IFRS 4 Insurance Contracts

1 INTRODUCTION AND SCOPE

IFRS 4 is a stepping stone standard (IFRS 4.IN2) that is used to specify the financial reporting for insurance contracts by insurers (i.e. by entities that issue such contracts) until the IASB completes the second phase of its project on insurance contracts. Accordingly, IFRS 4 specifies only certain aspects of the accounting and specifies selected disclosures (IFRS 4.1).

2 INSURANCE CONTRACTS, INSURANCE RISK, AND THE SCOPE OF IFRS 41

An insurance contract is a contract under which the insurer accepts significant insurance risk by agreeing to compensate the policyholder if a specified uncertain future event adversely affects the policyholder.

Insurance risk is risk, other than financial risk, transferred from the holder of a contract to the issuer. Financial risk is the risk of a possible future change in one or more of the following variables: interest rate, financial instrument price, commodity price, foreign exchange rate, index of prices or rates, credit rating, credit index or other variables. In the case of a non-financial variable, the variable must not be specific to a party to the contract, i.e. no contract party must be subject to an actual risk with regard to the variable.

The scope of IFRS 4 comprises all insurance contracts that the reporting entity issues as insurer as well as reinsurance contracts that it holds (IFRS 4.2a).

IFRS 4 also applies to financial instruments that the reporting entity issues with a discretionary participation feature (IFRS 4.2b).

Financial guarantee contracts issued by the entity are insurance contracts and would therefore principally be a matter of IFRS 4. However, they are scoped out by IFRS 4.4(d) unless the issuer has previously asserted explicitly that it regards such guarantees as insurance contracts and has used accounting applicable to insurance contracts. In the latter case, the issuer may elect to apply either IAS 32, IFRS 7, and IFRS 92 or IFRS 4 to such financial guarantee contracts. The issuer may make that election contract by contract, but the election for each contract is irrevocable (IFRS 4.4d).

3 FINANCIAL REPORTING FOR INSURANCE CONTRACTS

In certain cases it is necessary to separate a derivative embedded in an insurance contract from its host contract and measure the derivative at fair value and include changes in its fair value in profit or loss (IFRS 4.7–4.9). Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm's length transaction (IFRS 4.Appendix A).

Some insurance contracts contain both an insurance component and a deposit component. A deposit component is a contractual component that is not accounted for as a derivative under IAS 39 and would be within the scope of IAS 39 if it were a separate instrument (IFRS 4.Appendix A). In certain cases, unbundling of the insurance component and of the deposit component of an insurance contract is required or permitted. To unbundle a contract, the insurer applies IFRS 4 to the insurance component and IAS 39 to the deposit component (IFRS 4.10–4.12).

IFRS 4 permits insurers to continue with their existing accounting policies for insurance contracts that they issue and reinsurance contracts that they hold if those policies meet certain minimum criteria. Thus, applying IFRS 4 may not have a large impact on recognizing and measuring insurance contracts.3

An insurer must comply with the following rules (IFRS 4.14–4.20):

  • It is not possible to recognize provisions for risks arising under insurance contracts that do not exist at the end of the reporting period. Hence, catastrophe provisions and equalization provisions must not be recognized.
  • An adequacy test has to be carried out for insurance liabilities. This means that it has to be assessed at the end of each reporting period whether the insurer's recognized insurance liabilities are adequate, using current estimates of future cash flows under the insurer's insurance contracts. If that assessment shows that the carrying amount of the insurance liabilities (less related deferred acquisition costs and related intangible assets) is inadequate in the light of the estimated future cash flows, the entire deficiency has to be recognized in profit or loss.
  • An insurance liability (or a part of it) is removed from the statement of financial position only when it is extinguished (e.g. by payment).
  • It is prohibited to offset reinsurance assets against the related insurance liabilities and to offset income or expense from reinsurance contracts against the expense or income from the related insurance contracts (prohibition to offset reinsurance contracts).
  • It has to be considered whether reinsurance assets are impaired.

4 EXAMPLE WITH SOLUTION

Example
Scope of IFRS 4
Entity E sells only its own finished goods to wholesalers.
(a) E issues a product warranty for its own finished goods directly.
(b) E issues a product warranty for the finished goods produced by entity F. F is an unrelated third party of E.
Required
Assess whether the product warranties are within the scope of IFRS 4 in E's financial statements.
Hints for solution
In particular Section 2.
Solution
(a) A product warranty issued directly by a manufacturer is outside the scope of IFRS 4 because it is within the scope of IAS 18 and IAS 37 (IFRS 4.4a and 4.B18h).
(b) E issues a product warranty for the finished goods produced by F (i.e. by an unrelated third party of E). The product warranty is an insurance contract provided that the insurance risk is significant (IFRS 4.B18h).

1See IFRS 4.Appendix A regarding the definitions in this chapter.

2See the chapter on IFRS 9/IAS 39, Section 2.6 and Example 13.

3See PwC, Manual of Accounting, IFRS 2011, 8.18.

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