Ind AS 104 - Insurance Contract

Indian Accounting standard 104 details financial reporting by an insurer.  This standard requires limited improvements to accounting by an insurer and disclosure that explains the amounts arising from contracts and helps users understand the nuances of the contracts.

This standard applies to all the insurance contract that an insurer issues including reinsurance contract that it holds and financial instrument it issues with a discretionary participation feature. 

What is an insurance contract?

A contract under which an insurer accepts significant insurance risk from policyholder by agreeing to compensate the policyholder if a specified uncertain future event affects adversely.  

Uncertain future event

The essence of an insurance contract is uncertainty.  At the time of the contract, the following events are uncertain 

• whether an insured event will occur
• when will it occur
• how much will the insurer have to pay

The event can occur anytime during the term of the contract,  like life insurance. Or it can occur before the inception of contract like reinsurance but the financial impact is not known. 

Insurance risk

Insurance risk is defined in this standard as risk other than a financial risk that is transferred from the holder of the risk to the insurer. If a contract only transfers financial risk and no significant insurance risk then the contract is not an insurance contract.  

Insurer 

The party to a contract who is under an obligation to compensate the policyholder on the happening of an uncertain event 

Policyholder 

The party that had the right to be compensated on the happenings of the insured event.  

What is a discretionary participation feature?

A contractual right to receive, additional benefits as a supplement to guaranteed benefits:
(a) the benefits are likely to be a consequential portion of the total contractual benefits; 
(b) whose amount or timing is contractually at the discretion of the issuer; and 
(c) 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.

What are the exclusions to the scope?

An insurer shall not apply this standard to:

• Financial assets and liabilities held
• Product warranties issued directly
• Employers assets and liabilities 
• Contractual rights or obligations that are contingent on the future use of a non-financial item.  Also, a lessee’s residual value guarantee embedded in a financial lease
• Financial guarantee unless otherwise previously asserted by insurer 
• Contingent consideration receivable or payable
• A contract that insurer holds as a policyholder. However, the exception being reinsurance contract. 

Ind AS 39 applies to derivatives embedded in an insurance contract unless the embedded derivative is itself an insurance contract.  In case of a contract containing both insurance component and deposit component,  an insurer can unbundle it that is accountable for it separately if the insurer can measure the deposit component separately and the insurer’s accounting policy does not require it to recognise all obligations and rights arising from the deposit component. If both these conditions are met then an insurer shall apply this standard to the insurance component and Ind AS 39 to deposit component.

How are insurance contracts recognised and measured?

For recognition and measurement of insurance contracts, the following has been prescribed by the standard.  This test requires that an insurer must assess at the end of the reporting period, if the insurance liabilities are adequate,  take into consideration the current estimates of future cash flows.   The insurer must take into account all the contractual cash flows,  related cash flows and also cash flows resulting from embedded options and guarantees.  

Impairment of reinsurance assets

When there is a piece of objective evidence that the cedant would not receive the amounts due to it and if this has a reliably measurable impact on the amounts the cedant will receive then the reinsurance contract is impaired.   A cedant must reduce its carrying amount accordingly and account for the loss in profit and loss. 

Can an insurer change its accounting policies?

This standard applies to a first time adopter of Ind AS and an insurer already applying Ind AS.  An insurer can change the accounting policies if and only if the change makes the statements more relevant and no less reliable,  more reliable and no less relevant to the economic decision-making of the users.  Any changes in the accounting policies must justify the requirements of Ind AS 8. 
However, the following has been specified in the standard 

Current market interest rates An insurer issues permitted to change the accounting policies so that it can remeasure the designated insurance policies to reflect current market interest rates. However, an insurer need not apply to this to all the liabilities as would be required by Ind AS 8. 

Prudence An insurer need not change accounting policies to eliminate excessive prudence.

Future Investment Margin An insurer need not change the accounting policies to eliminate future investment margins. There is a rebuttable presumption that an insurer’s financial statements will become less reliable and less relevant if accounting policy for future investment margins is introduced.

Shadow Accounting  An insurer issues permitted to but not required to change accounting policy so that a recognised but unrealised gain or loss had the same impact on those measurements as realised gain or loss.  

Disclosure

An insurer shall disclose information that identifies and explains the amounts invested its financial statements arising from the insurance contract.  An insurer shall disclose information that enables the users to evaluate the nature and extent of risks arising from the insurance contract.