 

 

 

 

 

 

Clarity and implementation guidance required from Institute of Actuaries, IRDA and 

ICAI on the proposed changes 

Resolution of the key issues and concerns raised 

Significant systemic changes & dearth of trained resources 

No field testing available to validate the practical results of implementation 

Timing of the standard and effective dates not clear 

Preparing two set of books for financial reporting & regulatory reporting 

Divergence on certain issues between IASB and FASB to be addressed 

Necessary changes in Tax laws, IRDA Act, SEBI Act, RBI Act and other regulations 


Questions or Comments 

E mail id: mayank.bathwal@birlasunlife.com

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