Nepal Financial Reporting Standard 4
Insurance Contract
1) Objective
The objective of this NFRS is to specify the financial reporting for insurance contracts by any entity that issues such contracts (described in this NFRS as an insurer) until the Board completes the second phase of its project on insurance contracts. In particular, this NFRS requires:
· limited improvements to accounting by insurers for insurance contracts.
· disclosure that identifies and explains the amounts in an insurer's financial statements arising from insurance contracts and helps users of those financial statements understand the amount, timing and uncertainty of future cash flows from insurance contracts.
2) Scope
An entity shall apply this NFRS to:
· insurance contracts (including reinsurance contracts) that it issues and reinsurance contracts that it holds.
· financial instruments that it issues with a discretionary participation feature. NFRS 7 Financial Instruments: Disclosures requires disclosure about financial instruments, including financial instruments that contain such features.
3) Embedded Derivatives
NFRS 9 requires an entity to separate some embedded derivatives from their host contract, measure them at fair value and include changes in their fair value in profit or loss. NFRS 9 applies to derivatives embedded in an insurance contract unless the embedded derivative is itself an insurance contract.
As an exception to the requirements in NFRS 9, an insurer need not separate, and measure at fair value, a policyholder's option to surrender an insurance contract for a fixed amount (or for an amount based on a fixed amount and an interest rate), even if the exercise price differs from the carrying amount of the host insurance liability. However, the requirements in NFRS 9 do apply to a put option or cash surrender option embedded in an insurance contract if the surrender value varies in response to the change in a financial variable (such as an equity or commodity price or index), or a non-financial variable that is not specific to a party to the contract. Furthermore, those requirements also apply if the holder's ability to exercise a put option or cash surrender option is triggered by a change in such a variable (for example, a put option that can be exercised if a stock market index reaches a specified level).
4) Unbundling of deposit components
Some insurance contracts contain both an insurance component and a deposit component. In some cases, an insurer is required or permitted to unbundle those components:
· unbundling is required if both the following conditions are met:
(i) the insurer can measure the deposit component (including any embedded surrender options) separately (ie without considering the insurance component).
(ii) the insurer's accounting policies do not otherwise require it to recognise all obligations and rights arising from the deposit component.
· unbundling is permitted, but not required, if the insurer can measure the deposit component separately as in (a)(i) but its accounting policies require it to recognise all obligations and rights arising from the deposit component, regardless of the basis used to measure those rights and obligations.
· unbundling is prohibited if an insurer cannot measure the deposit component separately.
The following is an example of a case when an insurer's accounting policies do not require it to recognise all obligations arising from a deposit component. A cedant receives compensation for losses from a reinsurer, but the contract obliges the cedant to repay the compensation in future years. That obligation arises from a deposit component. If the cedant's accounting policies would otherwise permit it to recognise the compensation as income without recognising the resulting obligation, unbundling is required.
To unbundle a contract, an insurer shall:
· apply this NFRS to the insurance component.
· apply NFRS 9 to the deposit component.
5) Liability adequacy test
An insurer shall assess at the end of each reporting period whether its recognised insurance liabilities are adequate, using current estimates of future cash flows under its insurance contracts. If that assessment shows that the carrying amount of its insurance liabilities (less related deferred acquisition costs and related intangible assets, such as those discussed in paragraphs 31 and 32) is inadequate in the light of the estimated future cash flows, the entire deficiency shall be recognised in profit or loss.
If an insurer applies a liability adequacy test that meets specified minimum requirements, this NFRS imposes no further requirements. The minimum requirements are the following:
· The test considers current estimates of all contractual cash flows, and of related cash flows such as claims handling costs, as well as cash flows resulting from embedded options and guarantees.
· If the test shows that the liability is inadequate, the entire deficiency is recognised in profit or loss.
6) Impairment of reinsurance assets
If a cedant's reinsurance asset is impaired, the cedant shall reduce its carrying amount accordingly and recognise that impairment loss in profit or loss. A reinsurance asset is impaired if, and only if:
· there is objective evidence, as a result of an event that occurred after initial recognition of the reinsurance asset, that the cedant may not receive all amounts due to it under the terms of the contract; and
· that event has a reliably measurable impact on the amounts that the cedant will receive from the reinsurer.
7) Changes in accounting policies
An insurer may change its accounting policies for insurance contracts if, and only if, the change makes the financial statements more relevant to the economic decision-making needs of users and no less reliable, or more reliable and no less relevant to those needs. An insurer shall judge relevance and reliability by the criteria in NAS 8.
8) Current market interest rates
An insurer is permitted, but not required, to change its accounting policies so that it remeasures designated insurance liabilities to reflect current market interest rates and recognises changes in those liabilities in profit or loss. At that time, it may also introduce accounting policies that require other current estimates and assumptions for the designated liabilities. The election in this paragraph permits an insurer to change its accounting policies for designated liabilities, without applying those policies consistently to all similar liabilities as NAS 8 would otherwise require. If an insurer designates liabilities for this election, it shall continue to apply current market interest rates (and, if applicable, the other current estimates and assumptions) consistently in all periods to all these liabilities until they are extinguished.
9) Prudence
An insurer need not change its accounting policies for insurance contracts to eliminate excessive prudence. However, if an insurer already measures its insurance contracts with sufficient prudence, it shall not introduce additional prudence.
10) Future investment margins
An insurer need not change its accounting policies for insurance contracts to eliminate future investment margins. However, there is a rebuttable presumption that an insurer's financial statements will become less relevant and reliable if it introduces an accounting policy that reflects future investment margins in the measurement of insurance contracts, unless those margins affect the contractual payments. Two examples of accounting policies that reflect those margins are:
· using a discount rate that reflects the estimated return on the insurer's assets; or
· projecting the returns on those assets at an estimated rate of return, discounting those projected returns at a different rate and including the result in the measurement of the liability.
An insurer may overcome the rebuttable presumption described in paragraph 27 if, and only if, the other components of a change in accounting policies increase the relevance and reliability of its financial statements sufficiently to outweigh the decrease in relevance and reliability caused by the inclusion of future investment margins. For example, suppose that an insurer's existing accounting policies for insurance contracts involve excessively prudent assumptions set at inception and a discount rate prescribed by a regulator without direct reference to market conditions, and ignore some embedded options and guarantees. The insurer might make its financial statements more relevant and no less reliable by switching to a comprehensive investor-oriented basis of accounting that is widely used and involves:
· current estimates and assumptions;
· a reasonable (but not excessively prudent) adjustment to reflect risk and uncertainty;
· measurements that reflect both the intrinsic value and time value of embedded options and guarantees; and
· a current market discount rate, even if that discount rate reflects the estimated return on the insurer's assets.
11) Shadow accounting
In some accounting models, realised gains or losses on an insurer's assets have a direct effect on the measurement of some or all of (a) its insurance liabilities, (b) related deferred acquisition costs and (c) related intangible assets, such as those described in paragraphs 31 and 32. An insurer is permitted, but not required, to change its accounting policies so that a recognised but unrealised gain or loss on an asset affects those measurements in the same way that a realised gain or loss does. The related adjustment to the insurance liability (or deferred acquisition costs or intangible assets) shall be recognised in other comprehensive income if, and only if, the unrealised gains or losses are recognised in other comprehensive income. This practice is sometimes described as 'shadow accounting'.
12) Insurance contracts acquired in a business combination or portfolio transfer
To comply with NFRS 3, an insurer shall, at the acquisition date, measure at fair value the insurance liabilities assumed and insurance assets acquired in a business combination. However, an insurer is permitted, but not required, to use an expanded presentation that splits the fair value of acquired insurance contracts into two components:
a) a liability measured in accordance with the insurer's accounting policies for insurance contracts that it issues; and
b) an intangible asset, representing the difference between (i) the fair value of the contractual insurance rights acquired and insurance obligations assumed and (ii) the amount described in the subsequent measurement of this asset shall be consistent with the measurement of the related insurance liability.
13) Discretionary participation features
Some insurance contracts contain a discretionary participation feature as well as a guaranteed element. The issuer of such a contract:
a) may, but need not, recognise the guaranteed element separately from the discretionary participation feature. If the issuer does not recognise them separately, it shall classify the whole contract as a liability. If the issuer classifies them separately, it shall classify the guaranteed element as a liability.
b) shall, if it recognises the discretionary participation feature separately from the guaranteed element, classify that feature as either a liability or a separate component of equity. This NFRS does not specify how the issuer determines whether that feature is a liability or equity. The issuer may split that feature into liability and equity components and shall use a consistent accounting policy for that split. The issuer shall not classify that feature as an intermediate category that is neither liability nor equity.
c) may recognise all premiums received as revenue without separating any portion that relates to the equity component. The resulting changes in the guaranteed element and in the portion of the discretionary participation feature classified as a liability shall be recognised in profit or loss. If part or all of the discretionary participation feature is classified in equity, a portion of profit or loss may be attributable to that feature (in the same way that a portion may be attributable to non-controlling interests). The issuer shall recognise the portion of profit or loss attributable to any equity component of a discretionary participation feature as an allocation of profit or loss, not as expense or income (see NAS 1 Presentation of Financial Statements).
d) shall, if the contract contains an embedded derivative within the scope of NFRS 9, apply NFRS 9 to that embedded derivative.
14) Disclosure
a) An insurer shall disclose information that identifies and explains the amounts in its financial statements arising from insurance contracts.
b) An insurer shall disclose information that enables users of its financial statements to evaluate the nature and extent of risks arising from insurance contracts.
