Life Insurance – Finance – Insurance Law and Practice Important Questions
Question 1.
With the deferment of applicability of IFRS in insurance business by IRDAI to year 2021, discuss relevant provisions and implications as Applicable to insurance contracts from a CS perspective. Will this accounting reform bring in a positive stride for insurance business in India?
Answer:
IFRS 17 establishes the principles for the recognition, measurement, presentation and disclosure of insurance contracts within the scope of the standard. The objective of IFRS 17 is to ensure that an entity provides relevant information that faithfully represents those contracts. This Standard was published on 18th May 2017, effective for the Annual period on or after 01 January 2021 IFRS-17 is applicable to 3 types of insurance contracts:
- Insurance contracts, including inward reinsurance contracts accepted.
- Reinsurance contracts ceded.
- Investment contracts with discretionary participation features, by an entity which issues insurance contracts as well.
Separating components from an insurance contract may contain one or more components that would be within the scope of another standard if they were separate contracts. For example, an insurance contract may include an investment component or a service component (or both).
Unit Linked Life insurance policies, for example, have an insurance component and investment component. It is a contract bundled with insurance element and investment element and is like Term insurance + Mutual fund. In such cases, this principle applies. The standard provides the criteria to determine when a non-insurance component is distinct from the host insurance contract.
Investment component to be separated from a host insurance contract only if that investment component is distinct. The entity shall then apply IFRS 9 to account for the separated investment component. After performing the above steps, separate any promises to transfer distinct non-insurance goods or services. Such promises are accounted under IFRS I5 ‘Revenue from Contracts with Customers.
Level of aggregation:
IFRS 17 requires entities to identify portfolios of insurance contracts, which comprises contracts that are subject to similar risks and managed together. Contracts within a product line would be expected to have similar risks and hence would be expected to be in the same portfolio if they are managed together. (IFRS 17:14)
Each portfolio of insurance contracts issued shall be divided into a minimum of: (IFRS 17:16)
- A group of contracts that are onerous at initial recognition, if any,
- A group of contracts that at initial recognition have no significant possibility of becoming onerous subsequently, if any; and
- A group of the remaining contracts in the portfolio, if any.
An entity is not permitted to include contracts issued more than one year apart in the same group. If contracts within a portfolio would fall into different groups only because law or regulation specifically constrains the entity’s practical ability to set a different price or level of benefits for policyholders with different characteristics, the entity may include those contracts in the same group.
Recognition: An entity shall recognise a group of insurance contracts it issues from the earliest of the following:
- the beginning of the coverage period of the group of contracts
- the date when the first payment from a policyholder in the group becomes due; and
- for a group of onerous contracts, when the group becomes onerous.
Measurement:
On initial recognition, an entity shall measure a group of insurance contracts at the total of:
- the fulfilment cash flows'(“FCF”), which comprise.
- estimates of future cash flows.
- an adjustment to reflect the time value of money (”TVM”) and the financial risks associated with the future cash flows, and
- a risk adjustment for non-financial risk.
- the contractual service margin (“CSM”).
An entity shall include all the future cash flows within the boundary of each contract in the group. The entity may estimate the future cash flows at a higher level of aggregation and then allocate the resulting fulfilment cash flows to individual groups of contracts. The estimates of future cash flows shall be current, explicit, unbiased, and reflect all the information available to the entity without undue cost and effort about the amount, timing and uncertainty of those future cash flows. They should reflect the perspective of the entity, provided that the estimates of any relevant market variables are consistent with observable market prices. (IFRS 17:33)
Premium allocation approach:
An entity may simplify the measurement of the liability for remaining coverage of a group of insurance contracts using the Premium Allocation Approach (PAA) on the condition that at the inception of the group:
- the entity reasonably expects that this will be a reasonable approximation of the general model, or
- the coverage period of each contract in the group is one year or less.
- (iii) Where, at the inception of the group, an entity expects significant, variances in the fulfilment cash flows (FCF) during the period before a claim is incurred, such contracts are not eligible to apply the PAA.
Investment contracts with a DPF (Discretionary Participating Features) An investment contract with a DPF (Discretionary Participating Features) is a financial instrument and it does not include a transfer of significant insurance risk. It is in the scope of the standard only if the issuer also issues insurance contracts. The requirements of the Standard are modified for such investment contracts.
Reinsurance contracts held:
The requirements of the standard are modified for reinsurance contracts held, in estimating the present value of future expected cash flows for reinsurance contracts, entities use assumptions consistent with those used for related direct insurance contracts. Additionally, estimates include the risk of reinsurer’s non-performance.
Modification of an insurance contract Derecognition
An entity shall derecognise an insurance contract when it is extinguished, or if any of the conditions of a substantive modification of an insurance contract are met.
Presentation in the statement of financial position
An entity shall present separately in the statement of financial position the carrying amount of groups of:
- insurance contracts issued that are assets
- insurance contracts issued that are liabilities
- reinsurance contracts held that are assets; and
- reinsurance contracts held that are liabilities.
Insurance service result:
An entity shall present in profit or loss revenue arising from the groups of insurance contracts issued, and insurance service expenses account arising from a group of insurance contracts it issues, comprising incurred claims and other incurred insurance service expenses. Revenue and insurance service expenses shall exclude any investment components.
Disclosures:
An entity shall disclose qualitative and quantitative information about:
- the amounts recognised in its Financial Statements that arise from insurance contracts
- the significant judgements, and changes in those judgements, made when applying IFRS 17; and
- the nature and extent of the risks that arise from insurance contracts.
Transition:
An entity shall apply the standard retrospectively unless impracticable, in which case entities have the option of using either the modified retrospective approach or the fair value approach.
Question 2.
Explain the schedules prepared in the financial statements of an insurance company.
Answer:
Financial Statement of Insurance Company:
The Financial statements of Insurance Company are prepared in accordance with the Insurance Regulatory and Development Authority (Preparation of Financial Statements and Auditor’s Report of Insurance Companies) Regulations, 2002.
Schedule A of the regulation contains following parts:
1. PART I of Schedule A the regulation contains ‘Accounting principles for preparation of financial statements and while preparing the Financial Statement for the insurance companies in India, these principals are to be followed.
2. PART II of Schedule A of the regulation contains the details of Disclosures which are forming part of Financial Statements in the Insurance Company.
3. PART III of Schedule A of the regulation contains General instructions for preparation of Financial Statements.
4. PART IV of Schedule A of the regulation contains the Contents of Management Report.
5. PART V of Schedule A of the regulation Contains the formats for Preparation of Financial Statements of a life insurance company. Similarly, Schedule B of the regulations contain Part I, Part II, Part III, Part IV and Part V which contains the above-stated information about General Insurance companies.
As per the above-said Regulations, following financial statements are to be prepared by Insurance Companies
- Form of Revenue Account (Policyholders account)
- Form of Profit and Loss Account (Shareholders Account)
- Form of Balance Sheet (Policyholders and Shareholders)
- Schedules to Financial Statements
- Notes to accounts giving the significant accounting policies and actuarial assumption
- Disclosures on regulatory actions taken by any enforcement authority
- Details of directorships, if any, held by persons in charge of management
- ageing analysis of policyholders unclaimed amounts
- Details of payments made to Statutory Auditors
- Summary of related party transactions
- Key accounting ratios.