The International Accounting Standards Board (IASB) is in the process of replacing the existing International Financial Reporting Standard (IFRS) 4, Insurance Contracts with a new standard which is intended to eliminate inconsistencies and weaknesses in existing practices by providing a single principle - based framework to account for all types of insurance contracts, including reinsurance contracts that an insurer holds.
The final standard on insurance contracts is expected to be issued around the end of 2016 with the probable effective date not being earlier than 2020.
The IASB issued amendments to IFRS 4 on 12 September 2016 in order to address the concerns arising from implementing IFRS 9, Financial Instruments (effective from 1 January 2018 onwards) before implementing the forthcoming insurance contracts standard. These include temporary volatility in the statement of profit and loss and accounting mismatches for most insurers.
Overview of the amendments
The amendments introduce the following two approaches:
1. Overlay approach: It permits insurers to remove from profit or loss and recognise in Other Comprehensive Income (OCI), the difference between the amounts that would be recognised in the statement of profit and loss under IFRS 9 and under IAS 39, Financial Instruments: Recognition and Measurement, for specified assets relating to insurance activities.
This approach could be applied by an entity that issues contracts that are accounted for under IFRS 4 and which applies IFRS 9 in conjunction with IFRS 4.
Financial assets eligible for the overlay adjustment would have to be:
- Designated as relating to contracts that are in the scope of IFRS 4 (i.e. these would not include financial assets held in funds relating to investment contracts that are outside the scope of IFRS 4),
- Classified as at Fair Value Through Profit or Loss (FVTPL) under IFRS 9, and
- Not classified as at FVTPL in their entirety under IAS 39.
An entity would be able to change the designation of financial assets as relating to contracts in the scope of IFRS 4 only if there is a change in the relationship between those financial assets and contracts. Further, an entity is also permitted to apply the overlay approach prospectively to financial assets when the eligibility criteria are met.
2. Temporary exemption from IFRS 9: It provides an optional temporary exemption from applying IFRS 9 for companies whose activities are predominantly connected with insurance. Entities that defer the application of IFRS 9 will continue to apply the existing financial instruments standard i.e. IAS 39.
An entity should assess whether its insurance activities are predominant on the date of its initial application of IFRS 9. Such assessment would be based on the carrying amount of its liabilities arising from the contracts that are in the scope of IFRS 4 relative to the total carrying amount of its liabilities at the date on which it would otherwise be required to apply IFRS 9.
A subsequent reassessment of an entity’s predominant activity would be required only if there is a demonstrable change in the corporate structure of the entity.
Presentation and disclosure requirements
The IASB has also prescribed additional presentation and disclosure requirements with respect to the given approaches. These include disclosure of the approach applied, separate presentation of amounts reclassified to OCI under the overlay approach and disclosures relating to the nature of activities and liabilities of an insurer that enable application of the temporary exemption from IFRS 9.
The effective date for applying the amendments related to the temporary exemption from IFRS 9 is 1 January 2018. The amendments related to the overlay approach are effective when an insurer first applies IFRS 9 (including on early application of IFRS 9).
The amendment to IFRS 4 is an important step as it addresses widespread concerns of insurers relating to the application of IFRS 9. It also paves the way for a smoother implementation of the forthcoming insurance contracts standard, when issued. Insurance entities have been given an option to either use an overlay or a temporary exemption approach to reduce accounting mismatches and volatility in the statement of profit and loss arising from financial assets that relate to insurance activities. However, they need to consider the following factors while evaluating either approach:
• Judgement may be required in assessing the predominant activities of an insurer and may involve consideration of both qualitative and quantitative factors.
• If an insurance entity within a large group structure applies the temporary exemption from IFRS 9 (and is therefore required to continue applying IAS 39), this could result in entities within the same group applying different standards to financial instruments. This may require further consideration for group reporting purposes.
• Application of the overlay approach will still require companies to compute and track the accounting impact under both IFRS 9 and IAS 39 entailing additional efforts.
Impact on Ind AS implementation by insurers in India
In India, the Ministry of Corporate Affairs (MCA) issued a road map on 18 January 2016 requiring implementation of Indian Accounting Standards (Ind AS) by insurance companies for accounting periods beginning from 1 April 2018 onwards. This road map was issued subsequent to consultations with the Insurance Regulatory and Development Authority of India (IRDAI).
While a final standard on insurance contracts is expected to be issued by the IASB later this year, it is expected to apply internationally only after 2020. Further clarity may be required from the IRDAI on the guidance that will apply to insurance companies under Ind AS, including the impact of the above amendments to the existing IFRS 4.
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