Accounting for general insurance contracts Chapter 21 Accounting for general insurance contracts

Objectives of this lecture Understand the meaning of ‘general insurance’ Understand the asset measurement rules that are to be applied to the assets that back general insurance liabilities Understand how the liabilities pertaining to general insurance contracts are to be measured Know about the discount rate that should be used to discount liabilities to their present value

Objectives (cont.) Understand the revenue and expense recognition principles that should be adopted in relation to general insurance contracts Be aware of the disclosure requirements of AASB 1023

Introduction to general insurance contracts Currently we have three accounting standards dealing with insurance AASB 4 Insurance Contracts (does not apply to ‘general insurance’) AASB 1023 General Insurance Contracts AASB 1038 Life Insurance Contracts The IASB is currently working on Phase II of the ‘Insurance Project’ It is expected that a revised standard will replace these three standards but that this standard will not be operative until at least 2013 or 2014 This lecture focuses on AASB 1023

The role of the HIH Royal Commission It appears that the re-release of AASB 1023 in 2004 was affected by the Royal Commission The collapse of HIH Insurance Ltd in 2001 was one of the worst corporate collapses in Australia Justice Neville Owen comments Justice Owen’s recommendations for AASB 1023

Introduction to the requirements of AASB 1023 Application of AASB 1023 General insurance contract Life insurance contract General insurance

Recognition of insurance premium revenue Revenue to be brought to account from the ‘attachment date’, provided it can be measured reliably (AASB 1023) Revenue recognised should be tied to the pattern of the incidence of risk Most insurers bring revenue to account on a time basis, with an equal amount being attributed to each period Steps in measuring premium revenue (AASB 1023)

Revenue associated with unclosed business Business written close to the end of the reporting period in respect of which the date of attachment of risk precedes the end of the reporting period Insurer agrees to accept the risk before the customer has completed policy contract (i.e. cover note) Estimate of earned portion of premium relating to unclosed business is necessary for inclusion in premium revenue

Reinsurance Common for insurers to reinsure some or all of their insurance portfolio with another insurer Direct insurer The entity that originally wrote an insurance contract Must show all premiums received, including those redirected Premiums transferred to reinsurer are an expense of the direct insurer

Reinsurance (cont.) Reinsurer (AASB 1023) Party that has an obligation under a reinsurance contract to compensate an insured party if an insured event occurs Reinsurance premiums received are treated in the same way as premiums accepted by direct insurer, i.e. as revenue

Reimbursement of government charges Part of premium relates to government charges (e.g. stamp duty) imposed on the insured party Not treated as revenue by insurer but as revenue held on behalf of the government (i.e. a liability) Charges levied on insurer (e.g. licence fees and workers’ compensation insurance) incorporated in insurance premium Treated as part of premium revenue

Insurance claims Claims settled and paid during the year are treated as expenses of the period Expenses and liabilities should include outstanding claims as at the end of the reporting period Outstanding claims liability measurement (AASB 1023) Risk margin (AASB 1023) Expected future payments include (AASB 1023)

Requirement to discount obligations Outstanding claims liability is to be discounted to present value using (AASB 1023) Government bond rate might be appropriate Increase in present value of claim from one period to the next is included in claims expense (AASB 1023) Unearned premium liability (AASB 1023)

Liability adequacy test Assessment of whether carrying amounts of insurance liabilities need to be increased based on a review of future cash flows (AASB 1023) Present value of future claims to be compared with unearned premiums If present value exceeds unearned premium liability (AASB 1023): liability is deficient, and further liability and expense is to be recognised

Assets Different measurement approaches required for financial assets, investment properties and property, plant and equipment (AASB 1023) Financial assets (defined in AASB 139) Investment properties (AASB 140 and AASB 1023) Property, plant and equipment (AASB 1023)

Disclosure requirements Statement of comprehensive income (AASB 1023) Total deficiency Any write-downs of deferred acquisition costs Any write-downs of intangible assets Underwriting result for the period Net claims incurred Gross claims incurred (undiscounted) and reinsurance and other recoveries (undiscounted)

Disclosure requirements (cont.) Statement of financial position (AASB 1023) For outstanding claims liability, central estimate and risk margin Percentage risk margin adopted Probability of adequacy Process used to determine risk margin

Consistency with other standards AASB 1023 requires certain measurement approaches for ‘assets backing general insurance liabilities’ For assets not ‘backing general insurance liabilities’, alternative approaches could be used Would different valuation bases confuse financial statement users?

Opposition to AASB 1023 Major opposition to original AASB 1023 Requirement to include unrecognised gains and losses on investments in the profit and loss Claimed to introduce a degree of volatility to the accounts Also argued that results driven by marked-to-market investments would distort general insurers’ performance Some volatility will remain under current version of AASB 1023

Summary The lecture addresses accounting issues relating to general insurance contracts Main issues are: how and when revenue should be recognised how and when insurance claims should be recognised how assets should be valued Revenues to be recognised on the basis of pattern of incidence of risk Insurance claims settled and paid to be treated as expenses Unpaid insurance claims recognised as liabilities to be discounted to present values