Insurance Contracts

Introduction

In 2004, the IASB issued the current IFRS 4 Insurance Contracts to provide limited guidance on accounting for insurance contracts in order to introduce a model IFRS.
IFRS 4, in fact, allows insurance companies to derogate from the general principles of IAS 8, and then continue to apply the accounting treatments adopted prior to the transition to IFRSs.
This principle represents a short-term solution to the problem of accounting for insurance contracts, because if applied in the long term it would encourage the adoption of differing accounting treatments, thus undermining the comparability of financial statements.
The Board has developed a new model for measuring insurance liabilities with the proposed Exposure Draft Insurance Contracts, issued in July 2010.
The project is not part of the Memorandum of Understanding with the FASB. However, some aspects of the models that the two boards are developing will be discussed together.

Objective

The measurement approach proposed aims to provide useful information for investors to make their own investment decisions, eliminating the inconsistencies and weaknesses in the current IFRS 4.
The characteristics of such an approach would be as follows:
– to provide relevant information on the amounts, timing and uncertainty of future cash flows;
– to estimate the expected cash flows in accordance with principles consistent with those already provided by other IFRSs;
– to provide information on the risks by a specific item of risk adjustment;
– to present the results of the insurance company so that they highlight the ability to generate profit in the period.

Summary

On the basis of the principle proposed, the insurance liability is recognized at the time the insurance company becomes part of the contract.
The objective of the measurement model is to estimate the value of the fulfillment by the insurer to the present liabilities created by the insurance contract. To estimate this value, the insurer uses the present value estimation techniques that consider the following aspects:
– future cash flows, as determined by objective assessments that take account of different scenarios and for each scenario allocate a probability of realization;
– the time value of money;
– the risk adjustment to take into account the uncertainty of the estimated cash flows;
– a residual margin. The amount that eliminates every possible gain at initial recognition of the liability.
At each reporting date, the insurer shall estimate the insurance liability, without effecting the residual margin determined at initial recognition, and recognise the difference to profit or loss. Thus, the carrying amount of an insurance contract at the end of each reporting period shall be the sum of: (a) the present value of the fulfilment cash flows at that date, and (b) the remaining amount of the residual margin.

IASB work plan

The re-exposure of a review draft is expected by the end of 2012.

For more information, please refer to the IASB website.