Write up on IFRS 4 Insurance Contracts (23 October 2009)

This is an interesting article on IFRS 4 that I have read from the Star newpaper today:

Challenges in implementing new financial reporting standards

KPMG Chat

The Star, 23 October 2009

By ALEX KHAW

FINANCIAL Reporting Standards No. 4 (FRS 4), or IFRS 4 as it is known internationally, has been issued for adoption by the Malaysian Accounting Standards Board and will be effective for insurance companies in Malaysia effective Jan 1, 2010.

This is the first standard issued by the International Accounting Standards Board (IASB) that deals with insurance contracts.

The key reasons for this standard are to make limited improvements to accounting for insurance contracts, until IASB completes Phase II of its project on insurance contracts and also to require any entity issuing insurance contracts to disclose information about those contracts.

What does it apply to?

FRS 4 applies to insurance contracts that an entity issues and to reinsurance contracts that an entity issues and holds. It, however, does not apply to insurance contracts held by policyholders, other than holders of reinsurance contracts.

FRS 4 focuses on the type of contracts rather than the type of entities. This actually means that it addresses the accounting and disclosure requirements for insurance contracts with regards to their contractual rights and obligations arising from these contracts.

What is an insurance contract?

An insurance contract is defined as a contract where the insurer accepts significant insurance risk from the policyholder by agreeing to compensate the policyholder if an unspecified future event adversely affects the policyholder.

This specified uncertain future event is known as the “insured event” while the uncertain future event that is covered by an insurance contract creates “insurance risk”.

The good news is that, upon adoption of FRS 4, Malaysian insurers are generally allowed to continue using existing accounting practices for insurance contracts. Meanwhile, an entity is only permitted to change its accounting policies for insurance contracts if the changes improve either the relevance or the reliability of its financial statements.

The issue of insurance liabilities measurement is currently being addressed in Phase II of IFRS 4 project by the IASB, and an exposure draft is anticipated to be issued before year-end.

What are the key principles of FRS 4?

The first principle states that the insurer is required to disclose its accounting policies for insurance contracts, the key amounts of the recognised assets, liabilities, income and expenses arising from insurance contracts.

In addition, there is a need to disclose the significant assumptions used to measure these amounts and the effect of changes in these assumptions.

The second principle requires the disclosure of the risk management objectives, policies and methods for managing those insurance risks, such as credit, liquidity and market risks.

Nature of insurance risks in terms of their sensitivities, concentrations and claims development information are also needed.

Key challenges insurers need to consider

As Phase I of FRS 4 is focused on the disclosure requirements, insurers need to consider the involvement of senior management, as they would be deciding on what is to be disclosed, especially in the first year of implementation. Getting the right key resources could also be an issue, as expert resources could be scarce internally and to maintain them would be relatively costly.

Therefore some companies are expected to depend on external resources. Reinsurance is something else that needs to be considered, especially as insurance assets and liabilities are required to be disclosed gross and net of reinsurance, including gross and net incurred but not reported claims reserves.

This will also mean that actuarial calculations need to be reconsidered to align it to provide the necessary information to meet the disclosure requirements.

There will be increased financial reporting risk due to the technical complexities or staff’s non-familiarity with the Standard. This is further compounded by continued reliance on manual workarounds such as spreadsheets. To ensure accuracy and timeliness of the financial reporting, companies may need to look at the alignment of automation of their systems.

Finally, insurance companies should ideally use this disclosure as a tool to communicate the philosophy and performance of the business to its users and stakeholders instead of treating it as a compliance issue.

The enhanced disclosures will obviously allow stakeholders to ascertain the type of risks the insurers underwrites, how these risks are managed by the insurers and the impact on financial performance.

The disclosure requirements are principles based, and the guidance included in the standard is non-prescriptive.

At the end, the discretion is left to the management and directors of insurance companies to decide on how much detail should be given to satisfy the disclosure requirements and how the aggregate of these disclosures would have an impact on the overall picture of the business philosophy and performance of the company.

All these can only be achieved with early planning and with the effective date of FRS 4 looming near, that time is now.

● The writer is head of KPMG Financial Services Audit.”

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