As entities are well on their way to completing their 2015 financial statements under the new Irish GAAP, Martina Fitzpatrick highlights 10 timely and important points for insurers to consider.
Irish (re)insurers (insurers) that have applied Irish Generally Accepted Accounting Principles (Irish GAAP) in preparing annual financial statements in the past are most likely preparing their first set of financial statements in accordance with FRS 102 The Financial Reporting Standard in the UK and Ireland and FRS 103 Insurance Contracts, unless they have switched to IFRS and therefore apply IFRS 4 Insurance Contracts.
FRS 102 consolidates existing Irish GAAP guidance into one standard while FRS 103 largely incorporates the requirements of IFRS 4, FRS 27 Life Assurance and elements of the Association of British Insurers’ Statement of Recommended Practice on Accounting for Insurance Business (ABI SORP). FRS 27 and ABI SORP no longer apply.
FRS 103 sets out the accounting requirements for entities that apply FRS 102 and issue insurance contracts, including reinsurance contracts; hold reinsurance contracts; and issue financial instruments with discretionary participation features. Insurance contracts are defined as “a contract under which one party accepts significant insurance risk from another party by agreeing to compensate the policyholder if a specified uncertain event adversely affects the policyholder”. Appendix II of FRS 103 provides guidance on the definition of an insurance contract along with helpful examples of contracts that do and do not meet the definition.
As entities are well on their way to completing their 2015 financial statements under the new GAAP, the following is a timely list of 10 important points for insurers to consider.
1. Permitted improvements
Entities are allowed to continue with their existing accounting policies and practices for insurance contracts. However, FRS 103 permits the same flexibility when making accounting policy changes as is available to entities that apply IFRS 4. Improvements and changes can be made provided the new policies are not in conflict with local regulatory and legal requirements; the change will produce information that is more relevant to the decision-making needs of users; and the information provided is no less reliable. The improvements that are permitted, but not required, include:
- The re-measurement of designated insurance liabilities to reflect current market interest rates through profit and loss;
- Where realised gains/losses on assets affect the valuation of insurance liabilities, related deferred acquisition costs (DAC) and intangible assets, the re-measurement of liabilities for recognised but unrealised gains or losses is allowed. The related adjustment to the insurance liability will then be recognised through other comprehensive income (OCI) only if the unrealised gains or losses on the related asset are recognised through OCI; and
- Insurers can eliminate prudence for claims provisions, but cannot introduce more.
2. practices and policies
Unless previously applied, the following practices and policies may not be newly-adopted:
- Measuring insurance liabilities on an undiscounted basis, unless required by law or regulation);
- Measuring contractual rights to future investment fees at a value above their fair value when compared to current market fees for similar services;
- Using non-uniform accounting policies for insurance contracts, DAC and intangibles of subsidiaries; and
- Including future investment margins in the measurement of contracts other than life assurance business, except where the contractual payments are affected by those margins or the presumption that such information is less relevant can be rebutted.
3. Failure to meet required definition
Contracts written as insurance business that do not meet the definition of an insurance contract will apply Sections 11 and 12 (Financial Instruments) of FRS 102 and can be valued at amortised cost or fair value, depending on the nature – complex or not – of the financial instrument.
4. Monetary items
Unlike IFRS and FRS 23 The Effects of Changes in Foreign Exchange Rates, FRS 103 states that all assets and liabilities in a foreign currency arising from an insurance contract must be recorded as monetary items for the purpose of applying FRS 102. Hence, unearned premium reserve (UPR) and DAC are re-translated at the closing rate. This will remove foreign exchange volatility where the assets held to back insurance liabilities are also monetary items. It will create a GAAP difference on transition for insurers converting from FRS 23, however, as UPR and DAC would not have previously been re-translated after initial recognition given that they were considered to be non-monetary items.
5. Contract classification
Entities that did not previously apply FRS 26 Financial Instruments: Recognition and Measurement, which required a review of the classification between insurance and investment contracts, will need to perform a contract classification exercise on adoption of FRS 103. This exercise will determine which contracts are within the scope of FRS 103.
6. Required disclosures
Insurers that previously applied Irish GAAP, which included the suite of standards linked to FRS 26, will see less of an impact on their disclosures as a result of applying FRS 103. However, those that have not previously had to apply FRS 26 are now required to disclose their exposure to insurance and financial risks; detail their policies for managing those risks; outline sensitivity to changes in financial and insurance risk variables; and retain historic non-life claims development information for a period of 10 years. Transitional relief is available on first-time adoption, which allows the reporting of this information for an initial period of five years.
FRS 103 requires life insurers, which are subsidiaries of an entity that provides capital disclosures, to make disclosures in the notes of the financial statements about their capital position. The exemption available to 90%+ subsidiaries under FRS 27 no longer applies. Furthermore, all entities must make a ‘statement of compliance’ with this Standard and with FRS 102 in the notes to their financial statements.
7. Embedded derivatives
Where an insurance contract contains a separable embedded derivative, FRS 103 requires the separable embedded derivative to be accounted for separately in accordance with Sections 11 and 12 of FRS 102, unless the embedded derivative is itself an insurance contract and for certain policyholder surrender options. This is in contrast to the FRS 102 requirements to fair value non-insurance contracts.
8. Discretionary participation features
When an insurance contract contains a discretionary participation feature (DPF) as well as a guaranteed element, entities may recognise the guaranteed element separately as a liability. If the DPF and the guaranteed element are separated, the guaranteed element will be classified as a liability and the DPF classified as a liability or a separate component of equity. If the DPF and guaranteed element are not separated, on the other hand, the accounting treatment is to classify the whole contract as a liability.
Insurers may recognise the entire premium received as revenue without separating any portion that relates to the equity component. Furthermore, non-insurance contracts with a DPF should be treated similarly but they can avail of some additional options and exceptions on disclosures.
9. Interim measure
FRS 103 is an interim measure that has been put in place until a new international standard for insurance contracts is issued by the International Accounting Standards Board (IASB), at which time the Financial Reporting Council (FRC) expects to review FRS 103. In addition, life insurers will have to decide whether to change their accounting policies for insurance contracts as a result of the implementation of Solvency II.
10. Changes to the regulatory framework
The FRC issued FRED 64 in December 2015, which proposed amendments to FRS 103 and was applicable from 1 January 2016. The amendments reflect changes in the regulatory framework arising from the introduction of Solvency II, including updated terminology. While entities are permitted to continue with their established accounting policies, it may make sense to update some terminology now. However, life insurers will not replace the Modified Solvency Statutory Basis for reporting policyholder liabilities with the “established long-term insurance liability basis” until financial statements for periods beginning on or after 1 January 2016 (the adoption date for Solvency II) are being prepared.
Conclusion
Although it is expected that the transition to FRS 103 will not require significant changes to the way in which most entities account for insurance contracts, it allows them the flexibility to take advantage of improvement options similar to those available to entities applying IFRS 4. Although the points mentioned in this article are not a comprehensive list of all points that may be applicable for every circumstance, they can be used as a guide to highlight the key points entities should have considered
on transition.
Martina Fitzpatrick ACA is a Senior Manager in the Financial Services Group at EY.