Identifying the insurance contract Identifying the insurance contract

Scope of IFRS^®17 – Credit cards and similar products that provide insurance coverage

January 2020 and March 2019 International Accounting Standards Board meeting

Exposure draft of amendments to IFRS 17

International Accounting Standards Board, June 2019

Accounting for any investment component within an insurance contract

May and April 2019 International Accounting Standards Board meetings, and April 2019 TRG meeting

Scope of IFRS 17 – Credit cards that provide insurance coverage

March 2019 International Accounting Standards Board meeting

Scope of IFRS 17 – Loans that transfer significant insurance risk

March and February 2019 International Accounting Standards Board meetings and September 2018 TRG meeting

Combining multiple insurance contracts

May 2018 TRG meeting

Separating insurance components of a single contract

February 2018 TRG meeting

Other topics in this series

What’s the issue?

Some contracts – such as credit cards or other similar contracts that provide credit or payment arrangements – may provide insurance coverage and transfer significant insurance risk.

For example, consider a credit card where the card issuer provides insurance coverage for purchases made by the customer using the credit card, under which the card issuer would pay the customer for claims resulting from the suppliers’ misrepresentations or breaches of contract. Under this arrangement, the card issuer may:

• charge no fee to the customer;
• charge an annual fee that does not reflect an assessment of the insurance risk associated with that individual customer; or 
• charge a fee that reflects the insurance risk associated with each individual customer.

The credit card contract contains both insurance and non-insurance components. This could become a challenge for financial statement preparers because the requirements in IFRS 17 Insurance Contracts for separating non-insurance components differ from those in the current insurance contracts standard, IFRS 4 Insurance Contracts, as explained in the table below.

Stakeholders are concerned that, when IFRS 17 becomes effective, card issuers currently accounting for a loan (or a loan commitment) in a credit card contract under IFRS 9 or other IFRS Standards would need to change the accounting for those contracts that transfer significant insurance risk. This accounting change would need to take place only a short time after incurring costs to develop a new credit impairment model to comply with IFRS 9 Financial Instruments.

What did the Board decide?

At its meeting in January 2020 – in response to feedback on the exposure draft – the Board made the following two decisions on its proposed amendment for credit card contracts.
 

What’s the impact?

If insurance coverage is included in the contract but the pricing does not reflect an assessment of the insurance risk associated with the individual customer, the entity will be required to apply IFRS 17 only to the insurance coverage component and apply other applicable IFRS Standards, such as IFRS 9, to the other components of the credit card or similar contract.

A card issuer issuing a credit card contract or similar product that provides insurance coverage – but which would be partially excluded from the scope of IFRS 17 under this revised proposed amendment – would need to assess which standard(s) might apply to the different non-insurance components of the arrangement. For example:

• a loan or loan commitment and interest charged could fall under IFRS 9;

• revenue for supplying goods and other services provided by the card issuer might fall under IFRS 15 Revenue from Contracts with Customers; or

• IAS^®37 Provisions, Contingent Liabilities and Contingent Assets may apply to a contract if it becomes onerous and is either in the scope of IFRS 15 or not covered by another standard.

The Board’s objective – that entities issuing credit cards or similar arrangements with bundled insurance should apply IFRS 17 only to the insurance coverage component – will reduce the burden and accounting change from adopting IFRS 17 for banks that apply IFRS 9 to these products.  

With the Board having published its exposure draft of the amendments to IFRS 17, you can find our latest insight and analysis at home.Kpmg/ifrs17amendments.

What's the issue?

Under IFRS 17, insurers are required to identify any investment component within an insurance contract. This raises several questions about how an insurer:

• determines whether an investment component exists;
• assesses whether the investment component is distinct – i.e. separated from the insurance component of the contract for measurement purposes; and
• determines the amount of a non-distinct investment component to be excluded from insurance revenue and insurance service expenses.

The points raised in the TRG's discussion are likely to help insurers implement IFRS 17's requirements in this area.

What did the TRG discuss?

Determining whether an investment component exists

TRG members observed that an insurance contract contains an investment component if an entity is required to repay an amount to the policyholder in all circumstances, including when the contract matures, is terminated, or when an insured event occurs. While most TRG members supported clarifying the definition of an investment component along these lines, a few TRG members believed that such clarification is not needed.

Determining the existence of investment components is important because:

• a distinct investment component is separately accounted for under IFRS 9 Financial Instruments;
• non-distinct investment components are excluded from insurance revenue and insurance service expenses in profit or loss; and
• an investment component is a necessary condition for the existence of an investment return service, which may impact the determination of coverage units and a company’s revenue recognition pattern (see proposed amendments in January 2019).

TRG members observed that insurers would need to take all of the following steps.

• Assess at contract inception whether an investment component exists to identify components to be separated and whether a contract provides investment return services.
• Assess whether scenarios in which no payments are made have no commercial substance (because these scenarios are ignored when determining whether an investment component exists).
• Understand that the amount of a payment could be zero and assess whether this indicates that there is no investment component. For example, a contract may still contain an investment component if:
  • the policyholder nets a payment due from the insurer against an amount they owe to the insurer; or
  • the account value of a unit-linked contract has reduced to zero because of negative investment returns when it is due to be paid to the policyholder.

Assessing whether an investment component is distinct

TRG members noted that an investment component is distinct only if:

• the investment component and the insurance component are not highly inter-related; and
• a contract providing investment services with equivalent terms is (or could be) sold separately in the same market or jurisdiction, either by an insurer or another party.

They observed that the components could be highly inter-related if: 

• the value of one component varies with the value of the other component; or
• the policyholder is unable to benefit from one component unless the other is also present – e.g. the maturity or lapse of one component causes the other component to also mature or lapse, or a contractual term prevents the policyholder from cancelling one or both of the components.

As regards available investment services with equivalent terms, TRG members observed that:

• a service would need to reflect all of the terms of the investment component within the insurance contract to be considered equivalent; and  
• an investment component within an insurance contract for which the payment timing depends on the death of the policyholder would probably not be available in the market.

TRG members observed that these criteria result in a high hurdle to separate investment components.

Determining the amount of a non-distinct investment component

TRG members observed that there are three types of payments to policyholders under IFRS 17.

TRG members observed that an insurer needs to determine the amount of a non-distinct investment component – i.e. an investment component not separated from the insurance component and thus not separately accounted for under IFRS 9 – to exclude it from insurance revenue and incurred claims only when the latter are recognised.

TRG members noted that IFRS 17 does not specify how to determine the amount of a non-distinct investment component so there are different ways to do so. The determination may be more straightforward when there is an explicit investment component specified in the contract (e.g. an explicit surrender value). In other cases, it may be more challenging to determine the investment component. TRG members observed that one appropriate approach would be to employ a present value calculation. 

What did the Board decide?

The Board tentatively decided to amend the definition of an investment component as ‘the amounts that an insurance contract requires the entity to repay to a policyholder in all circumstances’.

The Board observed that the clarification is important because the questions received by the TRG indicates that there is confusion and hence the possibility of diversity in practice over the existence of investment components.

What's the impact?

It is important for insurers to carefully assess whether their contracts include investment components given the impact of this assessment on insurance revenue.

Concerns have been raised about how to differentiate investment components and premium refunds. Although the treatment may be identical for the balance sheet, profit or loss and the contractual service margin, there are specific separation and disclosure requirements that apply only to investment components.

Insurers’ concerns about the potential complexity of distinguishing premium refunds and investment components would be alleviated by the Board’s proposed amendment to clarify that, when reconciling opening and closing balances of insurance contract liabilities, insurers are not required to separately disclose premium refunds. However, within that reconciliation, insurers may disclose premium refunds either: 

• separately; or 
• together with either investment components or premiums received. 

Overall, it is important that insurers apply a robust approach that is consistent with the standard in identifying and determining the amount of investment components. This will require careful consideration of the terms of the contractual arrangements. 

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What’s the issue?

Some credit card contracts may provide insurance coverage and transfer significant insurance risk.

For example, consider a credit card where the card issuer provides insurance coverage for purchases made by the customer using the credit card, under which the card issuer would pay the customer for claims resulting from the supplier’s misrepresentation or breach of contract. Under this arrangement the card issuer either:

• charges no fee to the customer; or
• charges an annual fee that does not reflect an assessment of the insurance risk associated with that individual customer.
  

The credit card contract contains both insurance and non-insurance components. This could become a challenge for financial statement preparers because the requirements in IFRS 17 for separating non-insurance components differ from those in the current insurance contracts standard, IFRS 4, as explained in the table below.

Stakeholders are concerned that card issuers that currently account for a loan or a loan commitment in a credit card contract under IFRS 9 would need to change the accounting for those contracts that transfer significant insurance risk when IFRS 17 becomes effective – only a short time after having incurred costs to develop a new credit impairment model to comply with IFRS 9.

What did the Board decide?

The Board tentatively decided to amend IFRS 17 to exclude certain credit card contracts that provide insurance coverage from the scope of IFRS 17. A credit card contract would be eligible for the exclusion if the contract price set by the card issuer for a customer does not reflect an assessment of the insurance risk associated with that individual customer.

What’s the impact?

A card issuer issuing a credit card contract that provides insurance coverage, but would be excluded from the scope of IFRS 17 under this proposed amendment, would need to assess which standard(s) might apply to the different components of the arrangement. For example:

• a loan or loan commitment and interest charged could fall under IFRS 9;
• revenue for supplying goods and other services provided by the card issuer might fall under IFRS 15 Revenue from Contracts with Customers; or
• IAS 37 Provisions, Contingent Liabilities and Contingent Assets may apply to a contract if it becomes onerous and is either in the scope of IFRS 15 or not covered by another standard.

The insurance coverage provided under the credit card arrangement might arise only as a result of law or regulation. Therefore, payment obligations related to the insurance coverage might be disregarded when analysing whether the contractual terms give rise to cash flows that are solely payments of principal and interest under IFRS 9. (For example, IAS 37 might apply to such obligations.)

The staff highlighted some of the different features of credit cards that might not be covered by the exemption, but might otherwise be outside the scope of IFRS 17. For example:

• the card issuer merely acts as an agent in selling insurance provided by a third-party insurer;
• the insurance coverage meets the specified conditions for a fixed-fee service contract in paragraph 8 of IFRS 17 and would therefore be accounted for under IFRS 15;
• the insurance coverage provides for the settlement of the customer’s obligation created by the contract, such as a waiver of the loan balance of the credit card if the customer dies, and is captured by the scope exclusion for loans that was tentatively agreed in February 2019; and
• certain ‘chargeback’ mechanisms, which enable the card issuer to process claims from card holders requesting a refund of actual amounts paid using the credit card in respect of non-delivered goods or services.
   

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What's the issue?

Some loan contracts may transfer significant insurance risk – e.g. a waiver of some or all of the payments due if a specified uncertain future event adversely affects the borrower. Examples include mortgages with a death waiver, some student loans and lifetime mortgages (also known as equity release or reverse mortgages).

IFRS 17 does not include specific requirements with respect to separating a loan that includes an insurance component. Therefore, if the loan transfers significant insurance risk, then it would fall wholly in the scope of IFRS 17.

Currently under IFRS 4 Insurance Contracts, some lenders account for these contracts by separating a loan component from the insurance contract, then applying financial instruments accounting to the loan component (either under IFRS 9 Financial Instruments or IAS 39 Financial Instruments: Recognition and Measurement).

This practice would not be permitted to continue under IFRS 17, as currently drafted.

What did the TRG discuss in September 2018?

TRG members observed that if these loan contracts fall in the scope of IFRS 17, then the entire contract may need to be accounted for under IFRS 17, in the absence of a specific requirement that allows the lender to separate the loan and the insurance components.

TRG members noted that applying the requirements of IFRS 17 to the entire contract may cause complexities for lenders that have not applied insurance accounting to the loan component of such contracts before. Some stakeholders are concerned that applying IFRS 17 to these loans in their entirety would impose costs on lenders without any corresponding benefits.

What did the Board decide in February 2019?

The Board proposes amending IFRS 17 and IFRS 9 to allow lenders to apply either standard to loans for which the only insurance cover is for the settlement of some or all of the borrower’s obligations under the loan. Lenders would make this choice irrevocably at the portfolio level.  

What did the Board decide in March 2019?

The Board observed that its February 2019 decision would require specific transition requirements for loans that transfer significant insurance risk if the lender:

• elects to apply IFRS 9 Financial Instruments rather than IFRS 17 to these loans; and
• has already adopted IFRS 9 before initially applying IFRS 17.

For these loans, the Board tentatively decided to propose that lenders be required to apply the necessary transition requirements found in IFRS 9. It also proposed providing:

• reliefs related to designation and de-designation of financial liabilities as at fair value through profit or loss (FVTPL); and
• an exemption from:
  • restating comparatives; and
  • disclosing the effect on each financial statement line item (including earnings per share) under IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors.

The Board has observed that the IFRS 17 model would appropriately reflect these contracts’ features. However, it has also acknowledged that these contracts are often issued by banks and other financial institutions, rather than insurers. These lenders could benefit from having the option to apply IFRS 9 to these loan contracts. This would:

• facilitate comparison with other loans that they issue; and
• eliminate their IFRS 17 implementation costs for these contracts by aligning the accounting for these instruments to:   
  • other financial instruments held by the lender; and
  • their current internal management model.
    

In deciding which standard to apply, lenders would have to consider the impact that these contracts’ classifications would have under IFRS 9, as these could differ from their IAS 39 classifications.

For example, these contracts could be mandatorily measured at fair value through profit or loss under IFRS 9 (instead of at amortised cost, as most loans are), because the significant embedded insurance risk may mean that the contractual cash flows are not ‘solely payments of principal and interest’.

If a lender has already adopted IFRS 9 before it initially applies IFRS 17, then it may have applied IFRS 9 (fully or partially) to these contracts and measured them at FVTPL. These measurements might not change significantly on transition to IFRS 17 if the lender opts to continue accounting for these contracts under IFRS 9. In this case, some of the proposed transition reliefs may be less relevant – e.g. the exemption from restating comparatives.

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What's the issue?

Insurers sometimes simultaneously issue different contracts to the same policyholder. For example, an insurer may issue two contracts – one for home insurance and one for motor insurance – to the same policyholder at the same time, with the policyholder receiving a discount for the whole transaction.

This raises a question as to when it is necessary to treat multiple insurance contracts as a single contract under IFRS 17. 

What did the TRG discuss?

TRG members appeared to agree that an insurance arrangement with the legal form of a single contract would generally also be considered to be a single contract in substance. 

IFRS 17 acknowledges that if multiple insurance contracts with the same (or a related) counterparty achieve – or are designed to achieve – an overall commercial effect, then they may reflect a single contract in substance.

TRG members observed that any decision to combine multiple insurance contracts is based on significant judgement considering all relevant facts and circumstances. No single factor is determinative.

They also observed that:

• if the lapse or maturity of one contract causes the lapse or maturity of another, then this may indicate that the contracts were designed to achieve an overall commercial effect; and
• the fact that multiple insurance contracts are entered into at the same time with the same counterparty, or the existence of a discount if a policyholder purchases more than one insurance coverage does not necessarily mean that multiple insurance contracts achieve an overall commercial effect.  

It was also noted that allocating any discounts or cross-subsidies between multiple coverages to components proportionately, or on the basis of observable evidence, could better reflect the economics of the separate components.

What's the impact?

If there are indicators that multiple insurance contracts reflect a single contract in substance, then an insurer should apply judgement to determine whether it is appropriate to combine them. 

Relevant facts and circumstances to consider may include whether:

• the rights and obligations under the contracts are different when considered together instead of separately; or
• the different risks covered by different insurance contracts are interdependent – e.g. when the risk of one contract offsets or reduces that of the other.

The question of whether to combine contracts might be relevant to certain fronting arrangements.

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What's the issue?

Insurers may combine different types of insurance products, or coverages that have different insurance risks, into one legal insurance contract.

For example, an insurer may provide fire cover for a policyholder’s house and automobile cover for their car under a single contract. Insurers may also hold one legal reinsurance contract to reinsure multiple underlying contracts that may be included in different groups of contracts.

This raises the question of whether IFRS 17 permits different insurance components of a single legal contract to be separated for measurement purposes.

What did the TRG discuss? 

TRG members appeared to agree that, generally, the lowest unit of account used under IFRS 17 is the contract, including all insurance components. Generally, this is consistent with how most insurers design their contracts – i.e. in a way that reflects their substance.

However, the TRG members observed that in some circumstances the legal form of a contract does not reflect the substance of its contractual rights and obligations. In these cases, separating the contract for measurement purposes would be appropriate. The TRG acknowledged that separation of insurance components is not a matter of policy choice, but is an assessment based on judgement considering all relevant facts and circumstances.

However, the TRG members observed that in some circumstances the legal form of a contract does not reflect the substance of its contractual rights and obligations. In these cases, separating the contract for measurement purposes would be appropriate. TRG members acknowledged that separation of insurance components is not a matter of policy choice, but is an assessment based on judgement considering all relevant facts and circumstances.

What’s the impact?

If an insurer believes that the legal form of some of the contracts that it issues does not reflect the substance of their contractual rights and obligations, then – as noted by the TRG members – it should apply judgement to determine whether it is appropriate to separate a contract into multiple insurance components.

Relevant facts and circumstances to consider may include whether:

• the insurance components are sold separately;
• the insurance components can be cancelled or lapsed together; or
• the substance of the legal contract is the same as issuing separate contracts.
  

How an entity identifies its contract will impact various aspects of the accounting under IFRS 17, including the measurement of the contract and its insurance service results.

Speak to your usual KPMG contact to discuss how these observations could impact your business.

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This topic page is part of our Insurance – Transition to IFRS 17 series, which covers the discussions of the International Accounting Standards Board and its Transition Resource Group (TRG) regarding the new insurance contracts standard.

You can also find more insight and analysis on the new insurance contracts standard at IFRS – Insurance.

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