Product Classification

Definition of Insurance Contract

An insurance contract is a contract under which the insurer accepts significant insurance risk from the policyholder by agreeing to compensate the policyholder if a specified uncertain future event (the insured event) adversely affects the policyholder.

Definition of Insurance Risk

Insurance risk is risk, other than financial risk, transferred from the policyholder to the issuer. A contract that exposes the issuer to financial risk without significant insurance risk is not an insurance contract.

Definition of Financial Risk

Financial risk is the risk of possible future 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 variables. In the case of a non-financial variable, financial risk is the variable not specific to a party to the contract.

Decision Rule of Determining Product Classification

Does the contract transfer significant insurance risk? If yes go to 2)
Product Classification
1. If significant insurance risk => Insurance Contract
2. If less than significant insurance risk => Investment Contract

Significance of Insurance Risk is determined at the inception of issuing contracts using the Ratio of Additional Benefits (RAB) as follows:

RAB = (X – Y) * 100 / Y

Where X = Benefits to be paid upon the occurrence of the insured event

Y = Benefits to be paid if the insured event does not occur

For RAB < 5%, the product is classified as investment contract, which is accounted for as a financial instrument within the scope of IAS 39, except for investment contract with discretionary participating contracts.
For RAB > 5% and RAB < 10%, blur.
For RAB > 10%, the product is classified as insurance contract.

Accounting Model

Significant Insurance Risk -> Insurance Contracts -> Insurance Accounting
Less than Significant Insurance Risk -> Investment Contracts
- With Discretionary Participating Feature -> Insurance Accounting
- Without Discretionary Participating Feature -> Investment Accounting

Insurance Contracts and Investment Contract Accounting

Insurance Contract:

Not Long Duration: Traditional Life Insurance – Short Duration
Long Duration:
- Participating: Participating “Par” Business
  - Business Written in a Distinct Fund: Participating Funds
  - Business Not Written in a Distinct Fund: Other Participating Business
- Non-Participating: Non-Par
  - Not Fixed and Guaranteed: Contracts with an explicit account balance
  - Fixed and Guaranteed:
    - Premiums and Benefits over same Period: Traditional Life – Long Duration
    - Premiums and Benefits not over same Period: Limited Payment Contracts

Traditional Life Insurance – Short Duration

Definition

The contract provides insurance protection for a fixed period of short duration and enables the insurer to cancel the contract or to adjust the provisions of the contract at the end of a contract period, such as adjusting the amount of premiums charged or coverage provided.

The short-duration classification reflects the measurement expectation at the outset of the contract.

Examples

Most property and liability insurance contracts and travel insurance policy.

Benefit Reserve Methodology

Premium from short duration contracts are recognized as revenue over the period of the contract.

Benefit reserve is the estimate of claims outstanding plus liability for unearned premium.

Asset is recognized for deferred acquisition expenses.

Traditional Life Insurance – Long Duration

Definition

The contract generally is not subject to unilateral changes in its provisions, such as a non-cancellable or guaranteed renewable contract, and required the performance of services (including insurance protection) for an extended period.

Examples

Most whole life contacts, term life contracts, and endowment contracts.

Benefit Reserve Methodology

Premium from long duration contracts are recognized as revenue when due from the policyholders.

Benefit reserve represents the present value of future benefits to be paid to or on behalf of policyholders and related expenses less the present value of future net premiums, which is estimated using methods that include assumptions, such as expected investment yield, mortality, morbidity, terminations and expenses, applicable at the inception of the insurance contracts.

Asset is recognized for deferred acquisition expenses.

Limited Payment Contracts

Definition

One type of long duration contracts for which the premium paying period is shorter than the coverage period.

Examples

A single premium policy or a “3-Pay, 1-=Year endowment”

Benefit Reserve Methodology

Income are recognized over the period that benefits are provided rather than on collection of premiums.

Benefit reserve method is similar to the method for long-duration contracts. A deferred profit liability is recognized for deferred profits of limited payment contracts.

Asset is recognized for deferred acquisition expenses.

Contracts with Explicit Account Balances

Definition

These are typically insurance contracts with investment features but with sufficient insurance risk to be considered insurance contracts, such as universal-life type contracts.

Examples

Universal life and unit-linked contracts with significant insurance benefits.

Benefit Reserve Methodology

For contracts with explicit account balances, premiums collected are not reported as revenue; instead, deposit accounting is adopted.

Insurance contract liability are equal to the accumulation value, which represents premiums received and investment returns credited to the policy less deduction for mortality and morbidity costs and expense charges less any withdrawals from the account balances.

Asset is recognized for deferred acquisition expenses.

Participating Business (Applies to Both Insurance and Investment Contracts with Participating Features)

Definition

A Discretionary participation feature (DPF) is a contractual right to receive 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 performance of a pool of contracts, investment returns on assets or profit and loss of the company/fund/entity.

Examples

Whole life with DPF, account balance product with DPF, investment contract with DPF

Benefit Reserve Methodology

For contracts written in participating funds, insurance contract liabilities make provision for the present value of guaranteed benefits less estimated future net premium to be collected; plus the proportion of the net assets of the participating fund that would be allocated to policyholder.

For other participating business, insurance benefit liabilities make provision for the present value of guaranteed benefits and non-guaranteed participation less estimated future net premiums to be collected from policyholder.

Investment Contracts

Under IAS 39, investment contracts without DPF are accounted for either at

Fair Value Through Profit or Loss (FVPTL) or
Amortized Costs (AC)

Fair Value Through Profit or Loss (FVPTL)

Fair value through profit or loss (FVTPL) is adopted if there is a specific pool of assets backing the contracts and the asset valuation is also FVTPL. All unit-linked products that are classified as investment contracts without DPF fall under this category.

Contracts with an explicit account balance are measured at accumulation “fair value” unless the contract has a fixed crediting rate. This represents the majority of investment contracts and includes investment-linked business that does not provide sufficient insurance risk for the contract to be accounted for as an insurance contract. Accumulation value if determined with reference to the current unit value.
Changes in the accumulation value are recognized in the income statement as an investment contract benefit. The costs of policy administration, investment management, surrender charges and certain policyholder taxes assessed against customer’s account balances are included in revenue, and accounted for as described under Investment Contract fee revenue.
When the investment contract is measured at fair value, the front and fees that relate to the provision of investment management services are amortized and recognized as the services are provided.

Amortized Costs (AC)

Amortized costs (AC) is adopted for investment contracts without DPF if FVTPL is not adopted.

Investment contracts that have a fixed crediting rate or that do not have an explicit account balance are measured at amortized cost, being the fair value of consideration received at the date of initial recognition, less transaction costs and front-end fees, plus or minus the cumulative amortization using the effective interest rate method of any difference between that initial amount and the maturity value.
The effective interest rate equates the discounted cash payments to the initial amount. At each reporting date, the amortized cost liability is determined as the value of he future best estimate cash flows discounted at the effective interest rate. Any adjustment is immediately recognized as income or expense in the consolidated income statement.
Origination and other upfront fees (fees that are assessed against the account balance as consideration for origination of the contract) are charged on some non-participating investment contracts. Where the investment contract is recorded at amortized cost, these fees are amortized and recognized over the expected term of the policy as an adjustment to the effective yield.

Deferred Acquisition Costs (DAC) and Liability Adequacy Test

Acquisition costs are the costs that an insurer incurs to sell, underwrite and initiate a new insurance contract. IFRS allows the use of predecessor accounting for the deferral and amortization of acquisition costs, subject to periodic liability adequacy testing.

Deferred Acquisition Costs (DAC) for Insurance Contracts and Investment Contracts with DPF

Expenses that vary with the contracts and are primarily related to the production and renewal of insurance contracts are deferred, which includes certain variable expenses and an allocation of general operating expenses.

Examples of Deferrable Acquisition Costs

Agent Commissions
Agency and Agent Leader Override Benefits
Prize and Awards which are Production Linked
Product Advertising
Commission and Bonus Paid to Brokers and Direct marketing Sponsors
Persistency Bonus in Excess of the Ultimate Renewable Level
Stamp Duty Attributable to First Year Premium

Examples of Non-Deferrable Acquisition Costs

Other acquisition expenses and general operating expenses attributable to administrative activities and investment expenses cannot be deferred.

Costs attributable to administrative activities of back offices (e.g. Finance Department, Legal Department and etc.)
Restructuring Activities
Investment Management Expenses

Amortization of DAC

DAC are amortized and expensed over the term of the insurance contracts.

The unamortized balance of DAC is presented as an asset in the balance sheet and subject to recoverability whereby the total amount of acquisition costs deferred in each geographic area must be tested to demonstrate that such costs are expected to be recovered from the future profits of the contracts sold in the same period.

Deferred Acquisition Costs (DAC) for Investment Contracts without DPF

Only those expenses that are considered incremental to the sale of the contract are deferrable, which includes commission, override commissions and other selling costs that are incurred as a consequence of the successful sale of an investment contract.

Deferred costs associated with investment contracts without DPF may be described as deferred origination costs (DOC). No-deferral costs are expensed when incurred.

Examples of Deferrable Origination Costs (DOC)

Agent Commissions
Agency and Agent Leader Override Benefits
Prize and Awards which are Production Linked
Product Advertising
Commission and Bonus Paid to Brokers and Direct marketing Sponsors
Persistency Bonus in Excess of the Ultimate Renewable Level
Stamp Duty Attributable to First Year Premium

Liability Adequacy Test (LAT)

Liability adequacy test is a mandatory requirement of IFRS 4. An entity shall assess at the end of each reporting period whether its recognized insurance liabilities are adequate, using current estimates of future cash flows underlying its insurance contracts.

For traditional long duration life contracts, while the insurance contract liabilities are typically measured based on original policy benefits, the actual experience (e.g. investment yields, mortality, morbidity, terminations or expenses) may indicate that existing contract liability is insufficient to cover the present value of future benefit to be paid and the unamortized acquisition costs.

Deficient Aggregate Liability

If the aggregate liability recognized is determined to be deficient:

For traditional life contracts, DAC is initially written down, any deficiency remaining is recognized by increasing the net liability.
For universal life type, DAC is written down directly.

Long Duration Traditional Life Insurance Contract

The loss arising from LAT for long duration traditional life insurance contracts is illustrated as flows:

Sign	Logic	Amount
+	Present value of future payments for benefits and related settlement and maintenance costs, determined using current assumptions	100
–	Present value of future gross premium, based on current assumptions	-90
	Liability for future policy benefits using current assumptions	10
–	Recognized liability for future policy benefits	-8
–	Unamortized acquisition costs	-1
	Loss to be recognized (if greater than zero)	1

LAT may be performed at the level of each geographic market and the assessment is made in aggregate for all insurance contracts arising from all product groups.