Product Classification and DPFsSession 6
Insurance IFRS Seminar
December 1, 2016
Michael Lockerman
Session 6
2
Agenda
• IFRS 4 Scope
• Current IFRS 4 Product Classification
– Insurance Contracts
– Discretionary Participating Features
• Phase 2 proposals
4
IFRS 4 Scope
• Insurance contracts, including reinsurance contracts, issued by an
entity
• Reinsurance contracts held by an entity
• Investment contracts with discretionary participating features (DPF’s)
Therefore the first step in applying IFRS 4 is to determine the
appropriate product classification
6
Product Classification
Does the contract need to
be unbundled?Are any discretionary
participation features present?
Insurance Component Deposit Component
Yes YesNo
Does contract contain
significant insurance
risk?
Investment Contract
(IAS 39)Investment Contract with
discretionary participation
features
Insurance Contract
No
NoYes
Existing
accounting
Amortized Cost or FVExisting accounting with
Liability or equity choice
Does the contract need to
be unbundled?Are any discretionary
participation features present?
Insurance Component Deposit ComponentInsurance Component Deposit Component
Yes YesNo
Does contract contain
significant insurance
risk?
Investment Contract
(IAS 39)Investment Contract with
discretionary participation
features
Insurance Contract
No
NoYes
Existing
accounting
Amortized Cost or FVExisting accounting with
Liability or equity choice
8
IFRS 4 - Insurance ContractDefinition
– A single definition of insurance contracts
“a contract under which one party (the insurer) accepts significant insurance risk from another party (the policyholder) by agreeing to compensate the policyholder if a specified uncertain future event (the insured event) adversely affects the policyholder.”
– “A reinsurance contract is a type of insurance contract.”
9
Insurance Risk
– Distinction between insurance risk and other risks
• Financial risk: Change in interest rate, security price, commodity
price, etc.: NOT insurance risk
• Lapse, persistency or expense risk: NOT insurance risk in direct
contract
• Contracts including both financial risk and significant insurance
risk have insurance risk
• Must relate to uncertain future event that adversely affects the
policyholder
• Must be a pre-existing risk vs. risk created by the contract (
10
Insurance Risk
• Insurance risk evaluated at inception of contract
• A contract that initially does not meet the definition of
insurance may subsequently do so.
• Example: Annuity options
• Once insurance always insurance until all rights and
obligations extinguished
11
Significant Insurance Risk
– What is a significant insurance risk?
“Insurance risk is significant if, and only if, an insured event could cause an insurer to pay significant additional benefits in any scenario, excluding scenarios that lack commercial substance (ie have no discernible effect on the economics of the transaction). If significant additional benefits would be payable in scenarios that have commercial substance, the condition in the previous sentence may be met even if the insured event is extremely unlikely or even if the expected (ie probability-weighted) present value of contingent cash flows is a small proportion of the expected present value of all the remaining contractual cash flows.”
12
Significant Insurance Risk
Significance test:
– Compare:
(1) Cash flows that would be paid if the insured event occurred
Versus
(2) Cash flows that would be paid if no insured event occurred
• Are cash flows under (1) > (2)?
• Are additional benefits significant?
• Does the scenario have commercial substance?
• Evaluated on a contract-by-contract basis
• Reinsurance contract exception
13
Determining Insurance Risk
Simplified Example of 7 year endowment product. Death benefit equals the endowment benefit.
Scenario 1
• Policyholder dies in first
policy month and received
134k
Scenario 2
• Policyholder survives to
endowment and receives
134k, PV = 90k
14
IFRS 4 - Insurance ContractsInsurance Risk
• Lapse risk
• Not a pre-existing risk for the insurer
• Becomes an insurance risk if transferred to a reinsurer
– Financial guarantees
• Either under IFRS 4 or under IAS 39
– Mortgage guarantees
• Either under IFRS 4 or under IAS 39
15
Compensation for Loss
• The contract must compensate the policyholder for a loss.
The risk must be pre-existing.
– Gambling contracts are not insurance
– Catastrophe bonds are not insurance, but a policy that pays for
losses suffered in a hurricane is an insurance contract.
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Key classification differences
IFRS USGAAP
Single definition of an insurance
contract?Yes No
Required probability of significant
insurance loss
Any possibility with
commercial substance
Reasonable possibility;
requirement for
underwriting and timing
risk
Requirement for underwriting and
timing risk?Yes Yes
Significant loss required? Yes Yes
Scope limited to insurance
companies?No Yes
Separate contract for
accumulation phase versus payout
phase?
No Yes
17
IFRS 4 Product Classification
Does the contract need to
be unbundled?Are any discretionary
participation features present?
Insurance Component Deposit Component
Yes YesNo
Does contract contain
significant insurance
risk?
Investment Contract
(IAS 39)Investment Contract with
discretionary participation
features
Insurance Contract
No
NoYes
Existing
accounting
Amortized Cost or FVExisting accounting with
Liability or equity choice
Does the contract need to
be unbundled?Are any discretionary
participation features present?
Insurance Component Deposit ComponentInsurance Component Deposit Component
Yes YesNo
Does contract contain
significant insurance
risk?
Investment Contract
(IAS 39)Investment Contract with
discretionary participation
features
Insurance Contract
No
NoYes
Existing
accounting
Amortized Cost or FVExisting accounting with
Liability or equity choice
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Discretionary Participation Features
• A contractual right to receive, as a supplement to guaranteed benefits, additional benefits:
• that are likely to be a significant portion of the total contractual benefits;
• whose amount or timing is contractually at the discretion of the issuer; and
• that are contractually based on:
the performance of a specified pool of contracts or a specified type of contract;
realised and/or unrealised investment returns on a specified pool of assets held by the issuer; or
the profit or loss of the company, fund or other entity that issues the contract.
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Discretionary Participation Features
• May, but need not, report the fixed element separately from the
discretionary participation feature
• Should classify unallocated surplus arising from discretionary
participation features as either a liability or equity (not as an
intermediate category that is neither liability nor equity).
• Consider possible separation of embedded derivatives (apply IAS 39
to in-scope embedded derivatives with specific exemption for DPF
surrender options).
• Should, in all respects not described above, continue its existing
accounting policies for such contracts, unless it demonstrates that a
change in those accounting policies would result in more
understandable, relevant, reliable and comparable financial
statements.
21
Insurance Contracts
• Retain IFRS 4 definition
‘A contract under which one party (the issuer) accepts significant insurance risk from
another party (the policyholder) by agreeing to compensate the policyholder if a
specified uncertain future event (the insured event) adversely affects the policyholder’
• Significance measured using present values
• Underwriting or timing risk but additional guidance that timing delays may reduce
uncertainty
• Requires a scenario in which present value of cash outflows exceeds present value of
premiums. Evaluated on a contract by contract basis. Thus insurance risk can be
significant even if the chance of losses on the portfolio is remote
• Reinsurance exception: If a reinsurance contract transfer substantially all of the
insurance risk of the reinsured portions of the underlying contracts, then it is an
insurance contract
• Financial guarantee contracts generally excluded from the scope (included in 2010
version)
22
Discretionary Participating Features
• Definition of DPF is the same as in current IFRS 4
• Investment contracts with DPF are included in the scope if the entity also issues insurance contracts.
• Guidance is basically the same for investment contracts with DPF as for insurance contracts.
• Modification of some guidance to reflect that there is no insurance risk contract boundary, coverage period)