3.2.1 Key definitions

The following key definitions are relevant to the application of FRS 103. [FRS 103 Appendix I].

3.2.2 Transactions within the scope of FRS 103

FRS 103 applies to financial statements prepared by an entity that applies FRS 102 and that are intended to give a true and fair view of a reporting entity's financial position and profit or loss (or income and expenditure) for a period. [FRS 103.1.1].

Unless specifically excluded from its scope (see 3.2.3 below) an entity that applies FRS 102 should apply FRS 103 to: [FRS 103.1.2]

• insurance contracts (including reinsurance contracts) that it issues and reinsurance contracts that it holds; and
• financial instruments (other than insurance contracts) that it issues with a discretionary participation feature (see 7.2 below).

FRS 103 applies to entities with insurance contracts and financial instruments with a discretionary participation feature (DPF) within its scope as follows: [FRS 103.1.3]

• the sections on Scope, Accounting Policies, Recognition and Measurement, Disclosure and Transition apply to all entities;
• the sections on Recognition and Measurement: Requirements for entities with long-term insurance business and Disclosure: Additional requirements for with-profits business apply only to entities with long-term insurance business; and
• Appendix II: Definition of an insurance contract applies to all entities.

It can be seen from this that FRS 103 applies to insurance contracts and not just to entities that specialise in issuing insurance contracts. It is a transaction-based standard. Consequently, non-insurance entities will be within its scope if they issue contracts that meet the definition of an insurance contract.

FRS 103 describes any entity that issues an insurance contract as an insurer whether or not the entity is regarded as an insurer for legal or supervisory purposes. [FRS 103.1.9].

Section 11 and Section 12 of FRS 102 contain scope exemptions for insurance and reinsurance contracts issued by an entity and for reinsurance contracts held by an entity and for financial instruments issued by an entity with a discretionary participation feature (DPF) (see Section 7 below). [FRS 102.11.7(f)-(g), 12.3(d), (j)]. Financial instruments that do not meet the definition of an insurance contract and do not contain a DPF are within the scope of either Section 11 or Section 12 of FRS 102. This will be the case even if they have the legal form of an insurance contract. [FRS 103.1.8]. These contracts are commonly referred to as ‘investment contracts’.

The following table illustrates the standards applying.

A reinsurance contract is a type of insurance contract and therefore all references in FRS 103 to insurance contracts apply equally to reinsurance contracts. [FRS 103.1.10].

Because insurance contracts and investment contracts with a DPF are scoped out of Sections 11 and 12 of FRS 102, FRS 103 applies to all the assets and liabilities arising from such contracts. These include:

• insurance and reinsurance receivables owed by the policyholder direct to the insurer;
• insurance receivables owed by an intermediary to an insurer on behalf of the policyholder where the intermediary is acting in a fiduciary capacity;
• insurance claims agreed with the policyholder and payable;
• insurance contract policy liabilities;
• claims handling cost provisions;
• the present value of acquired in-force business (discussed at 10.1 below);
• deferred or unearned premium reserves;
• reinsurance assets (i.e. expected reinsurance recoveries in respect of claims incurred);
• deferred acquisition costs; and
• liabilities related to discretionary participation features (DPF).

Receivables due from intermediaries to insurers that have a financing character and balances due from intermediaries not acting in a fiduciary capacity, for example loans to intermediaries repayable from commissions earned, are outside the scope of FRS 103 as they do not arise from insurance contracts.

3.2.3 Transactions not within the scope of FRS 103

FRS 103 applies only to accounting for insurance contracts and financial instruments with a DPF. The recognition, measurement and disclosure requirements for all other assets held and liabilities assumed by an insurer are contained in FRS 102. In particular, the recognition, measurement and disclosure requirements for financial assets held and financial liabilities assumed are contained in Sections 11, 12 and Section 34 – Specialised Activities – of FRS 102. [FRS 103.1.6].

FRS 103 describes transactions to which FRS 103 is not applied. These primarily relate to transactions covered by sections of FRS 102 that could potentially meet the definition of an insurance contract. These transactions are discussed below.

3.2.4 The product classification process

Insurers need to determine which transactions should be within the scope of FRS 103 and which transactions are not within its scope. Therefore, one of the main procedures required of insurers, when applying FRS 103 for the first time, is to conduct a product classification review.

The assessment of the appropriate classification for a contract will include an assessment of whether the contract contains significant insurance risk (discussed at 4 below), and whether the contract contains embedded derivatives (discussed at 5 below), deposit components (discussed at 6 below) or discretionary participation features (discussed at 7 below).

The diagram below illustrates a product classification decision tree.

4.3.1 Service contracts

Some fixed-fee service contracts in which the level of service depends on an uncertain event may meet the definition of an insurance contract. However, in the UK, these are not regulated as insurance contracts. For example, a service provider could enter into a maintenance contract in which it agrees to repair specified equipment after a malfunction. The fixed service fee is based on the expected number of malfunctions but it is uncertain whether a particular machine will break down. The malfunction of the equipment adversely affects the owner and the contract compensates the owner (in kind, rather than cash). Similarly, a contract for car breakdown services in which the provider agrees, for a fixed annual fee, to provide roadside assistance or tow the car to a nearby garage could meet the definition of an insurance contract even if the provider does not agree to carry out repairs or replace parts. [FRS 103 Appendix II.6].

In respect of the type of service contracts described above, their inclusion seems an unintended consequence of the definition of an insurance contract. However, the FRC considers that applying FRS 103 to these contracts should be no more burdensome than applying other FRS 102 if such contracts were outside the scope of FRS 103 since:

1. there are unlikely to be material liabilities for malfunctions and breakdowns that have already occurred;
2. if the service provider applied accounting policies consistent with Section 23 of FRS 102, this would be acceptable either as an existing accounting policy or, possibly, an improvement of existing policies unless they involve practices prohibited by paragraph 2.3 of FRS 103 (see 9 below); and
3. if FRS 103 did not apply to the contracts, the service provider would apply Section 21 of FRS 102 to determine whether its contracts were onerous. [FRS 103 Appendix II.7].

4.4.1 Lapse, persistency and expense risk

Lapse or persistency risk (the risk that the policyholder will cancel the contract earlier or later than the issuer had expected in pricing the contract) is not insurance risk because, although this can have an adverse effect on the issuer, the cancellation is not contingent on an uncertain future event that adversely affects the policyholder. [FRS 103 Appendix II.15].

Similarly, expense risk (the risk of unexpected increases in the administrative costs incurred by the issuer associated with the serving of a contract, rather than the costs associated with insured events) is not insurance risk because an unexpected increase in expenses does not adversely affect the policyholder. [FRS 103 Appendix II.15].

Therefore, a contract that exposes the issuer to lapse risk, persistency risk or expense risk is not an insurance contract unless it also exposes the issuer to significant insurance risk. [FRS 103 Appendix II.16].

4.4.2 Insurance of non-insurance risks

If the issuer of a contract which does not contain significant insurance risk mitigates the risk of that contract by using a second contract to transfer part of that first contract's risk to another party, this second contract exposes that other party to insurance risk. This is because the policyholder of the second contract (the issuer of the first contract) is subject to an uncertain event that adversely affects it and thus it meets the definition of an insurance contract. [FRS 103 Appendix II.16]. This is illustrated by the following example, based on an example in IFRS 4.

4.4.3 Self insurance, pooling of insurance risk by insurance mutuals, and intragroup insurance contracts

An insurer can accept significant insurance risk from a policyholder only if the insurer is an entity separate from the policyholder. [FRS 103 Appendix II.17].

Therefore, ‘self insurance’, such as a self-insured deductible where the insured cannot claim for losses below the excess limit of an insurance policy, is not insurance risk because there is no insurance contract. Accounting for self insurance and related provisions is covered by Section 21 of FRS 102 which requires that a provision is recognised only if there is a present obligation as a result of a past event, it is probable that an outflow of resources will occur and a reliable estimate can be determined. [FRS 102.21.4].

A mutual insurer (as defined in the PRA Rulebook) accepts risk from each policyholder and pools that risk. Although policyholders bear the pooled risk collectively in their capacity as owners, the mutual has still accepted the risk that is the essence of an insurance contract and therefore FRS 103 applies to those contracts. [FRS 103 Appendix II.17].

When there are insurance contracts between entities in the same group these would be eliminated in the consolidated financial statements as required by Section 9 – Consolidated and Separate Financial Statements – of FRS 102. [FRS 102.9.15]. If any intragroup insurance contract is reinsured with a third party that is not part of the group, this third party reinsurance contract should be accounted for as a direct insurance contract in the consolidated financial statements of a non-insurer because the intragroup contract will be eliminated on consolidation. This residual direct insurance contract (i.e. the policy with the third party) is outside the scope of FRS 103 from the viewpoint of the consolidated financial statements of a non-insurer because policyholder accounting is excluded from the standard as discussed at 3.2.3.F above.

4.5.1 Examples of insurance contracts

The following are examples of contracts that are insurance contracts, if the transfer of insurance risk is significant: [FRS 103 Appendix II.18]

1. insurance against theft or damage to property;
2. insurance against product liability, professional liability, civil liability or legal expenses;
3. life insurance and prepaid funeral plans (although death is certain, it is uncertain when death will occur or, for some types of life insurance, whether death will occur within the period covered by the insurance);
4. life-contingent annuities and pensions (contracts that provide compensation for the uncertain future event – the survival of the annuitant or pensioner – to assist the annuitant or pensioner in maintaining a given standard of living, which would otherwise be adversely affected by his or her survival);
5. disability and medical cover;
6. surety bonds, fidelity bonds, performance bonds and bid bonds (i.e. contracts that provide compensation if another party fails to perform a contractual obligation, for example an obligation to construct a building);
7. credit insurance that provides for specified payments to be made to reimburse the holder for a loss it incurs because a specified debtor fails to make payment when due under the original or modified terms of a debt instrument. These contracts could have various legal forms, such as that of a guarantee, some types of letter of credit, a credit derivative default contract or an insurance contract. Although these contracts meet the definition of an insurance contract they also meet the definition of a financial guarantee contract and are within the scope of Section 21 of FRS 102 and not FRS 103 unless the issuer has previously asserted explicitly that it regards such contracts as insurance contracts and has used accounting applicable to such contracts (see 3.2.3.D above);
8. product warranties issued by another party for goods sold by a manufacturer, dealer or retailer are within the scope of FRS 103. However, as discussed at 3.2.3.A above, product warranties issued directly by a manufacturer, dealer or retailer are outside the scope of FRS 103;
9. title insurance (insurance against the discovery of defects in title to land that were not apparent when the contract was written). In this case, the insured event is the discovery of a defect in the title, not the title itself;
10. travel assistance (compensation in cash or in kind to policyholders for losses suffered while they are travelling);
11. catastrophe bonds that provide for reduced payments of principal, interest or both if a specified event adversely affects the issuer of the bond (unless the specified event does not create significant insurance risk, for example if the event is a change in an interest rate or a foreign exchange rate);
12. insurance swaps and other contracts that require a payment based on changes in climatic, geological and other physical variables that are specific to a party to the contract; and
13. reinsurance contracts.

These examples are not intended to be an exhaustive list.

IFRS 4 contains various illustrative examples that provide further guidance on situations which may be useful to entities applying FRS 103.

4.5.2 Examples of transactions that are not insurance contracts

The following are examples of transactions that are not insurance contracts: [FRS 103 Appendix II.19]

1. investment contracts that have the legal form of an insurance contract but do not expose the insurer to significant insurance risk, for example life insurance contracts in which the insurer bears no significant mortality risk;
2. contracts that have the legal form of insurance, but pass all significant risk back to the policyholder through non-cancellable and enforceable mechanisms that adjust future payments by the policyholder as a direct result of insured losses, for example some financial reinsurance contracts or some group contracts;
3. self insurance, in other words retaining a risk that could have been covered by insurance. There is no insurance contract because there is no agreement with another party (see 4.4.3 above);
4. contracts (such as gambling contracts) that require a payment if an unspecified uncertain future event occurs, but do not require, as a contractual precondition for payment, that the event adversely affects the policyholder. However, this does not preclude the specification of a predetermined payout to quantify the loss caused by a specified event such as a death or an accident (see 4.4 above);
5. derivatives that expose one party to financial risk but not insurance risk, because they require that party to make payment based solely on changes in one or more of a specified interest rate, financial instrument price, commodity price, foreign exchange rate, index of prices or rates, credit rating or credit index or other variable, provide in the case of a non-financial variable that the variable is not specific to a party to the contract;
6. a credit-related guarantee (or letter of credit, credit derivative default contract or credit insurance contract) that requires payments even if the holder has not incurred a loss on the failure of a debtor to make payments when due;
7. contracts that require a payment based on a climatic, geological or other physical variable that is not specific to a party to the contract. These are commonly described as weather derivatives and are accounted for under Sections 11 and 12 of FRS 102; and
8. catastrophe bonds that provide for reduced payments of principal, interest or both, based on a climatic, geological or other physical variable that is not specific to a party to the contract.

IFRS 4 contains various illustrative examples that provide further guidance on situations which may be useful to entities applying FRS 103.

If the contracts described at (a) to (h) above create financial assets or financial liabilities they are within the scope of Sections 11 and 12 of FRS 102. Among other things, this means that the parties to the contract use what is sometimes called deposit accounting, which involves the following:

• one party recognises the consideration received as a financial liability, rather than as revenue; and
• the other party recognises the consideration as a financial asset, rather than as an expense. [FRS 103 Appendix II.20].

If the contracts described at (a) to (h) above do not create financial assets or financial liabilities, Section 23 of FRS 102 applies. Under Section 23 of FRS 102, revenue associated with a transaction involving the rendering of services is recognised by reference to the stage of completion of the transaction if the outcome of the transaction can be estimated reliably. [FRS 103 Appendix II.21].

FRS 103 refers to Examples 15, 17 and 17A in the appendix to Section 23 of FRS 102 as being relevant to the recognition of revenue for the types of contract described at (a) to (h). [FRS 103 Appendix II.22].

Where the consideration for a contract meeting the definition of an investment contract comprises both a fee for the origination and an ongoing charge for the provision of (e.g. investment management) services, the insurance undertaking should record the origination fee as revenue on the date on which it becomes entitled to it where it can be demonstrated that the undertaking has no further obligations in respect of the fee. [FRS 103 Appendix II.23].

Incremental costs that are directly attributable to securing an investment management contract are recognised as an asset if they can be identified separately and measured reliably and if it is probable that they will be recovered. The asset represents the entity's contractual right to benefit from providing investment management services and is amortised as the entity recognises the related revenue. If the entity has a portfolio of investment management contracts, it may assess their recoverability on a portfolio basis. [FRS 103 Appendix II.24].

4.6.1 The meaning of ‘significant’

No quantitative guidance supports the determination of ‘significant’ in FRS 103. This is consistent with IFRS 4. The absence of qualitative guidance was a deliberate decision made by the IASB when drafting IFRS 4 because the IASB considered that if quantitative guidance was provided it would create an arbitrary dividing line that would result in different accounting treatments for similar transactions that fall marginally on different sides of that line and would therefore create opportunities for accounting arbitrage. [IFRS 4.BC33].

IFRS 4 contains an example in the Implementation Guidance which states that ‘significant’ means that the insured benefits certainly must be greater than 101% of the benefits payable if the insured event did not occur. [IFRS 4.IG2 E1.3]. It is, however, unclear how much greater than 101% the insured benefits must be to meet the IFRS 4 definition of ‘significant’.

This practical impact of this lack of guidance is that insurers have to apply their own criteria to what constitutes significant insurance risk and there probably is inconsistency in practice as to what these dividing lines are, at least at the margins.

There is no specific requirement under FRS 103 for insurers to disclose any thresholds used in determining whether a contract has transferred significant insurance risk. However, Section 8 – Notes to the Financial Statements – of FRS 102 requires an entity to disclose the judgements that management has made in the process of applying the entity's accounting policies that have the most significant effect on the amounts recognised in the financial statements. [FRS 102.8.6].

4.6.2 The level at which significant insurance risk is assessed

Significant insurance risk must be assessed by individual contract, rather than by blocks of contracts or by reference to materiality to the financial statements. Thus, insurance risk may be significant even if there is a minimal probability of material losses for a whole book of contracts. The purpose of this is to make it easier to classify a contract as an insurance contract. [FRS 103 Appendix II.28].

However, if a relatively homogeneous book of small contracts is known to consist of contracts that all transfer insurance risk, an insurer need not examine each contract within that book to identify a few non-derivative contracts that transfer insignificant insurance risk. [FRS 103 Appendix II.28].

Multiple, mutually linked contracts entered into with a single counterparty (or contracts that are otherwise interdependent) should be considered a single contract for the purposes of assessing whether significant insurance risk is transferred. [FRS 103 Appendix II.28fn]. This requirement is intended to prevent entities entering into contracts that individually transfer significant insurance risk but collectively do not and accounting for part(s) of what is effectively a single arrangement as (an) insurance contract(s).

If an insurance contract is unbundled (see 6 below) into a deposit component and an insurance component, the significance of insurance risk transferred is assessed by reference only to the insurance component. The significance of insurance risk transferred by an embedded derivative is assessed by reference only to the embedded derivative (see 5 below). [FRS 103 Appendix II.31].

4.6.3 Significant additional benefits

The ‘significant additional benefits’ mentioned in the definition of significant insurance risk described refer to amounts that exceed those that would be payable if no insured event occurred (see 4.6 above). These additional amounts include claims handling and claims assessment costs, but exclude: [FRS 103 Appendix II.27]

1. the loss of the ability to charge the policyholder for future services, for example where the ability to collect fees from a policyholder for performing future investment management services ceases if the policyholder of an investment-linked life insurance contract dies. This economic loss does not reflect insurance risk and the future investment management fees are not relevant in assessing how much insurance risk is transferred by a contract;
2. the waiver on death of charges that would be made on cancellation or surrender (i.e. to cease paying premiums such that the insurance contracts ceases to have effect) of the contract. The contract brought these charges into existence and therefore the waiver of them does not compensate the policyholder for a pre-existing risk. Hence, they are not relevant in determining how much insurance risk is transferred by a contract;
3. a payment conditional on an event that does not cause a significant loss to the holder of the contract, for example where the issuer must pay one million currency units if an asset suffers physical damage causing an insignificant economic loss of one currency unit to the holder. The holder in this case has transferred to the insurer the insignificant insurance risk of losing one currency unit. However, at the same time the contract creates non-insurance risk that the issuer will need to pay 999,999 additional currency units if the specified event occurs; and
4. possible reinsurance recoveries. The insurer will account for these separately.

It follows from this that if a contract pays a death benefit exceeding the amount payable on survival (excluding waivers under (b) above), the contract is an insurance contract unless the additional death benefit is insignificant (judged by reference to the contract rather than to an entire book of contracts). Similarly, an annuity contract that pays out regular sums for the rest of a policyholder's life is an insurance contract, unless the aggregate life-contingent payments are insignificant. [FRS 103 Appendix II.29]. In this case, the insurer could suffer a significant loss on an individual contract if the annuitant survives longer than expected.

Additional benefits could include a requirement to pay benefits earlier than expected if the insured event occurs earlier provided the payment is not adjusted for the time value of money. An example could be whole life insurance cover that provides a fixed death benefit whenever a policyholder dies. Whilst it is certain that the policyholder will die, the timing of death is uncertain and the insurer will suffer a loss on individual contracts when policyholders die early, even if there is no overall expected loss on the whole book of contracts. [FRS 103 Appendix II.30].

4.7.1 Reassessment of insurance risk of contracts acquired in a business combination

Section 19 of FRS 102 is silent as to whether there should be a reassessment of the classification of contracts previously classified as insurance contracts under FRS 103 which are acquired as part of a business combination. In contrast, IFRS 3 – Business Combinations – states that there should be no reassessment of the classification of contracts previously classified as insurance contracts under IFRS 4 which are acquired as a part of a business combination. [IFRS 3.17(b)].

In our view, as FRS 102 provides no specific guidance on this issue, an insurer could use the hierarchy in Section 10 of FRS 102 (see Chapter 9) in order to apply the guidance in IFRS 3 and not reassess the classification of insurance contracts acquired in a business combination.

7.3.1 Negative DPF

Cumulative unallocated realised and unrealised returns on investments backing insurance and investment contracts with a DPF may become negative and result in an unallocated amount that is negative (a cumulative unallocated loss).

When the balance on the FFA of a with-profits fund is negative, an entity should explain the nature of the negative balance, the circumstances in which it arose and why no action to eliminate it was considered necessary. [FRS 103.5.5].

7.3.2 Contracts with switching features

Some contracts may contain options for the counterparty to switch between terms that would, prima facie, result in classification as an investment contract without DPF features (accounted for under Sections 11 and 12 of FRS 102) and terms that would result in a classification as an investment contract with DPF features (accounted for under FRS 103).

We believe that the fact that this switch option makes these contracts investment contracts with a DPF means that the issuer should continuously be able to demonstrate that the DPF feature still exists and also be able to demonstrate actual switching in order to classify these contracts as investment contracts with a DPF under FRS 103.

8.1.1 Definition of an insurance company in UK law

An insurance company is defined by the CA 2006 as: [s1165(3)]

• an authorised insurance company; or
• any other person (whether incorporated or not) who:
  • carries on insurance market activity; or
  • may effect or carry out contracts of insurance under which the benefits provided by that person are exclusively or primarily benefits in kind in the event of accident to or breakdown of a vehicle.

An authorised insurance company means a person (whether incorporated or not) who has permission under Part 4A of the Financial Services and Markets Act (2000) (c.8) to effect or carry out contracts of insurance. [s1165(2)]. Insurance market activity has the meaning given in section 316(3) of the Financial Services and Markets Act 2000, [s1165(7)], and refers to those engaging in insurance activity in the Lloyd's insurance market.

An insurance group is a group where the parent company is an insurance company, or where: [s1165(5)]

• the parent company's principal subsidiary undertakings are wholly or mainly insurance companies; and
• the parent company does not itself carry on any material business apart from the acquisition, management and disposal of interests in subsidiary undertakings.

A parent company's principal subsidiary undertakings are the subsidiary undertakings of the company whose results or financial position would principally affect the figures shown in the group accounts and the management of interests in subsidiary undertakings includes the provision of services to such undertakings. [s1165(6)].

When a group contains a mixture of insurance subsidiaries and non-insurance subsidiaries, judgement may need to be exercised to determine which subsidiaries are those whose results or financial position principally affect the figures in the group financial statements and therefore whether the group is an insurance group preparing consolidated financial statements under Schedule 3 to the Regulations or a non-insurance group preparing financial statements under either Schedule 1 or Schedule 2 to the Regulations. The presentation and disclosure requirements of Schedule 1 are discussed in Chapter 6.

8.2.1 Intangible assets

Intangible assets are not defined in the CA 2006 but Note (2) to the Schedule 3 balance sheet format states that amounts are only included in the balance sheet as concessions, patents, licences, trademarks and similar rights and assets if either the assets were acquired for valuable consideration and are not required to be shown under goodwill, or the assets in question were created by the company itself. However, entities preparing FRS 102 financial statements must apply the more restrictive requirements of the standard. Note (3) to the Schedule 3 balance sheet format states that goodwill can only be included to the extent that the goodwill was acquired for valuable consideration.

Schedule 3 does not address the presentation of negative goodwill. However, FRS 102 requires that negative goodwill is disclosed immediately below positive goodwill, with a subtotal of the net amount of the positive goodwill and the negative goodwill. [FRS 102.19.24(b)].

8.2.2 Investments in group undertakings and participating interests

A ‘participating interest’ means an interest held by, or on behalf of, an undertaking in the shares of another undertaking which it holds on a long-term basis for the purpose of securing a contribution to its activities by the exercise of control or influence arising from or related to that interest. In the context of the balance sheet formats, ‘participating interest’ does not include an interest in a group undertaking. A holding of 20% or more of the shares of the undertaking is presumed to be a participating interest unless the contrary is shown. An interest in shares of another undertaking includes an interest which is convertible into an interest in shares and an option to acquire shares or any such interest, even if the shares are unissued until the conversion or exercise of the option. [10 Sch 11].

For investments in subsidiaries, associates and jointly controlled entities in separate and individual financial statements, neither the current accounting rules, fair value accounting rules nor the alternative accounting rules of Schedule 3 permit the use of cost less impairment. Consequently, an investor can account for these only at fair value with changes in fair value recognised in other comprehensive income (except for reversals of a revaluation decrease recognised in profit or loss or a revaluation decrease which exceeds accumulated revaluation gains recognised in equity which are recognised in profit or loss) or at fair value with changes in fair value recognised in profit or loss. [FRS 102.9.26].

8.2.3 Other financial investments

Note (5) to the Schedule 3 balance sheet format states that debt-securities and other fixed-income securities is to comprise transferable debt securities and any other transferable fixed-income securities issued by credit institutions, other undertakings or public bodies, in so far as they are not covered within investments in group undertakings and participating interests.

Note (6) to the Schedule 3 balance sheet format states that participation in investment pools is to comprise shares held by the company in joint investments constituted by several undertakings or pension funds, the management of which has been entrusted to one of those undertakings or to one of those pension funds.

Note (7) to the Schedule 3 balance sheet format states that loans to policyholders for which the policy is the main security are to be included in ‘other loans’ and their amount must be disclosed in a note to the accounts. Loans secured by mortgage are to be shown as such even where they are also secured by insurance policies. Where the amount of other loans not secured by policies is material, an appropriate breakdown must be given in the notes to the accounts.

Note (8) to the Schedule 3 balance sheet format states that deposits with credit institutions should comprise sums the withdrawal of which is subject to a time restriction. Sums deposited with no restriction must be shown under ‘Cash at bank and in hand’ even if they bear interest.

8.2.4 Reinsurers' share of technical provisions

Note (12) to the Schedule 3 balance sheet format states that the reinsurance amounts are to comprise the actual or estimated amounts which, under contractual reinsurance arrangements, are deducted from the gross amount of technical provisions.

8.2.5 Debtors

Debtors arising out of direct insurance operations must be split between those due from policyholders and those due from intermediaries.

Note (13) to the Schedule 3 balance sheet format states that amounts owed by group undertakings and undertakings in which the company has a participating interest must be shown separately as sub-assets of the relevant asset class.

8.2.6 Other assets

Tangible fixed assets would include property, plant and equipment, as defined in FRS 102.

The items reported under stocks will generally correspond with inventories under FRS 102. [FRS 102.13.1].

The Regulations do not define cash at bank and in hand. This line item would include bank deposits with notice or maturity periods. Such bank deposits may or may not meet FRS 102's definition of ‘cash’ (i.e. cash on hand and demand deposits) or ‘cash equivalents’ (i.e. short-term, highly liquid investments that are readily convertible to known amounts of cash and that are subject to an insignificant risk of changes in value). [FRS 102.7.2]. See Chapter 7 at 3.3 for the definition of cash and cash equivalents.

While ‘own shares’ have an asset line heading in the Schedule 3 balance sheet format, FRS 102 requires investments in own shares to be treated as treasury shares and deducted from equity. [FRS 102.22.16]. Consequently, this line item will not be used under FRS 102.

Note (15) to the Schedule 3 balance sheet format states that ‘other’ is to comprise assets which are not covered by the other items and where such assets are material, they must be disclosed in a note to the accounts.

8.2.7 Prepayments and accrued income (including deferred acquisition costs)

Note (17) to the Schedule 3 balance sheet format states that deferred acquisition costs arising in general business must be stated separately from those arising in long-term business. In the case of general business, the amount of any deferred acquisition costs must be established on a basis consistent with that used for unearned premiums. See 8.5.7 below.

8.2.8 Capital and reserves

Every balance sheet of a company which carries on long-term business must show separately as an additional item the aggregate of any amounts included in capital and reserves which are not required to be treated as realised profits under section 843 of the CA 2006. [3 Sch 11(1)].

Called up share capital in relation to a company means so much of its share capital as equals the aggregate amounts of the calls made on its shares (whether or not those calls have been paid) together with any share capital paid up without being called, and any share capital to be paid on a specified future date under the articles, the terms of allotment of the relevant shares or any other arrangements for payment of those shares. [s547].

The share premium account is a statutory reserve that arises on the issue of share capital. It is beyond the scope of this publication to explain the rules governing share premium in detail but a summary explaining how the share premium arises and can be applied or reduced is contained in Chapter 6 at 5.3.12.B.

The revaluation reserve arises where an asset is carried at valuation using the alternative accounting rules in the Regulations. [3 Sch 29].

Figure 33.7 below shows the analysis required in respect of reserves.

The capital redemption reserve is a statutory reserve which is established when the shares of a limited company are redeemed or purchased wholly or partly out of the company's profits, or where treasury shares are cancelled. It is beyond the scope of this chapter to explain the rules governing redemptions/purchases of shares, treasury shares and the capital redemption reserve.

The reserve for own shares is used where the company purchases its own shares to be held by an employee share ownership plan (ESOP) that is treated as an extension of the sponsoring entity or where shares are held as treasury shares. [FRS 102.9.33-37, 22.16].

Where the Articles of Association specifically provide for reserves to be established, the line item ‘Reserves provided for by Articles of Association’ is used.

8.2.9 Subordinated liabilities

Note (18) to the Schedule 3 balance sheet format states that subordinated liabilities comprise all liabilities in respect of which there is a contractual obligation that, in the event of winding up of bankruptcy, they are to be repaid only after the claims of other creditors have been met (whether or not they are represented by certificates).

8.2.10 Fund for future appropriations (FFA)

Note (19) to the Schedule 3 balance sheet format states that the FFA is to comprise all funds the allocation of which either to policyholders or shareholders has not been determined by the end of the financial year. Transfers to and from the FFA must be shown in the profit and loss line item, ‘Transfers to or from the FFA’.

The Implementation Guidance to FRS 103 states that where there is reasonable certainty over the allocation to policyholders or owners of all items recognised in the technical account for long-term business, it is inappropriate to establish an FFA. However, certain long-term business funds of:

• proprietary insurers are established in such a way that allocation between equity and policyholders' liabilities is not clear cut; and
• mutual insurers are established in such a way that allocation between disclosed surplus and policyholders' liabilities is not clear cut; and
• therefore it is appropriate to establish an FFA. [FRS 103.IG2.50].

Where an FFA is established, the notes to the financial statements should indicate the reasons for its use and the nature of the funds involved (see 11.4 below). [FRS 103.IG2.51].

8.2.11 Technical provisions

The Schedule 3 balance sheet format permits the reinsurers' share of technical provisions to be shown either separately within liabilities or under assets item Da. However, FRS 103 prohibits the offsetting of reinsurance assets against the related insurance liabilities (see 8.10 below) and therefore the reinsurers' share of technical provisions must be shown as an asset.

Note (20) to the Schedule 3 balance sheet format states that the provision for unearned premiums for long-term business may be included in the long-term business provision rather than within unearned premiums.

Note (21) to the Schedule 3 balance sheet format states that the long-term business provision is to comprise the actuarially estimated value of the company's liabilities including bonuses already declared and after deducting the actuarial value of future premiums. It should also include claims incurred but not reported plus the estimated costs of settling such claims.

Note (22) to the Schedule 3 balance sheet format states that claims outstanding is to comprise the estimated ultimate cost to the company of settling all claims arising from events which have occurred up to the end of the financial year (including, in the case of general business, claims incurred but not reported) less amounts already paid in respect of such claims.

Note (23) to the Schedule 3 balance sheet format states that provisions for bonuses and rebates is to comprise amounts intended for policyholders or contract beneficiaries by way of bonuses and rebates to the extent that such amounts have not been credited to policyholders or contract beneficiaries or included in liabilities item Ba or in liabilities item C2.

Note (24) to the Schedule 3 balance sheet format states that equalisation provisions are those required to be maintained in respect of general business by the company in accordance with the rules made by the Financial Conduct Authority or the Prudential Regulation Authority under Part 10 of the Financial Services and Markets Act 2000. They also comprise any amounts required to be set aside by a company to equalise fluctuations in loss ratios in future years or to provide for special risks in accordance with Council Directive 87/343/EEC. Since the implementation of the Solvency II Directive, effective from 1 January 2016, the UK (and EU) regulatory framework does not permit equalisation or catastrophe provisions.

Note (25) to the Schedule 3 balance sheet format states that other technical provisions are to include the provision for unexpired risks (see 8.5.5 below). Where the provision for unexpired risks is significant, it must be disclosed separately.

8.2.12 Technical provisions for linked liabilities

Note (26) to the Schedule 3 balance sheet format states that this comprises technical provisions constituted to cover liabilities relating to investment in the context of long-term policies under which the benefits payable to policyholders are wholly or partly determined by reference to the value of, or the income from, property of any description (whether or not specified in the contract), or by reference to fluctuations in, or in an index of, the value of property of any description (whether or not so specified). ‘Property’ in this context means any type of asset. Any additional technical provisions constituted to cover death risks, operating expenses or other risk (such as benefits payable at the maturity date or guarantee surrender values) must be included in the long-term business provision.

This item must also comprise technical provisions representing the obligations of a tontine's organiser in relation to its members.

The Implementation Guidance to FRS 103 states that the relevant provision for any contract should not be less than the element of any surrender or transfer value which is calculated by reference to the relevant fund or funds or index. [FRS 103.IG2.47]. The net assets held to cover linked liabilities at the reporting date may differ from the technical provisions for linked liabilities. However, the reasons for any significant mismatching should be disclosed. [FRS 103.IG2.48].

Where the technical provision for linked liabilities has regard to the timing of the tax obligation, the effect of this should be excluded from the determination of deferred tax. [FRS 103.IG2.49].

8.2.13 Provisions for other risks

8.2.14 Deposits received from reinsurers

Note (27) to the Schedule 3 balance sheet format states that this item is to comprise amounts deposited by or withheld from other insurance undertakings under reinsurance contracts. These amounts may not be merged with other amounts owed to or by those other undertakings. Where the company ceded insurance and has received as a deposit securities which have been transferred to its ownership, this item is to comprise the amount owned by the company by virtue of the deposit.

8.2.15 Creditors

Note (28) to the Schedule 3 balance sheet format states that amounts owed to group undertakings and undertakings in which the company has a participating interest must be shown separately as sub-items.

Note (29) to the Schedule 3 balance sheet format states that the amount of any convertible debenture loans must be shown separately.

8.3.1 Gross written premiums

Note (1) to the Schedule 3 profit and loss format states that gross premiums written is to comprise all amounts during the financial year in respect of insurance contracts entered into regardless of the fact that such amounts may relate in whole or in part to a later financial year and must include:

• premiums yet to be determined, where the premium calculation can be done only at the end of the year;
• single premiums, including annuity premiums, and in long-term business, single premiums resulting from bonus and rebate provisions in so far as they must be considered as premiums under the terms of the contract;
• additional premiums in the case of half-yearly, quarterly or monthly payments and additional payments from policyholders for expenses borne by the company;
• in the case of co-insurance, the company's portion of total premiums;
• reinsurance premiums due from ceding and retroceding undertakings, including portfolio entries.

The above must be shown after deductions of cancellations and portfolio withdrawals credited to ceding and retroceding undertakings.

In addition, gross premiums written must not include the amounts of taxes or duties levied with premiums.

8.3.2 Outwards reinsurance premiums

Note (2) to the Schedule 3 profit and loss format states that outwards reinsurance premiums must comprise all premiums paid or payable in respect of outwards reinsurance contracts entered into by the company. Portfolio entries payable on the conclusion or amendment of outwards reinsurance contracts must be added; portfolio receivables must be deducted.

8.3.3 Changes in the provision for unearned premiums, net of reinsurance

Note (3) to the Schedule 3 profit and loss format states that in the case of long-term business, the change in unearned premiums may be included either in this line item or within changes in other technical provisions.

8.3.4 Claims incurred, net of reinsurance

Note (4) to the Schedule 3 profit and loss format states that this is to comprise all payments made in the financial year with the addition of the provision for claims (but after deducting the provision for claims for the preceding financial year).

The amounts must include annuities, surrenders, entries and withdrawals of loss provisions to and from ceding insurance undertakings and reinsurers and external and internal claims management costs and charges for claims incurred but not reported. Sums recoverable on the basis of salvage and subrogation must be deducted.

Where the difference between the loss provision at the beginning of the year and the payments made during the year on account of claims incurred in previous years and the loss provision shown at the end of the year for such outstanding claims is material, it must be shown in the notes to the accounts, broken down by category and amount.

8.3.5 Bonuses and rebates, net of reinsurance

Note (5) to the Schedule 3 profit and loss format states that bonuses comprise all amounts chargeable for the financial year which are paid or payable to policyholders and other insured parties or provided for their benefit, including amounts used to increase technical provisions or applied to the reduction of future premiums, to the extent that such amounts represent an allocation of surplus or profit arising on business as a whole or a section of business, after deduction of amounts provided in previous years which are no longer required. Rebates are to comprise such amounts to the extent that they represent a partial refund of premiums resulting from the experience of individual contracts.

Where material, the amount charged for bonuses and that charged for rebates must be disclosed separately in the notes to the accounts.

8.3.6 Acquisition costs

Note (6) to the Schedule 3 profit and loss format states that acquisition costs comprise costs arising from the conclusion of insurance contracts. They must cover both direct costs, such as acquisition commissions or the cost of drawing up the insurance document or including the insurance contract in the portfolio, and indirect costs, such as the advertising costs or the administrative expenses connected with the processing of proposals and the issuing of policies. In the case of long-term business, policy renewal commissions must be included within administrative expenses.

8.3.7 Administrative expenses

Note (7) to the Schedule 3 profit and loss format states that administrative expenses must include the costs arising from premium collection, portfolio administration, handling of bonuses and rebates and inward and outward reinsurance. In particular, they must include staff costs and depreciation provisions in respect of office furniture and equipment in so far as these need not be shown under acquisition costs, claims incurred or investment charges.

8.3.8 Investment income, expenses and charges

Note (8) to the Schedule 3 profit and loss format states that investment income and charges must, to the extent that they arise in the long-term technical fund, be disclosed in the long-term technical account. Other investment income, expenses and charges must either be disclosed in the non-technical account or attributed between the appropriate technical and non-technical accounts. Where the company makes such an attribution it must disclose the basis for it in the notes to the accounts. See 8.7 below.

8.3.9 Unrealised gains and losses on investments

Note (9) to the Schedule 3 profit and loss format states that in the case of investments attributed to the long-term fund, the difference between the valuation of the investments and their purchase price or, if they have previously been valued, their valuation as at the last balance sheet date, may be disclosed (in whole or in part) under either item 3 (investment income) or item 10 (investment expenses and charges), as the case may be, of the long-term technical account, and in the case of investments shown as assets held to cover linked liabilities must also be disclosed.

In the case of other investments, the difference between the valuation of investments and their purchase price or, if they have previously been valued, their valuation as at the last balance sheet date, may be disclosed (in whole or in part) under items 3a (unrealised gains on investments) or 5a (unrealised losses on investments), as the case may require, of the non-technical account.

8.3.10 Allocated investment return

Note (10) to the Schedule 3 profit and loss format states that the investment return allocated initially to one part of the profit and loss account (see 8.3.8 above) may be transferred to another part of the profit and loss account. See 8.7 below.

One reason that such a transfer might be made is so that, for example, a long-term insurer could recognise investment return in the life technical account on a longer-term rate of return basis.

Where part of the investment return allocated initially to the non-technical account is transferred the general business technical account, any transfer must be deducted from item 6 in the non-technical account and added to item 2 of the technical account – general business.

Where part of the investment return allocated initially to the long-term business account is transferred to the non-technical account, the transfer to the non-technical account should be deducted from item 2 of the long-term business account and added to item 4 of the non-technical account.

The reasons for such transfers (which may consist of a reference to any relevant statutory requirement) and the basis on which they are made must be disclosed in the notes to the accounts. See 11.7 below.

8.3.11 Exchange gains or losses

Exchange differences required to be included within profit or loss under Section 30 of FRS 102 should be dealt with through the non-technical account except for long-term insurance business where exchange differences should be recognised in the technical account for long-term business. Exchange differences taken to other comprehensive income arising from translating results and financial position into a different presentational currency [FRS 102.30.18(c)] can, where appropriate, in the case of long-term business, be recognised in the FFA. [FRS 103.2.32].

8.3.12 Employee benefits

The net interest on the net defined benefit liability during the reporting period [FRS 102.28.23(d)] should be recognised, as appropriate, in the technical account for long-term business or the non-technical account. [FRS 103.2.33].

As an exception to the requirement in paragraph 28.23(d) of FRS 102 to remeasure the net defined benefit liability in other comprehensive income, the remeasurement of the net defined benefit liability which is not attributable to owners should be treated as an amount, the allocation of which, either to policyholders or to owners, has not been determined by the reporting date (i.e. reported within the FFA). It should be included as a separate line in the technical account for long-term insurance business immediately above the line for transfer to or from the FFA, and reflected in that transfer. The impact should be disclosed separately in the notes to the financial statements. [FRS 103.2.34].

8.3.13 Other comprehensive income

As discussed at 8.3 above, Schedule 3 to the Regulations does not address the presentation of other comprehensive income. Illustrative examples of the presentation of other comprehensive income are in Chapter 6 at 6.5.2.

Other comprehensive income means items of income and expense (including reclassification adjustments), that are not recognised in profit or loss as required or permitted by FRS 102. [FRS 102 Appendix I]. Therefore, profit or loss is the default category; all comprehensive income is part of profit or loss unless FRS 102 permits or requires otherwise.

FRS 102 requires the following items to be included in other comprehensive income:

1. changes in revaluation surplus relating to property, plant and equipment [FRS 102.17.15E-F] and intangible assets. [FRS 102.18.18G-H]. See Chapter 15 at 3.6.3 and Chapter 16 at 3.4.2.C;
2. actuarial gains and losses, and the return on plan assets excluding amounts included in net interest on the net defined benefit liability (known collectively as ‘remeasurements’ of the net defined benefit liability) on defined benefit plans. [FRS 102.28.23(d), 25]. See Chapter 25 at 3.6.10.B;
3. exchange gains and losses arising from translating the financial statements of a foreign operation (including in consolidated financial statements, exchange differences on a monetary item that forms part of the net investment in the foreign operation). However, under FRS 102, cumulative exchange differences accumulated in equity are not reclassified to profit and loss on disposal of a net investment in a foreign operation; [FRS 102.9.18A, 30.13]
4. the effective portion of fair value gains and losses on hedging instruments in a cash flow hedge or a hedge of the foreign exchange risk in a net investment in a foreign operation. The amounts taken to equity in respect of the hedge of the foreign exchange risk in a net investment in a foreign operation are not reclassified to profit or loss on disposal or partial disposal of the foreign operation. [FRS 102.12.23-24, 25A]. See Chapter 10 at 10.8 and 10.9;
5. fair value gains and losses through other comprehensive income for an investor that is not a parent measuring its interests in jointly controlled entities, [FRS 102.15.9(c), 15.14-15A], and investments in associates in its individual financial statements. [FRS 102.14.4(c), 14.9-10A]. See Chapter 12 at 3.3.4 and Chapter 13 at 3.6.2;
6. fair value gains and losses through other comprehensive income for investments in subsidiaries, associates and jointly controlled entities used by the parent in its separate financial statements or in consolidated financial statements for certain excluded subsidiaries. [FRS 102.9.26(b), 9.26A, 9.9, 9.9A, 9.9B(b)]. See Chapter 8 at 3.4 and 4.2; and
7. any unrealised gain arising on an exchange of business or non-monetary assets for an interest in a subsidiary, jointly controlled entity or associate. [FRS 102.9.31(c)]. See Chapter 8 at 3.8.

Of the above items, only the amounts taken to other comprehensive income in relation to cash flow hedges (at (d) above) may be reclassified to profit or loss in a subsequent period under FRS 102.

Where the entity applies the recognition and measurement requirements of IAS 39 or IFRS 9 to financial instruments, further items are reported in other comprehensive income (see Chapter 10).

In addition, Schedule 3 to the Regulations restricts when unrealised profits can be reported in the profit and loss account. [3 Sch 18(a)]. Consequently, certain unrealised profits may be required to be reported in other comprehensive income rather than in profit or loss. Whether profits are available for distribution must be determined in accordance with applicable law. TECH 02/17BL provides guidance on the determination of the profits available for distribution (under the CA 2006). [FRS 102 Appendix III.29].

8.4.1 Gross premiums written and reinsurance outwards premiums

Premiums, including those for inwards reinsurance, should be recognised when due for payment. When the amount due is not known, for example with certain pensions business, estimates should be used. [FRS 103.3.3]. An insurer should not accrue for future premiums receivable under a contract. This is because such premiums are included within the calculation of the insurance liability (see 8.4.4 below). FRS 103 does not elaborate as to how estimates should be made when the amount due is not known.

For linked business (i.e. business where the benefits payable to policyholders are wholly or partly to be determined by reference to the value of, or the income form, property of any description or by reference to fluctuations in, or an index of, the value of property of any description), the due date for payment may be taken as the date when the liability is established. [FRS 103.3.3].

Reinsurance outwards premiums should be recognised when paid or payable. [FRS 103.3.4].

8.4.2 Claims recognition

Claims payable on maturity should be recognised when the claims become due for payment and claims payable on death should be recognised on notification. [FRS 103.3.5].

Where a claim is payable and the policy or contract remains in force, the relevant instalments should be recognised when due for payment. There should be consistent treatment between the recognition of the claim in the technical account for long-term business and the calculation of the long-term business provision and/or the provision for linked liabilities as appropriate. [FRS 103.3.5].

Surrenders should be included within claims incurred and recognised either when paid or at the earlier date on which, following notification, the policy ceases to be included within the calculation of the long-term business provision and/or the provision for linked liabilities. [FRS 103.3.6].

8.4.3 Deferred acquisition costs

Acquisition costs are costs arising from the conclusion of insurance contracts including direct costs and indirect costs connected with the processing of proposals and the issuing of policies. [FRS 103 Appendix I]. Direct costs include acquisition commissions or the cost of drawing up the insurance document or including the insurance contract in the portfolio. Indirect costs include advertising costs or the administrative expenses connected with the processing of proposals and the issuing of policies. [3 Sch P&L Note 1].

FRS 103 does not permit acquisition costs to be deferred for with-profit funds. [FRS 103.3.10]. This prohibition applies to with-profits business and with-profit funds to which the Prudential Regulatory Authority (PRA) realistic capital regime (as set out in section 1.3 of INSPRU as at 31 December 2015) was being applied, either voluntarily or compulsorily, prior to 1 January 2016. [FRS 103.3.1(b)].

For other long-term insurance business, acquisition costs can be deferred except to the extent that: [FRS 103.3.7]

• the costs in question have already been recovered (for example where the design of the policy provides for the recovery of costs as incurred);
• the net present value of margins within insurance contracts is not expected to be sufficient to cover deferred acquisition costs after providing for contractual liabilities to policyholders and expenses; and
• the receipt of future premiums or the achievement of future margins is insufficiently certain based on estimates of future expected discontinuance rates or other experience.

Advertising costs can only be deferred where they are directly attributable to the acquisition of new business. [FRS 103.3.8].

FRS 103 does not specify a particular method for the amortisation of deferred acquisition costs. However, the costs that are carried forward should be amortised over a period no longer than the one in which, net of any related deferred tax provision, they are expected to be recoverable out of margins on related insurance contracts in force at the reporting date, and in a similar profile to those margins. [FRS 103.3.9]. This implies that amortisation based on profit margins arising from the business is the most appropriate methodology.

8.4.4 Measurement of insurance liabilities and related assets

Schedule 3 requires that technical provisions must at all times be sufficient to cover any liabilities arising out of insurance contracts as far as can reasonably be foreseen. [3 Sch 49].

Schedule 3 requires that the long-term business provision must in principle be computed separately for each long-term contract, save that statistical or mathematical methods may be used where they may be expected to give approximately the same results as individual calculations. [3 Sch 52(1)].

There is also a requirement that the computation of the long-term business provision must be made annually by a Fellow of the Institute or Faculty of Actuaries on the basis of recognised actuarial methods, with due regard to the actuarial principles laid down in Directive 2009/138/EC of the European Parliament and of the Council of 25 November 2009 on the taking up and pursuit of the business of Insurance and Reinsurance (Solvency II). [3 Sch 52(3)]. The Department for Business, Energy & Industrial Strategy (BEIS) has confirmed to the FRC that this reference should not be interpreted to mean that insurance companies are required to change their accounting basis to one consistent with Solvency II and that Solvency II should only be considered when it is relevant to the accounting basis applied in the company's accounts. [FRS 103 Appendix III.2A].

8.4.5 Value of in-force life assurance business held by parents that are not insurers

Banking and other non-insurance entities with insurance subsidiaries sometimes account for the insurance business in their consolidated financial statements on an embedded value or similar basis under which, in addition to the value of the retained surplus in the insurance subsidiary, an asset is recognised for the VIF. The continuation of such a practice is permitted only if the valuation policy is amended, if necessary, to exclude from the measurement of the value of the future profit to shareholders any value attributable to future investment margins. [FRS 103.3.16].

No value should be attributed to in-force long-term insurance business other than:

• in accordance with the requirements above and at 8.4.4.B; or
• amounts recognised as an intangible asset as part of the allocation of fair values under acquisition accounting as discussed at 10 below [FRS 103.3.17].

When the value attributable to a VIF asset recognised by a banking or other non-insurance entity in respect of its insurance subsidiaries in the consolidated financial statements includes an amount in relation to non-participating business written in a with-profits fund or an interest of a with-profits fund in a subsidiary or associate an adjustment should be made to eliminate any double-counting of the same VIF. [FRS 103.3.18].

8.5.1 Written and earned premiums

The Implementation Guidance states that underwriting results should be determined on an annual basis, notwithstanding that this will normally require some estimation to be made at the reporting date, particularly with regard to outstanding claims. [FRS 103.IG2.1].

Written premiums should comprise the total premiums receivable for the whole period of cover provided by the contracts entered into during the reporting period, regardless of whether these are wholly due for payment in the reporting period, together with any adjustments arising in the reporting period to such premiums receivable in respect of business written in prior reporting periods. [FRS 103.IG2.2].

The Implementation guidance further states that regardless of the method by which commission is remitted (e.g. by an intermediary), grossing up premiums for commission should be applied, if necessary on an estimated basis, as this correctly reflects the contractual arrangements in force. This also applies where the premiums are determined by an intermediary. Where, however, policies are issued to intermediaries on a wholesale basis and they are themselves responsible for setting the final amount payable by the insured without reference to the insurer, the written premium will normally comprise the premium payable to the insurer and grossing up will be inappropriate unless it reflects the contractual position. [FRS 103.IG2.3].

Written premiums should include an estimate for pipeline premiums (i.e. premiums written but not reported to the undertaking by the reporting date) relating only to those underlying contracts of insurance where the period of cover has commenced prior to the reporting date. [FRS 103.IG2.4]. Under some policies written premiums may be adjusted retrospectively in the light of claims experience or where the risk covered cannot be assessed accurately at the commencement of cover. Where written premiums are subject to an increase retrospectively, recognition of potential increases should be deferred until the additional amount can be ascertained with reasonable certainty. Where written premiums are subject to a reduction, a remeasurement taking account of such a reduction should be made as soon as the entity has an obligation to the policyholder. [FRS 103.IG2.6].

Where an insurer has offered renewal and is therefore contractually liable to pay claims if renewal is subsequently confirmed by the policyholder, it should recognise the renewal premium in income, subject to making a provision for anticipated lapses and the necessary proportion of unearned premiums. [FRS 103.IG2.5].

Additional or return premiums should be treated as a remeasurement of the initial premium. Where a claims event causes a reinstatement premium to be paid, the recognition of the reinstatement premium and the effect on the initial premium should reflect the respective incidence of risk attaching to those premiums in determining under the annual accounting basis that proportion earned and unearned at the reporting date. [FRS 103.IG2.7].

Written premiums should be recognised as earned premiums over the period of the policy having regard to the incidence of risk. Time apportionment of the premium is normally appropriate if the incidence of risk is the same throughout the period of cover. If there is a marked unevenness in the incidence of risk over the period of cover, a basis which reflects the profile of risk should be used. The proportion of the written premiums relating to the unexpired period of these policies should be carried forward as an unearned premiums provision at the reporting date. [FRS 103.IG2.8].

Schedule 3 requires that the provision for unearned premiums must in principle be calculated separately for each insurance contract, save that statistical methods (and in particular proportional and flat rate methods) may be used where they may be expected to give approximately the same results as individual calculations. Where the pattern of risk varies over the life of a contract, this must be taken into account in calculation methods. [3 Sch 50].

8.5.2 Portfolio premiums and claims

A portfolio premium is an amount payable by one insurer to another in consideration for a contract whereby the latter agrees to assume responsibility for the claims arising on a portfolio of in-force business written by the former from a future date until the expiry of the policies. A portfolio claim is an amount payable by one insurer to another in consideration for a contract whereby the latter agrees to assume responsibility for the unpaid claims incurred by the former prior to a date specified in the contract. [FRS 103 Appendix I]. This is different from reinsurance where the reinsurer agrees to pay losses suffered by the reinsured rather than assuming responsibility for the losses.

The Implementation Guidance states that portfolio premiums payable should be included within premiums for reinsurance outwards in the financial statements of the transferor undertaking but deferred to subsequent reporting periods as appropriate in respect of any unexpired period of risk at the reporting date. In the financial statements of the transferee undertaking they should be included within written premiums with any amount unearned at the reporting date being carried forward in the unearned premiums provision. [FRS 103.IG2.29].

Portfolio claims transfers should be recognised in the financial statements of the transferor undertaking as payments in settlement of the claims transferred in accordance with the requirements of (note 4) to the profit and loss account (see 8.3.4 above). [FRS 103.IG2.30]. Similarly, the consideration receivable by the transferee undertaking should be credited to claims payable in the statement of financial position. [FRS 103.IG2.31]. Disclosure should be made in notes to the financial statements of any claims portfolio transfers, which materially affect the transferee undertaking's exposure to risk. [FRS 103.IG2.32].

8.5.3 Claims provisions

Schedule 3 requires that technical provisions must at all times be sufficient to cover any liabilities arising out of insurance contracts as far as can reasonably be foreseen. [3 Sch 49].

A provision must in principle be computed separately for each claim on the basis of the costs still expected to arise, save that statistical methods may be used if they result in an adequate provision having regard to the nature of the risks. The provision must also allow for claims incurred but not reported by the balance sheet date, the amount of the allowance being determined having regard to past experience as to the number and magnitude of claims reported after previous balance sheet dates. All claims settlement costs (whether direct or indirect) must be included in the calculation of the provision. [3 Sch 53(a)-(c), FRS 103.IG2.9].

Recoverable amounts arising out of salvage or subrogation must be estimated on a prudent basis and either deducted from the provision for claims outstanding (in which case if the amounts are material they must be shown in the notes to the accounts) or shown as assets. [3 Sch 53(d)]. Once potential recoveries qualify for recognition as separate assets (e.g. property, plant and equipment) they should be accounted for as such under the appropriate section of FRS 102.

In determining the estimate of the amount required to settle the obligation at the reporting date, the Implementation Guidance states that, in relation to an entity's existing accounting policies, the level of claims provisions should continue to be set such that no adverse run-off deviation is envisaged. In determining the estimate of the amount required to settle the obligation at the reporting date consideration should be given to the probability and magnitude of future experience being more adverse than previously assumed. An entity may not introduce this practice either if it changes its existing accounting policies or develops a new accounting policy. [FRS 103.IG2.10].

The Implementation Guidance further states that provision should be made at the reporting date for all claims handling expenses to cover the anticipated future costs of negotiating and settling claims which have been incurred, whether reported or not, up to the reporting date. Separate provisions should be assessed for each category of business. [FRS 103.IG2.11]. In determining the provision for claims handling expenses, unless clear evidence is available to the contrary, it should be assumed that the activity of the claims handling department will remain at its current level and therefore that the contribution to its costs from future new business will remain at the same level. [FRS 103.IG2.12]. The provision for claims handling expenses should be included within the provision for claims outstanding but need not be separately disclosed. Claims handling expenses incurred should be included within claims incurred in the technical account for general business. [FRS 103.IG2.13].

8.5.4 Discounting of claims provisions

Schedule 3 prohibits implicit discounting or deductions from general insurance claims provisions. [3 Sch 53(7)].

Schedule 3 permits explicit discounting of general insurance claims subject to conditions. These conditions are: [3 Sch 54]

• the expected average interval between the date for settlement of the claims being discounted and the accounting date must be at least four years;
• the discounting or deductions must be effected on a recognised prudential basis;
• when calculating the total cost of settling claims, the company must take account of all factors that could cause increases in that cost;
• the company must have adequate data at its disposal to construct a reliable model of the rate of claims settlements; and
• the rate of interest used for discounting must not exceed a rate prudently estimate to be earned by assets of the company which are appropriate in magnitude and nature to cover the provisions for claims being discounted during the period necessary for the payment of such claims and must not exceed either a rate justified by the performance of such assets over the preceding five years or a rate justified by the performance of such assets during the year preceding the balance sheet date.

The Implementation Guidance to FRS 103 states that the four year test described above should be applied by reference to the end of each reporting period in respect of all claims outstanding at that date, and not just once in the accounting period in which the claims were incurred. [FRS 103.IG2.14]. The calculation of the average interval should be weighted on the basis of expected claims before any deduction for reinsurance. [FRS 103.IG2.16].

When applied, explicit discounting should normally be adopted by reference to categories of claims (with similar characteristics but not solely by length of settlement pattern), rather than to individual claims. [FRS 103.IG2.15].

In considering if there is adequate data available to construct a reliable model of the rate of claims settlement, the principal factors to be considered are the amount of future claims settlements, the timing of future cash flows and the discount rate. Procedures should be undertaken to assess the accuracy of the claims settlement pattern predicted by the model in prior periods and the current model should be adjusted, as appropriate, to reflect the out-turn and conclusions of analyses in the previous period. Cash flows should be modelled gross and net of reinsurance as reinsurance recoveries may arise later than the related claims payments. [FRS 103.IG2.17].

For the purpose of determining an appropriate discount rate, justification of the rate requires consideration of the returns achieved over the period in question to the extent that this is relevant to the future. [FRS 103.IG2.18].

The effect of the unwinding of discounted claims provisions during a reporting period should be disregarded in considering whether material adverse run-off deviations have arisen requiring disclosure under (Note 4) of the Notes to the Profit and Loss Account format in Schedule 3 to the Regulations (see 8.3.4 above). [FRS 103.IG2.19].

Any unwinding of the discount on general insurance business claims provisions in a reporting period should be recorded under the headings for investment income or gains in the appropriate sections of the income statement (referred to as the profit and loss account in the CA 2006). Separate disclosure should then be made, where material, of the amount of the investment return which corresponds to the unwinding of the discount. [FRS 103.IG2.20].

8.5.5 Unexpired risks provision

The Regulations require that the provision for unexpired risks must be computed on the basis of claims and administrative expenses likely to arise after the end of the financial year from contracts concluded before that date, in so far as their estimate value exceeds the provision for unearned premiums and any premiums receivable under those contracts. [3 Sch 51].

The Implementation Guidance below helps apply the requirements of paragraphs 2.14 to 2.19 of FRS 103 and the principles of Section 21 and Section 32 – Events after the End of the Reporting Period – to general insurance contracts.

When the estimated value of claims and expenses attributable to the unexpired periods of policies in force at the reporting date exceeds the unearned premiums provision in relation to such policies after deduction of any deferred acquisition costs, an unexpired risks provision should be established. If material, this provision should be disclosed separately either in the statement of financial position or in the notes to the financial statements. [FRS 103.IG2.21].

The assessment of whether an unexpired risks provision is necessary should be made for each grouping of business which is managed together. Any unexpired risks surpluses and deficits within that grouping should be offset in that assessment. [FRS 103.IG2.22]. For this purpose business should only be regarded as ‘managed together’ where no constraints exist on the ability to use assets in relation to such business to meet any of the associated liabilities and either:

• there are significant common characteristics, which are relevant to the assessment of risk and setting of premiums for the business lines in question; or
• the lines of business are written together as separate parts of the same insurance contracts. [FRS 103.IG2.23].

For delegated authorities (i.e. where the insurer is unable to influence the terms on which policies are issued) a provision should be established at the reporting date for any anticipated losses arising on policies issued in the period after the reporting date which the delegated authority entered into before that date. [FRS 103.IG2.24].

The assessment of whether an unexpired risks provision is required, and if so its amount, should be based on information available at the reporting date which may include evidence of relevant previous claims experience on similar contracts adjusted for known differences, events not expected to recur and, where appropriate, the normal level of seasonal claims if the previous reporting period was not typical in this respect. The assessment should not however take into account any new claims events occurring after the reporting date, as these are non-adjusting events. In accordance with paragraph 32.10 of FRS 102 exceptional claims events occurring after the end of the reporting period but before the financial statements are authorised for issue should be disclosed in the notes to the financial statements together with an estimate of their financial effect. Where there is uncertainty concerning future events, in accordance with paragraph 2.9 of FRS 102, an insurer should include a degree of caution in the exercise of the judgements needed in making the estimates required such that liabilities are not understated. [FRS 103.IG2.25].

In calculating the best estimate of the amount required to settle future claims in relation to the unexpired periods of risk on policies in force at the reporting date, the future investment return arising on investments supporting the unearned premiums provision and the unexpired risks provision may be taken into account. For the purposes of calculating this provision, the deferred acquisition costs should be deducted from the unearned premiums provision. The investment return will be that expected to be earned by the investments held until the future claims are settled. [FRS 103.IG2.26].

Deferred acquisition costs should not be written off, in whole or in part, to profit or loss as being irrecoverable for the purpose of reducing or eliminating the need for an unexpired risks provision. [FRS 103.IG2.27].

8.5.6 Equalisation and catastrophe provisions

An entity is allowed to recognise a liability for possible future claims only if permitted by the regulatory framework that applies to the entity. However, following the implementation of the Solvency II Directive, with effect from 1 January 2016 the UK (and EC) regulatory framework does not permit equalisation or catastrophe provisions.

Where an entity has equalisation or catastrophe provisions (e.g. in an overseas subsidiary where these are permitted by the local regulatory framework) the presentation of such liabilities must follow the requirements of the legal framework that applies to the entity. [FRS 103.2.13(a)]. For disclosure requirements see 11.2.1.A below.

8.5.7 Deferred acquisition costs

The Implementation Guidance for applying the requirements of Note (17) to the balance sheet – see 8.2.7 above – states that acquisition costs should be deferred commensurate with the unearned premiums provision. The proportion of acquisition costs to be deferred will be the same proportion of the total acquisition costs as the ratio of unearned premiums to gross written premiums for the class of business in question. For this purpose acquisition expenses should be allocated to classes of business. Where this is not possible for reinsurance business inwards an estimate should be made. [FRS 103.IG2.34].

Advertising costs should not be deferred unless they are directly attributable to the acquisition of new business. [FRS 103.IG2.35].

Related reinsurance commissions deferred should not be netted against deferred acquisition costs but should be shown as liabilities in the statement of financial position. [FRS 103.IG2.36].

8.7.1 The longer term rate of return for equities and properties

The longer term investment return on equities and properties should be determined using one of the following methods: [FRS 103.IG2.72]

• grossing-up actual income earned for each asset class by a factor representing the longer term rate of investment return divided by an assumed long-term dividend or rental yield (based on the assumption that income will reflect the mix of assets held during the reporting period). Adjustments will be required for special factors which may distort the underlying yields of the portfolio such as (in the case of equities), special or stock dividends and share buy-backs; or
• applying the longer term rate of return to investible assets held during the period (taking account of new money invested and changes in portfolio mix) by reference to the quarterly or monthly weighted average of each group of assets after excluding the effect of short-term market movements.

The longer term rate of return should be determined separately for equities and property and for each material currency in which relevant investments are held. [FRS 103.IG2.73]. Taking into account the investment policy followed by the entity, the longer term rate of investment return should reflect a combination of historical experience and current market expectations for each geographical area and each category of investments. The rates chosen should be best estimates based on historical market real rates of return and current inflation expectations, having regard, where appropriate, to the following factors: [FRS 103.IG2.74]

• comparison of the business's actual returns and market returns over the previous five years or such longer period as may be appropriate;
• longer term rates of return currently used in the business for other purposes, for example, product pricing, with-profits bonus policy, and pensions funding;
• the rate used for the purpose of achieved profits method reporting;
• consensus economic and investment market forecasts of investment returns; and
• any political and economic factors which may influence current returns.

Rates of return should be set with a view to ensuring that longer term returns credited to operating results do not consistently exceed or fall below actual returns being earned. Any downturn in expectations of longer term returns should be recognised immediately by reducing the assumed rate of return. Rates used should be reviewed at least annually although changes would be expected to be infrequent. [FRS 103.IG2.75].

8.7.2 The longer term rate of return for fixed income securities

The longer term investment return on fixed income securities may be determined using one of the following methods: [FRS 103.IG2.76]

• a redemption yield calculated so that any excess of the purchase price over the amount repayable on maturity is recognised in profit or loss by instalments so that it is written off by the time that the security is redeemed; or
• amortised cost with realised gains and losses subject to continuing amortisation over the remaining period to the maturity date.

The Implementation Guidance explains that the longer term return may be based on interest earned where the net effect of amortisation would be immaterial. In the case of irredeemable fixed interest securities and short-term assets, the allocated longer term rate of investment return should be the interest income receivable in respect of the reporting period. [FRS 103.IG2.76].

8.7.3 The longer term rate of return for derivatives

The Implementation Guidance states that where derivatives have a material effect and are used to adjust exposure to the various classes of instruments, the calculation of the longer-term rate of return for equities and properties should be adjusted to reflect the underlying economic exposure. [FRS 103.IG2.77].

8.7.4 Attributing tax to the transfer to the non-technical account

The Implementation Guidance states that, in common with other types of business, taxable profits for UK entities with long-term insurance business are now derived from pre-tax profits reported in the financial statements. However, the requirement for tax expense (income) to be allocated to the same account (technical or non-technical) as the transaction or other event that resulted in the tax expense (income) means that the amount shown in the non-technical account as the transfer from (to) the long-term business technical account is net of tax. There is therefore a requirement for the tax attributable to the transfer to be brought into account in arriving at profit before tax in the non-technical account. [FRS 103.IG2.79].

Entities should determine the amount to be brought into account in the non-technical account in respect of the transfer from (to) the long-term business technical account using a method which is consistent with the approach in paragraph 29.22 of FRS 102 which requires tax to be presented in the same component of total comprehensive income as the transaction or other event that resulted in the tax expense or income. This should fairly represent that part of the tax expense (income) in the long-term business technical account which is based on pre-tax accounting profits or on timing differences in the recognition of such profits for accounting and tax purposes. [FRS 103.IG2.80].

The reconciliation of the tax expense included in profit or loss to the profit or loss on ordinary activities before tax multiplied by the applicable tax rate required by paragraph 29.27(b) of FRS 102 applies only to the tax expense (income) that appears in the non-technical account. [FRS 103.IG2.81].

8.8.1 Using a liability adequacy test under existing accounting policies

If an insurer applies a liability adequacy test that meets specified minimum requirements, FRS 103 imposes no further requirements. The minimum requirements are the following: [FRS 103.2.15]

1. 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; and
2. if the test shows that the liability is inadequate, the entire deficiency is recognised in profit or loss.

If the insurer's liability adequacy test meets these requirements then the test should be applied at the level of aggregation specified in that test. [FRS 103.2.17].

The standard does not specify:

• what criteria in the liability adequacy test determine when existing contracts end and future contracts start;
• at what level of aggregation the test should be performed;
• whether or how the cash flows are discounted to reflect the time value of money or adjusted for risk and uncertainty;
• whether the test considers both the time value and intrinsic value of embedded options and guarantees;
• whether additional losses recognised because of the test are recognised by reducing the carrying amount of deferred acquisition costs or by increasing the carrying amount of the related insurance liabilities; or
• whether the liability adequacy test can be performed net of expected related reinsurance recoveries.

For UK general business, applying the requirements for the unexpired risks provision (see 8.5.5 above) would normally satisfy the criteria above. For UK long-term business, the measurement requirements described at 8.4.4 above would normally satisfy the criteria above.

8.8.2 Using the liability adequacy test specified in FRS 103

If an insurer's accounting policies do not require a liability adequacy test that meets the minimum criteria discussed, it should: [FRS 103.2.16]

1. determine the carrying amount of the relevant insurance liabilities less the carrying amount of:
   1. any related deferred acquisition costs; and
   2. any related intangible assets such as those acquired in a business combination. However, related reinsurance assets are not considered because an insurer assesses impairment for them separately (see 8.11 below).
2. determine whether the amount described in (a) is less than the carrying amount that would be required if the relevant insurance liabilities were within the scope of Section 21 of FRS 102. If it is less, the entire difference should be recognised in profit or loss and the carrying amount of the related deferred acquisition costs or related intangible assets should be reduced or the carrying amount of the relevant insurance liabilities should be increased.

This test should be performed at the level of a portfolio of contracts that are subject to broadly similar risks and managed together as a single portfolio. [FRS 103.2.17]. Investment margins should be reflected in the calculation if, and only if, the carrying amounts of the liabilities and any related deferred acquisition costs and intangible assets also reflect those margins. [FRS 103.2.18].

Section 21 requires an amount to be recognised as a provision that is the best estimate of the expenditure required to settle the present obligation. This is the amount that an entity would rationally pay to settle the obligation at the balance sheet date or transfer it to a third party at that time. [FRS 102.21.7].

Section 21's requirements are potentially more prescriptive and onerous than those applying if an insurer has an existing liability adequacy test which meets the minimum FRS 103 criteria discussed at 8.8.1 above.

8.8.3 Interaction between the liability adequacy test and shadow accounting

FRS 103 does not address the interaction between the liability adequacy test (LAT) and shadow accounting (discussed at 9.5 below). The liability adequacy test requires all deficiencies to be recognised in profit or loss whereas shadow accounting permits certain losses to be recognised in other comprehensive income if they are directly affected by movements in assets which were recognised in other comprehensive income.

In our view, an entity can apply shadow accounting to offset an increase in insurance liabilities to the extent that the increase is caused directly by market interest rate movements that lead to changes in the value of investments that are recognised directly in other comprehensive income. Although FRS 103 does not specify the priority of shadow accounting over the LAT, because the LAT is to be applied as a final test to the amount recognised under the insurer's accounting policies, it follows that shadow accounting has to be applied first.

8.13.1 Derecognition of insurance and reinsurance assets

FRS 103 does not address the derecognition of insurance or reinsurance assets. Although not carried over to FRS 103, the Basis to Conclusions of IFRS 4 states that the IASB could identify no reason why the derecognition criteria for insurance assets should differ from those for financial assets accounted for under IAS 39 (IFRS 9). [IFRS 4.BC105].

It would seem reasonable for insurers to apply the derecognition criteria for financial assets in Section 11 of FRS 102 (or IAS 39 or IFRS 9 if applied) to insurance and reinsurance assets.

8.13.2 Impairment of insurance assets

FRS 103 does not specify the impairment model to be used for receivables arising under insurance contracts that are not reinsurance assets (discussed at 8.11 above). An example of these would be premium receivables due from policyholders. Insurers should therefore apply their existing accounting policies for determining impairment provisions for these assets, although an impairment model similar to that required by the applicable model being applied for financial assets (depending on accounting policy choice for recognition and measurement) would appear to be appropriate. As FRS 103 does not mandate an impairment model for insurance assets, there is no prohibition on an entity applying the recognition and measurement criteria of IFRS 9 (as permitted by Sections 11 and 12 of FRS 102) from using an expected loss impairment model for insurance assets.

8.13.3 Gains and losses on buying reinsurance

FRS 103 does not restrict the recognition of gains on entering into reinsurance contracts but instead requires specific disclosure of the gains and losses that arise (see 11.2.2 below).

Insurers are therefore permitted to continue applying their existing accounting policies to gains and losses on the purchase of reinsurance contracts and are also permitted to change those accounting policies according to the criteria discussed at Section 9 below.

8.13.4 Policy loans

Some insurance contracts permit the policyholder to obtain a loan from the insurer with the insurance contract acting as collateral for the loan. FRS 103 is silent on whether an insurer should treat such loans as a prepayment of the insurance liability or as a separate financial asset. Consequently, insurers can either present these loans either as separate assets or as a reduction of the related insurance liability depending on previous GAAP requirements.

8.13.5 Investments held in a fiduciary capacity

Insurers often make investments on behalf of policyholders as well as on behalf of shareholders. In some cases, this can result in the insurer holding an interest in an entity which, either on its own, or when combined with the interest of the policyholder, gives the insurer control of that entity (as defined by Section 9 – Consolidated and Separate Financial Statements).

9.1.1 Measuring insurance liabilities on an undiscounted basis

An insurer is only permitted to change its accounting policies to measure insurance liabilities on an undiscounted basis if otherwise required by Schedule 3 to the Regulations (or other legal framework that applies to the entity). [FRS 103.2.6(a)].

Schedule 3 to Regulations permits explicit discounting for general insurance business only subject to certain conditions (see 8.5.4 above).

9.1.2 Measuring contractual rights to future investment management fees in excess of their fair value

It is not uncommon to find insurance contracts that give the insurer an entitlement to receive a periodic investment management fee. In the FRC's opinion, these rights should not be measured at an amount that exceeds fair value as implied by a comparison with current fees charged by other market participants for similar services. The assumption is that the fair value at inception of such contractual rights will equal the origination costs paid to acquire the contract, unless future investment management fees and related costs are out of line with market comparables. [FRS 103.2.6(b)].

9.1.3 Introducing non-uniform accounting policies for the insurance contracts of subsidiaries

FRS 102 requires consolidated financial statements to be prepared using uniform accounting policies for like transactions. [FRS 102.10.17]. However, under previous UK GAAP, some insurers consolidated subsidiaries using accounting policies for the measurement of the subsidiaries' insurance contracts (and related deferred acquisition costs and intangible assets) which were different from those of the parent and were, instead, in accordance with the relevant local GAAP applying in each jurisdiction.

The use of non-uniform accounting policies in consolidated financial statements reduces the relevance and reliability of financial statements and is not permitted by FRS 102. However, prohibiting this practice in FRS 103 would not be consistent with IFRS 4. Therefore, an insurer is permitted to continue using non-uniform accounting policies for the insurance contracts (and related deferred acquisition costs and intangible assets, if any) and change them only if the change does not make the accounting policies more diverse and also satisfied the other requirements in FRS 103. [FRS 103.2.6(c)].

There is one exception to this requirement which is discussed at 9.2 below.

10.1.1 Practical issues

11.2.1 Recognised assets, liabilities, income and expense

As discussed at 8 above, the presentation of the balance sheet and profit and loss account for insurance entities is mandated by Schedule 3 to the Regulations. Details of the presentation requirements are discussed at 8.2 and 8.3 above.

Those UK entities that underwrite insurance contracts that are not insurance entities will usually prepare financial statements under Schedule 1 to the Regulations. The Schedule 1 formats do not cater for insurance balances and therefore those entities will have to use judgement in deciding how to sub-analyse the Schedule 1 line items in order to provide separate disclosure of insurance assets, liabilities, income and expense, if material.

Schedule 3 to the Regulations requires disclosure of the total amount of commissions for direct business including acquisition, renewal, collection and portfolio management. For this purpose, commission should exclude payments made to employees of the undertaking. [FRS 103.4.6].

In respect of deferred acquisition costs, Schedule 3 to the Regulations requires disclosure of: [3 Sch P&L Note 17(c)-(e)]

• how the deferral of acquisition costs has been treated (unless otherwise expressly stated in the accounts); and
• where such costs are included as a deduction from the provision for unearned premiums, the amount of such deduction; or
• where the actuarial method used in the calculation of the provisions within the long-term business provision has made allowance for explicit recognition of such costs, the amount of the cost so recognised.

Section 11 of FRS 102 requires an entity to disclose the carrying amount of financial assets pledged as collateral for liabilities or contingent liabilities and any terms and conditions relating to assets pledged as collateral. [FRS 102.11.46]. In complying with this requirement, it might be necessary to disclose segregation requirements that are intended to protect policyholders by restricting the use of some of the insurer's assets.

11.2.2 Gains or losses on buying reinsurance

A cedant is required to provide specific disclosure about gains or losses on buying reinsurance as discussed at 8.13.3 and 11.2 above. In addition, if gains and losses on buying reinsurance are deferred and amortised, disclosure is required of the amortisation for the period and the amounts remaining unamortised at the beginning and end of the period. [FRS 103.4.5(a)(i)-(ii)].

11.2.3 Processes used to determine significant assumptions

As noted at 11.2 above, FRS 103 requires disclosure of the process used to determine the assumptions that have the greatest effect on the measurement of the recognised amounts. Where practicable, quantified disclosure of these assumptions should also be given. [FRS 103.4.5(b)].

FRS 103 does not prescribe specific assumptions that should be disclosed. However, the Regulations require disclosure of the principal assumptions used in making the long-term business provision. [3 Sch 52(2)]. In order to comply with that requirement, the Implementation Guidance to FRS 103 states that an entity should disclose for each principal category of business the more significant assumptions relating to the following: [FRS 103.IG2.43]

• premiums;
• persistency;
• mortality and morbidity;
• interest rates;
• the discount rates used with, if relevant, an explanation of the basis of reflecting risk margins; and
• if applicable, any other significant factors.

The Implementation Guidance to IFRS 4 states that the description of the process used to describe assumptions might include a summary of the most significant of the following: [IFRS 4.IG32]

1. the objective of the assumptions, for example, whether the assumptions are intended to be neutral estimates of the most likely or expected outcome (‘best estimates’) or to provide a given level of assurance or level of sufficiency. If they are intended to provide a quantitative or qualitative level of assurance that level could be disclosed;
2. the source of data used as inputs for the assumptions that have the greatest effect, for example, whether the inputs are internal, external or a mixture of the two. For data derived from detailed studies that are not carried out annually, the criteria used to determine when the studies are updated and the date of the latest update could be disclosed;
3. the extent to which the assumptions are consistent with observable market prices or other published information;
4. a description of how past experience, current conditions and other relevant benchmarks are taken into account in developing estimates and assumptions. If a relationship would normally be expected between past experience and future results, the reasons for using assumptions that differ from past experience and an indication of the extent of the difference could be explained;
5. a description of how assumptions about future trends, such as changes in mortality, healthcare costs or litigation awards were developed;
6. an explanation of how correlations between different assumptions are identified;
7. the policy in making allocations or distributions for contracts with discretionary participation features. In addition, the related assumptions that are reflected in the financial statements, the nature and extent of any significant uncertainty about the relative interests of policyholders and shareholders in the unallocated surplus associated with those contracts, and the effect on the financial statements of any changes during the period in that policy or those assumptions could be disclosed; and
8. the nature and extent of uncertainties affecting specific assumptions.

11.2.4 The effects of changes in assumptions

As noted at 11.2 above, FRS 103 requires disclosure of the effects of changes in assumptions used to measure insurance assets and insurance liabilities, showing separately the effect of each change that has a material impact on the financial statements. [FRS 103.4.5(c)]. This requirement is consistent with Section 10 of FRS 102 which requires disclosure of the nature and amount of a change in an accounting estimate. [FRS 102.10.18].

Additionally, the Regulations specifically require that, where the difference between the loss provision made at the beginning of the year for outstanding claims incurred in previous years and the payments made during the year on account of claims incurred in previous years and the loss provision shown at the end of the year for outstanding claims is material, it must be shown in the notes to the accounts broken down by category and amount. [3 Sch P&L Note 4]. The effect of unwinding discounted claims provisions should be disregarded in considering whether material adverse run-off deviations have occurred. [FRS 103.IG2.19].

Assumptions are often interdependent. When this is the case, any analysis of changes by assumption may depend on the order in which the analysis is performed and may be arbitrary to some extent. Not surprisingly, FRS 103 does not specify a rigid format or content for this analysis. This allows insurers to analyse the changes in a way that meets the objective of the disclosure requirement and is appropriate for their particular circumstances. If practicable, the impact of changes in different assumptions might be disclosed separately, particularly if changes in those assumptions have an adverse effect and others have a beneficial effect. The impact of interdependencies between assumptions and the resulting limitations of any analysis of the effect of changes in assumption might also be described.

The Implementation Guidance to IFRS 4 states that the effects of changes in assumptions both before and after reinsurance held might be disclosed, especially if a significant change in the nature or extent of an entity's reinsurance programme is expected or if an analysis before reinsurance is relevant for an analysis of the credit risk arising from reinsurance held. [IFRS 4.IG36].

11.2.5 Reconciliations of changes in insurance assets and liabilities

As noted at 11.2 above, FRS 103 requires reconciliations of changes in insurance liabilities, reinsurance assets and, if any, related deferred acquisition costs, although it does not prescribe the line items that should appear in the reconciliations. [FRS 103.4.5(d)].

The Implementation Guidance to IFRS 4 states that for insurance liabilities the changes might include: [IFRS 4.IG37]

1. the carrying amount at the beginning and end of the period;
2. additional insurance liabilities arising during the period;
3. cash paid;
4. income and expense included in profit or loss;
5. liabilities acquired from, or transferred to, other insurers; and
6. net exchange differences arising on the translation of the financial statements into a different presentation currency, and on the translation of a foreign operation into the presentation currency of the reporting entity.

A reconciliation of deferred acquisition costs might include: [IFRS 4.IG39]

1. the carrying amount at the beginning and end of the period;
2. the amounts incurred during the period;
3. the amortisation for the period;
4. impairment losses recognised during the period; and
5. other changes categorised by cause and type.

An insurer may have intangible assets related to insurance contracts acquired in a business combination or portfolio transfer. FRS 103 does not require any disclosures for intangible assets in addition to those required by Section 18 of FRS 102.

11.3.1 Objectives, policies and processes for managing insurance contract risks

As noted at 11.3 above, FRS 103 requires an insurer to disclose its objectives, policies and processes for managing risks arising from insurance contracts and the methods used to manage those risks. [FRS 103.4.8(a)].

No further guidance is provided by FRS 103. However, the Implementation Guidance to IFRS 4 suggests that such disclosure provides an additional perspective that complements information about contracts outstanding at a particular time and might include information about: [IFRS 4.IG48]

1. the structure and organisation of the entity's risk management function(s), including a discussion of independence and accountability;
2. the scope and nature of its risk reporting or measurement systems, such as internal risk measurement models, sensitivity analyses, scenario analysis, and stress testing, and how these are integrated into the entity's operating activities. Useful disclosure might include a summary description of the approach used, associated assumptions and parameters (including confidence intervals, computation frequencies and historical observation periods) and strengths and limitations of the approach;
3. the processes for accepting, measuring, monitoring and controlling insurance risks and the entity's underwriting strategy to ensure that there are appropriate risk classification and premium levels;
4. the extent to which insurance risks are assessed and managed on an entity-wide basis;
5. the methods employed to limit or transfer insurance risk exposures and avoid undue concentrations of risk, such as retention limits, inclusion of options in contracts, and reinsurance;
6. asset and liability management (ALM) techniques; and
7. the processes for managing, monitoring and controlling commitments received (or given) to accept (or contribute) additional debt or equity capital when specified events occur.

It might be useful to provide disclosures both for individual types of risks insured and overall. They might include a combination of narrative descriptions and specific quantified data, as appropriate to the nature of the contracts and their relative significance to the insurer.

11.3.2 Insurance risk – general matters

As noted at 11.3 above, FRS 103 requires disclosure about insurance risk (both before and after risk mitigation by reinsurance). [FRS 103.4.8(b)].

The Implementation Guidance to IFRS 4 suggests that disclosures made to satisfy this requirement might build on the following foundations: [IFRS 4.IG51]

1. information about insurance risk might be consistent with (though less detailed than) the information provided internally to the entity's key management personnel so that users can assess the entity's financial position, performance and cash flows ‘through the eyes of management’;
2. information about risk exposures might report exposures both gross and net of reinsurance (or other risk mitigating elements, such as catastrophe bonds issued or policyholder participation features). This is especially relevant if a significant change in the nature or extent of an entity's reinsurance programme is expected or if an analysis before reinsurance is relevant for an analysis of the credit risk arising from reinsurance held;
3. in reporting quantitative information about insurance risk, disclosure of the strengths and limitations of those methods, the assumptions made, and the effect of reinsurance, policyholder participation and other mitigating elements might be useful;
4. risk might be classified according to more than one dimension. For example, life insurers might classify contracts by both the level of mortality risk and the level of investment risk. It may sometimes be useful to display this information in a matrix format; and
5. if risk exposures at the reporting date are unrepresentative of exposures during the period, it might be useful to disclose that fact.

The following disclosures required by FRS 103 might also be relevant:

• the sensitivity of profit or loss and equity to changes in variables that have a material effect on them (see 11.3.3);
• concentrations of insurance risk (see 11.3.4); and
• the development of prior year insurance liabilities (see 11.3.5).

The Implementation Guidance to IFRS 4 also suggests that disclosures about insurance risk might also include: [IFRS 4.IG51A]

• information about the nature of the risk covered, with a brief summary description of the class (such as annuities, pensions, other life insurance, motor, property and liability);
• information about the general nature of participation features whereby policyholders share in the performance (and related risks) of individual contracts or pools of contracts or entities. This might include the general nature of any formula for the participation and the extent of any discretion held by the insurer; and
• information about the terms of any obligation or contingent obligation for the insurer to contribute to government or other guarantee funds established by law.

11.3.3 Insurance risk – sensitivity information

As noted at 11.3 above, IFRS 4 requires disclosures about sensitivity to insurance risk. [FRS 103.4.8(b)(i)].

To comply with this requirement, disclosure is required of either: [FRS 103.4.9]

1. a sensitivity analysis that shows how profit or loss and equity would have been affected had changes in the relevant risk variable that were reasonably possible at the end of the reporting period occurred; the methods and assumptions used in preparing that sensitivity analysis; and any changes from the previous period in the methods and assumptions used. However, if an insurer uses an alternative method to manage sensitivity to market conditions, such as an embedded value analysis, it may meet this requirement by disclosing that alternative sensitivity analysis and the disclosures required by paragraph 34.30 of FRS 102; or
2. qualitative information about sensitivity, and information about those terms and conditions of insurance contracts that have a material effect on the amount, timing and uncertainty of future cash flows.

Quantitative disclosures may be provided for some insurance risks and qualitative information about sensitivity and information about terms and conditions for other insurance risks.

The Implementation Guidance to IFRS 4 states that insurers should avoid giving a misleading sensitivity analysis if there are significant non-linearities in sensitivities to variables that have a material effect. For example, if a change of 1% in a variable has a negligible effect, but a change of 1.1% has a material effect, it might be misleading to disclose the effect of a 1% change without further explanation. [IFRS 4.IG53]. Further, if a quantitative sensitivity analysis is disclosed and that sensitivity analysis does not reflect significant correlations between key variables, the effect of those correlations may need to be explained. [IFRS 4.IG53A].

11.3.4 Insurance risk – concentrations of risk

As noted at 11.3 above, FRS 103 requires disclosure of concentrations of insurance risk, including a description of how management determines concentrations and a description of the shared characteristic that identifies each type of concentration (e.g. type of insured event, geographical area, or currency). [FRS 103.4.8(b)(ii)].

The Implementation guidance to IFRS 4 states that such concentrations could arise from, for example: [IFRS 4.IG55]

1. a single insurance contract, or a small number of related contracts, for example when an insurance contract covers low-frequency, high-severity risks such as earthquakes;
2. single incidents that expose an insurer to risk under several different types of insurance contract. For example, a major terrorist incident could create exposure under life insurance contracts, property insurance contracts, business interruption and civil liability;
3. exposure to unexpected changes in trends, for example unexpected changes in human mortality or in policyholder behaviour;
4. exposure to possible major changes in financial market conditions that could cause options held by policyholders to come into the money. For example, when interest rates decline significantly, interest rate and annuity guarantees may result in significant losses;
5. significant litigation or legislative risks that could cause a large single loss, or have a pervasive effect on many contracts;
6. correlations and interdependencies between different risks;
7. significant non-linearities, such as stop-loss or excess of loss features, especially if a key variable is close to a level that triggers a material change in future cash flows; and
8. geographical and sectoral concentrations.

Disclosure of concentrations of insurance risk might include a description of the shared characteristic that identifies each concentration and an indication of the possible exposure, both before and after reinsurance held, associated with all insurance liabilities sharing that characteristic. [IFRS 4.IG56].

Disclosure about the historical performance of low-frequency, high-severity risks might be one way to help users assess cash flow uncertainty associated with those risks. For example, an insurance contract may cover an earthquake that is expected to happen, on average, once every 50 years. If the earthquake occurs during the current reporting period the insurer will report a large loss. If the earthquake does not occur during the current reporting period the insurer will report a profit. Without adequate disclosure of long-term historical performance, it could be misleading to report 49 years of large profits, followed by one large loss, because users may misinterpret the insurer's long-term ability to generate cash flows over the complete cycle of 50 years. Therefore, describing the extent of the exposure to risks of this kind and the estimated frequency of losses might be useful. If circumstances have not changed significantly, disclosure of the insurer's experience with this exposure may be one way to convey information about estimated frequencies. [IFRS 4.IG57]. However, there is no specific requirement to disclose a probable maximum loss (PML) in the event of a catastrophe because there is no widely agreed definition of PML. [IFRS 4.BC222].

11.3.5 Insurance risk – claims development information

As noted at 11.3 above, FRS 103 requires disclosure of actual claims compared with previous estimates (i.e. claims development). The disclosure about claims development should go back to the period when the earliest material claim arose for which there is still uncertainty about the amount and the timing of the claims payments, but need not go back more than ten years. Disclosure need not be provided for claims for which uncertainty about claims payments is typically resolved within one year. [FRS 103.4.8(b)(iii)].

As discussed at 3.3 above, transitional relief is available for this disclosure requirement.

The requirement applies to all insurers, not only to property and casualty insurers. In practice, however, life insurers have not made these disclosures under IFRS. This is because the Implementation Guidance to IFRS 4 suggests that, because insurers need not disclose the information for claims for which uncertainty about the amount and timing of payments is typically resolved within a year, it is unlikely that many life insurers will need to give the disclosure. Additionally, the claims development disclosure should not normally be needed for annuity contracts because each periodic payment is regarded as a separate claim about which there is no uncertainty. [IFRS 4.BC220, IG60].

The Implementation Guidance to IFRS 4 suggests that it might also be informative to reconcile the claims development information to amounts reported in the balance sheet and disclose unusual claims expenses or developments separately, allowing users to identify the underlying trends in performance. [IFRS 4.IG59].

FRS 103, like IFRS 4, is silent as to whether development information should be provided on both a gross basis and a net basis. If the effect of reinsurance is significant it would seem appropriate to provide such information both gross and net of reinsurance.

FRS 103 (and IFRS 4) is also silent as to the presentation of:

• exchange differences associated with insurance liabilities arising on retranslation;
• claims liabilities acquired in a business combination or portfolio transfer; and
• claims liabilities disposed of in a business combination or portfolio transfer.

As FRS 103 is silent on these matters, a variety of treatments would appear to be permissible provided they are adequately explained to the users of the financial statements and consistently applied in each reporting period. For example, exchange rates could be fixed at the date the claims are incurred, the original reporting period dates or amounts could be retranslated at each reporting date. Claims liabilities acquired in a business combination or portfolio transfer could be reallocated to the prior reporting periods in which they were originally incurred by the acquiree or all liabilities could be allocated to the reporting period in which the acquisition/portfolio transfer occurred.

An illustrative example of one possible format for presenting claims development based on the example in IFRS 4 is reproduced below. This example presents discounted claims development information by accident year. Other formats are permitted, including for example, presenting information by underwriting year or reporting period rather than underwriting year. In the interests of brevity, this illustrative example provides only five years of data although the standard itself requires ten (subject to the transitional relief upon first-time adoption). The effect of reinsurance is ignored. Given the long tail nature of many non-life insurance claims liabilities it is likely that many non-life insurers will still have claims outstanding at the reporting date that are more than ten years old and which will need to be included in a reconciliation of the development table to the balance sheet.

11.3.6 Credit risk, liquidity risk and market risk disclosures

As noted at 11.3 above, FRS 103 requires disclosure of information about credit risk, liquidity risk and market risk that, as a financial institution, Section 34 of FRS 102 would require if insurance contracts were within the scope of Sections 11 and 12 of FRS 102. [FRS 103.4.8(c)].

Such disclosure should include: [FRS 102.34.24]

• the exposures to risk and how they arise;
• the objectives, policies and processes for managing the risk and the methods used to measure the risk; and
• any changes in risk exposures, objectives, policies and processes from the previous period.

The Implementation Guidance to IFRS 4 suggests that, to be informative, the disclosure about credit risk, liquidity risk and market risk might include: [IFRS 4.IG64]

1. information about the extent to which features such as policyholder participation features might mitigate or compound those risks;
2. a summary of significant guarantees, and of the levels at which guarantees of market prices or interest rates are likely to alter cash flows; and
3. the basis for determining investment returns credited to policyholders, such as whether the returns are fixed, based contractually on the return of specified assets or partly or wholly subject to the insurer's discretion.

11.3.7 Exposures to market risk from embedded derivatives

As noted at 11.3 above, disclosure is required if there are 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. [FRS 103.4.8(d)].

Fair value measurement is not required for derivatives embedded in an insurance contract if the embedded derivative is itself an insurance contract (see 5 above). Examples of these include guaranteed annuity options and guaranteed minimum death benefits as illustrated below.

Both of the examples of embedded derivatives above meet the definition of an insurance contract where the insurance risk is deemed significant. However, in both cases, market risk or interest rate risk may be much more significant than the mortality risk. So, if interest rates or equity markets fall substantially, these guarantees would have significant value. Given the long-term nature of the guarantees and the size of the exposures, an insurer might face extremely large losses in certain scenarios. Therefore, particular emphasis on disclosures about such exposures might be required.

The Implementation Guidance to IFRS 4 states that, to be informative, disclosures about such exposures may include: [IFRS 4.IG70]

• the sensitivity analysis discussed at 11.3.6.C above;
• information about the levels where these exposures start to have a material effect on the insurer's cash flows; and
• the fair value of the embedded derivative, although this is not a required disclosure.

11.5.1 Capital statement

An entity should present a statement setting out its total regulatory capital resources relating to long-term insurance business. The statement should show, for each section of that business as defined below: [FRS 103.IG3.1]

• equity (or in the case of a mutual, the equivalent, often described as disclosed surplus);
• adjustments to restate these amounts in accordance with regulatory requirements;
• each additional component of capital included for regulatory purposes, including capital retained within a life fund whether attributable to shareholders, policyholders or not yet allocated between shareholders and policyholders; and
• the total capital available to meet regulatory capital requirements.

Available capital will comprise a number of distinct elements, each of which will be separately disclosed, including: [FRS 103.IG3.2]

• equity as included in the published statement of financial position, represented by surplus held within a life fund or by assets held separately from those of the fund itself;
• amounts that are wholly attributable to owners, but held within a life fund and where the distribution out of the fund is restricted by regulatory or other considerations;
• surplus held in life funds that has yet to be attributed or allocated between owners and policyholders (in the case of a mutual all such surplus is attributable to policyholders but is not treated as a liability); and
• qualifying debt capital, whether issued by the life entity itself or by another entity within the group.

The capital statement should show as separate sections: [FRS 103.IG3.3]

• each UK with-profits life fund (or each Republic of Ireland with-profits fund for a Republic of Ireland entity) that is material to the group; and
• the entity's other long-term insurance business, showing the extent to which the various components of capital are subject to constraints such that they are available to meet requirements in only part of the entity's business, or are available to meet risks and regulatory capital requirements in all parts of the business.

The Implementation Guidance observes that the purpose of the capital statement is to set out the financial strength of the entity and to provide an analysis of the nature of capital, and constraints over the availability of the capital to meet risks and regulatory requirements. It is important that sources of capital are shown separately and the extent to which the capital in each section is subject to constraint in its availability to meet requirements in other parts of the entity. Such constraints can arise for any of the following reasons: [FRS 103.IG3.4]

• Ownership – the capital may be subject to specific ownership considerations (for example, the FFA of a UK (or Republic of Ireland) with-profits fund, for which the allocation between policyholders and shareholders has not been determined).
• Regulatory – local regulatory limitations may require the maintenance of solvency margins in particular funds or countries, or
• Financial – the availability of capital in certain cases can be restricted due to the imposition of taxes or other financial penalty in the event of the capital being required to be redeployed across the group.

The aggregate amount of regulatory capital resources included in the capital statement should be reconciled to equity, FFA and other amounts shown in the entity's statement of financial position, showing separately for each component of capital the amount relating to the entity's business other than long-term insurance business. Where such other business is significant, an explanation should be given of the extent to which this capital can be used to meet the requirements of the life assurance business. [FRS 103.IG3.5].

Although the detailed requirements apply to long-term insurance business, entities will need to incorporate information on other parts of the business, together with consolidation adjustments, in order to demonstrate how the aggregated capital attributed to the long-term insurance business reconciles to the total shown in the consolidated statement of financial position, and the extent to which capital outside the long-term insurance business may be made available to meet the capital requirements of the long-term insurance business. This reconciliation applies to each different type of capital shown in the capital statement. [FRS 103.IG3.6].

Where the entity is a subsidiary, narrative supporting the capital statement should explain the extent to which the capital of the entity is able to be transferred to a parent or fellow subsidiaries, or the extent to which it is required to be retained within the entity. [FRS 103.IG3.7].

Entities with life assurance liabilities should reconcile their regulatory capital resources to their shareholders' funds. Adjustments to reconcile the capital shown in the statement of financial position to the amount for regulatory purposes may include the following: [FRS 103.IG3.8]

• the difference between provisions measured on the realistic basis and the regulatory basis;
• the inclusion in capital of the FFA;
• the exclusion from capital of the shareholders' share of accrued bonus;
• the exclusion of goodwill and other intangible assets, such as an amount attributed to the acquired value of in-force life assurance business (VIF); and
• changes to the valuation of assets and the exclusion of certain non-admissible assets for regulatory purposes, for example any regulatory adjustment to a pension fund deficit that is recognised as a liability.

Disclosure of these adjustments should be sufficient to give a clear picture of the capital position from a regulatory perspective and its relationship to the equity shown in the consolidated statement of financial position.

Where the amount of a capital instrument that qualifies for inclusion as regulatory capital is restricted (for example, where a limited percentage of total regulatory capital may be in the form of debt) the full amount of the instrument should be included, with a separate deduction for the amount in excess of the restriction. [FRS 103.IG3.9].

Disclosure should be made of any formal intra-group arrangements to provide capital to particular funds or business units, including intra-group loans and contingent arrangements. Where the entity is a subsidiary, disclosure should also be made of similar arrangements between the entity and a parent or fellow subsidiary. [FRS 103.IG3.10].

Separate disclosure of each class of capital is important to an understanding of the funding of the business and the way any future losses would be absorbed or new business financed. Regulatory capital can include both equity and a surplus within the fund. Such surplus may be wholly attributable to owners, or remain unallocated as part of the FFA. In a mutual fund, all surplus is attributable to policyholders. Debt instruments qualifying as capital may be also be issued from the fund itself, or may form part of the owners' equity outside the life fund; a debt instrument issued by the fund to the owners may effectively transfer capital from the owners to the fund. [FRS 103.IG3.11].

Intra-group arrangements should be included in the regulatory capital of a section only where they are subject to formal arrangements. [FRS 103.IG3.12].

11.5.2 Disclosures relating to liabilities and capital

The capital statement should be supported by the following disclosures: [FRS 103.IG3.13]

• narrative or quantified information on the regulatory capital requirements applying to each section of the business shown in the capital statement, and on the capital targets set by management for that section;
• narrative disclosure of the basis of determining regulatory capital and the corresponding regulatory capital requirements, and any major inconsistencies in this basis between the different sections of the business;
• narrative disclosure showing the sensitivity of regulatory liabilities (including options and guarantees), and the components of total capital, to changes in market conditions, key assumptions and other variables, as well as future management actions in response to changes in market conditions; and
• narrative disclosure of the entity's capital management policies and objectives, and its approach to managing the risks that would affect the capital position.

The Implementation Guidance considers that these disclosures are important to the user's ability to understand the management of capital by the entity, its financial adaptability in changing circumstances, and the resources available to each group of policyholders.

In relation to liabilities arising from long-term insurance business, the entity should include the following additional information: [FRS 103.IG3.14]

• the process used to determine the assumptions that have the greatest effect on the measurement of liabilities including options and guarantees and, where practicable, quantified disclosure of those assumptions;
• those terms and conditions of options and guarantees relating to long-term insurance contracts that could in aggregate have a material effect on the amount, timing and uncertainty of the entity's future cash flows; and
• information about exposures to interest rate risk or market risk under options and guarantees if the entity does not measure these at fair value or at an amount estimated using a market-consistent stochastic model.

To comply with the last bullet point above, an insurer should disclose: [FRS 103.IG3.18]

1. a description of the nature and extent of the options and guarantees;
2. the basis of measurement for the amount at which these options and guarantees are stated, and the amount included, if any, for the additional payment that may arise in excess of the amounts expected to be paid if the policies did not include the option or guarantee feature;
3. the main variables that determine the amount payable under the option or guarantee; and
4. information on the potential effects of adverse changes in those market conditions that affect the entity's obligations under options and guarantees.

The requirement of paragraph (d) above may be met by disclosing: [FRS 103.IG3.19]

• for options and guarantees that would result in additional payments to policyholders if current asset values and market rates continued unchanged (i.e. those that are ‘in the money’ for the policyholder), an indication of the change in these amounts if the variables moved adversely by a stated amount; and
• for options and guarantees that would result in additional payments to policyholders only if there was an adverse change in current asset values and market rates (i.e. those that are ‘out of the money’ for the policyholder):
  • an indication of the change in these variables, from current levels, which would cause material amounts to become payable under the options and guarantees; and
  • an indication of the amount that would result from a specified adverse change in these variables from the levels at which amounts first become payable under the options and guarantees.

The above disclosures may be made in aggregate for classes of options and guarantees that do not differ materially, or which are not individually material.

The Implementation Guidance states that although it is important to explain all movements in liabilities and capital during the period that are material to the group, this does not imply that the impact of each change in assumption needs to be shown separately. Where there is a common cause for the change of assumption the impacts can be grouped together. As an example, the impact of changes in investment return attributable to changing market circumstances does not need to be broken down between the various classes of investment. [FRS 103.IG3.15].

The description of the process would include the objective (whether a best-estimate or a given level of assurance is intended); the sources of data; whether assumptions are consistent with observable market data or other published information; how past experience, current conditions and future trends are taken into account; correlations between different assumptions; management's policy for future bonuses; and the nature and extent of uncertainties affecting the assumptions. [FRS 103.IG3.16].

Options and guarantees are features of life assurance contracts that: (a) confer potentially valuable guarantees underlying the level or nature of policyholder benefits; or (b) are options to change these benefits exercisable at the discretion of the policyholder. For the purposes of FRS 103, the term is used to refer only to those options and guarantees whose potential value is affected by the behaviour of financial variables, and not to potential changes in policyholder benefits arising solely from insurance risk (including mortality and morbidity), or from changes in the entity's creditworthiness. It includes a financial guarantee or option that applies if a policy lapses, but does not include the option to surrender or allow a policy to lapse. [FRS 103.IG3.17].

The capital statement should show the amount of policyholder liabilities attributed to each section of the business shown in the statement, analysed between: [FRS 103.IG3.20]

• with-profits business;
• linked business;
• other long-term insurance business; and
• insurance business accounted for as financial instruments in accordance with the requirements of Sections 11 and 12 of FRS 102.

The total of these policyholder liabilities should be the amounts shown in the entity's statement of financial position.

11.5.3 Movements in capital

An entity should include a reconciliation of the movements in the total amount of available capital for long-term insurance business shown in the capital statement from the comparative amounts at the end of the previous reporting period. This disclosure should cover individually each UK (or Republic of Ireland) life fund that is separately shown in the capital statement required under 11.5.1 above, and other long-term insurance business in aggregate. [FRS 103.IG3.21].

This disclosure should set out in tabular form the effect of changes resulting from: [FRS 103.IG3.22]

• changes in assumptions used to measure liabilities from long-term insurance business, showing separately the effect of each change in an assumption that has had a material effect on the group;
• changes in management policy;
• changes in regulatory requirements and similar external developments; and new business and other factors (for example changing market prices affecting assets and liabilities, surrenders, lapses and maturities), describing any material items.

Changes in management policy above refers to significant changes in the management of the fund such as changes in investment policy or changes in the use of the inherited estate. Where management actions are clearly directly related to changes in assumptions or other factors it will be appropriate to show the net impact, but the narrative should discuss the constituent factors. An example might be the combined effect of a reduced level of bonuses assumed as a result of a reduction in the assumed level of future investment return and a reduction in investment returns earned in the period. [FRS 103.IG3.23].

11.6.1 Segmental disclosures for general business required in individual and separate financial statements

A company must disclose: [3 Sch 85(1)]

• gross premiums written;
• gross premiums earned;
• gross claims incurred;
• gross operating expenses; and
• the reinsurance balance.

The ‘reinsurance balance’ means the aggregate total of all those items included in the technical account for general business which relate to reinsurance outwards transactions including items recorded as reinsurance commissions and profit participation. [FRS 103.IG2.62].

These amounts must be broken down between: [3 Sch 85(2)]

• direct insurance; and
• reinsurance acceptances (if reinsurance acceptances amount to 10% or more of the gross premiums written).

Where the amount of gross premiums written in direct insurance for each group exceeds €10 million, the amounts in respect of direct insurance must be further broken down into the following groups of classes: [3 Sch 85(3)]

• accident and health;
• motor (third party liability);
• motor (other classes);
• marine, aviation and transport;
• fire and other damage to property;
• third-party liability;
• credit and suretyship;
• legal expenses;
• assistance; and
• miscellaneous.

The entity must, in any event, disclose the amounts relating to the three largest groups of classes in its business. [3 Sch 85(4)].

Total gross direct insurance premiums must also be split by the following categories if any one exceeds 5% of total gross premiums resulting from contracts concluded by the company in: [3 Sch 87]

• in the EU member state of the Head Office;
• in the other EU member States; and
• in other countries.

There must also be disclosed the total amount of commissions for direct insurance business accounted for in the financial year, including acquisition, renewal collection and portfolio management commissions. [3 Sch 88].

11.6.2 Segmental disclosures for long-term business required in individual and separate financial statements

A company must disclose: [3 Sch 86]

• gross premiums written, broken down between those written by way of direct insurance and those written by reinsurance; and
• the reinsurance balance.

Gross premiums written by way of direct insurance must be further broken down, when it exceeds 10% of the gross premiums written or (as the case may be) of the gross premiums written by way of direct insurance, between:

• individual premiums and premiums under group contracts;
• periodic premiums and single premiums; and
• premiums from non-participating contracts, premiums from participating contracts and premiums from contracts where the investment risk is borne by policyholder.

The ‘reinsurance balance’ means the aggregate total of all those items included in the technical account for long-term which relate to reinsurance outwards transactions including items recorded as reinsurance commissions and profit participation. [FRS 103.IG2.62].

Single premium contracts are those contracts under which there is no expectation of continuing premiums being paid at regular intervals. Additional single premiums paid in respect of existing individual contracts should be included. Regular premium contracts should include those contracts under which the premiums are payable at regular intervals during the policy year, including repeated or recurrent single premiums where the level of premiums is defined. [FRS 103.IG2.56].

The Implementation Guidance to FRS 103 states that new annual and single premiums should be disclosed separately in the financial statements together with an explanation of the basis adopted for recognising premiums as either annual or single premiums. New annual premiums should be shown as the premiums payable in a full year (i.e. annual premium equivalent). Department for Work and Pensions rebates received on certain pensions contracts should be treated as single premiums. [FRS 103.IG2.57]. Internal transfers between products where open market options are available should be counted as new business. If no open market exists, the transfer should not be treated as new business. [FRS 103.IG2.58].

Total gross direct insurance premiums must also be split by the following categories if any one exceeds 5% of total gross premiums resulting from contracts concluded by the company in: [3 Sch 87]

• in the EU member state of the Head Office;
• in the other EU member States; and
• in other countries.

There must also be disclosed the total amount of commissions for direct insurance business accounted for in the financial year, including acquisition, renewal collection and portfolio management commissions. [3 Sch 88].