Recognition and measurement (AASB4_08-15_COMPsep20_01-21)

Paragraphs 10–12 of AASB 108 Accounting Policies, Changes in Accounting Estimates and Errors specify criteria for an entity to use in developing an accounting policy if no Standard applies specifically to an item. However, this Standard exempts an insurer from applying those criteria to its accounting policies for:

(a)            insurance contracts that it issues (including related acquisition costs and related intangible assets, such as those described in paragraphs 31 and 32); and

(b)            reinsurance contracts that it holds.

Nevertheless, this Standard does not exempt an insurer from some implications of the criteria in paragraphs 10–12 of AASB 108. Specifically, an insurer:

(a)            shall not recognise as a liability any provisions for possible future claims, if those claims arise under insurance contracts that are not in existence at the end of the reporting period (such as catastrophe provisions and equalisation provisions).

(b)            shall carry out the liability adequacy test described in paragraphs 15–19.

(c)            shall remove an insurance liability (or a part of an insurance liability) from its statement of financial position when, and only when, it is extinguished—ie when the obligation specified in the contract is discharged or cancelled or expires.

(d)            shall not offset:

(i)              reinsurance assets against the related insurance liabilities; or

(ii)             income or expense from reinsurance contracts against the expense or income from the related insurance contracts.

(e)            shall consider whether its reinsurance assets are impaired (see paragraph 20).

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 Standard imposes no further requirements. The minimum requirements are the following:

(a)            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.

(b)            If the test shows that the liability is inadequate, the entire deficiency is recognised in profit or loss.

If an insurer’s accounting policies do not require a liability adequacy test that meets the minimum requirements of paragraph 16, the insurer shall:

(a)            determine the carrying amount of the relevant insurance liabilities^[1] less the carrying amount of:

(i)              any related deferred acquisition costs; and

(ii)             any related intangible assets, such as those acquired in a business combination or portfolio transfer (see paragraphs 31 and 32). However, related reinsurance assets are not considered because an insurer accounts for them separately (see paragraph 20).

(b)            determine whether the amount described in (a) is less than the carrying amount that would be required if the relevant insurance liabilities were within the scope of AASB 137. If it is less, the insurer shall recognise the entire difference in profit or loss and decrease the carrying amount of the related deferred acquisition costs or related intangible assets or increase the carrying amount of the relevant insurance liabilities.

If an insurer’s liability adequacy test meets the minimum requirements of paragraph 16, the test is applied at the level of aggregation specified in that test. If its liability adequacy test does not meet those minimum requirements, the comparison described in paragraph 17 shall be made at the level of a portfolio of contracts that are subject to broadly similar risks and managed together as a single portfolio.

The amount described in paragraph 17(b) (ie the result of applying AASB 137) shall reflect future investment margins (see paragraphs 27–29) if, and only if, the amount described in paragraph 17(a) also reflects those margins.

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:

(a)            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

(b)            that event has a reliably measurable impact on the amounts that the cedant will receive from the reinsurer.

AASB 9 addresses the accounting for financial instruments and is effective for annual periods beginning on or after 1 January 2018. However, for an insurer that meets the criteria in paragraph 20B, this Standard provides a temporary exemption that permits, but does not require, the insurer to apply AASB 139 Financial Instruments: Recognition and Measurement rather than AASB 9 for annual periods beginning before 1 January 2023. An insurer that applies the temporary exemption from AASB 9 shall:

(a) use the requirements in AASB 9 that are necessary to provide the disclosures required in paragraphs 39B–39J of this Standard; and

(b) apply all other applicable Standards to its financial instruments, except as described in paragraphs 20A–20Q, 39B–39J and 46–47 of this Standard.

An insurer may apply the temporary exemption from AASB 9^[2] if, and only if:

(a) it has not previously applied any version of AASB 9, other than only the requirements for the presentation of gains and losses on financial liabilities designated as at fair value through profit or loss in paragraphs 5.7.1(c), 5.7.7–5.7.9, 7.2.14 and B5.7.5–B5.7.20 of AASB 9; and

(b) its activities are predominantly connected with insurance, as described in paragraph 20D, at its annual reporting date that immediately precedes 1 April 2016, or at a subsequent annual reporting date as specified in paragraph 20G.

An insurer applying the temporary exemption from AASB 9 is permitted to elect to apply only the requirements for the presentation of gains and losses on financial liabilities designated as at fair value through profit or loss in paragraphs 5.7.1(c), 5.7.7–5.7.9, 7.2.14 and B5.7.5–B5.7.20 of AASB 9. If an insurer elects to apply those requirements, it shall apply the relevant transition provisions in AASB 9, disclose the fact that it has applied those requirements and provide on an ongoing basis the related disclosures set out in paragraphs 10–11 of AASB 7 (as amended by AASB 9 (2010)).

An insurer’s activities are predominantly connected with insurance if, and only if:

(a) the carrying amount of its liabilities arising from contracts within the scope of this Standard, AASB 1023 and AASB 1038, which includes any deposit components or embedded derivatives unbundled from insurance contracts applying paragraphs 7–12 of this Standard, is significant compared to the total carrying amount of all its liabilities; and

(b) the percentage of the total carrying amount of its liabilities connected with insurance (see paragraph 20E) relative to the total carrying amount of all its liabilities is:

(i) greater than 90 per cent; or

(ii) less than or equal to 90 per cent but greater than 80 per cent, and the insurer does not engage in a significant activity unconnected with insurance (see paragraph 20F).

For the purposes of applying paragraph 20D(b), liabilities connected with insurance comprise:

(a) liabilities arising from contracts within the scope of this Standard, AASB 1023 and AASB 1038, as described in paragraph 20D(a);

(b) non-derivative investment contract liabilities measured at fair value through profit or loss applying AASB 139 (including those designated as at fair value through profit or loss to which the insurer has applied the requirements in AASB 9 for the presentation of gains and losses (see paragraphs 20B(a) and 20C)); and

(c) liabilities that arise because the insurer issues, or fulfils obligations arising from, the contracts in (a) and (b). Examples of such liabilities include derivatives used to mitigate risks arising from those contracts and from the assets backing those contracts, relevant tax liabilities such as the deferred tax liabilities for taxable temporary differences on liabilities arising from those contracts, and debt instruments issued that are included in the insurer’s regulatory capital.

In assessing whether it engages in a significant activity unconnected with insurance for the purposes of applying paragraph 20D(b)(ii), an insurer shall consider:

(a) only those activities from which it may earn income and incur expenses; and

(b) quantitative or qualitative factors (or both), including publicly available information such as the industry classification that users of financial statements apply to the insurer.

Paragraph 20B(b) requires an entity to assess whether it qualifies for the temporary exemption from AASB 9 at its annual reporting date that immediately precedes 1 April 2016. After that date:

(a) an entity that previously qualified for the temporary exemption from AASB 9 shall reassess whether its activities are predominantly connected with insurance at a subsequent annual reporting date if, and only if, there was a change in the entity’s activities, as described in paragraphs 20H–20I, during the annual period that ended on that date.

(b) an entity that previously did not qualify for the temporary exemption from AASB 9 is permitted to reassess whether its activities are predominantly connected with insurance at a subsequent annual reporting date before 31 December 2018 if, and only if, there was a change in the entity’s activities, as described in paragraphs 20H–20I, during the annual period that ended on that date.

For the purposes of applying paragraph 20G, a change in an entity’s activities is a change that:

(a) is determined by the entity’s senior management as a result of external or internal changes;

(b) is significant to the entity’s operations; and

(c) is demonstrable to external parties.

Accordingly, such a change occurs only when the entity begins or ceases to perform an activity that is significant to its operations or significantly changes the magnitude of one of its activities; for example, when the entity has acquired, disposed of or terminated a business line.

A change in an entity’s activities, as described in paragraph 20H, is expected to be very infrequent. The following are not changes in an entity’s activities for the purposes of applying paragraph 20G:

(a) a change in the entity’s funding structure that in itself does not affect the activities from which the entity earns income and incurs expenses.

(b) the entity’s plan to sell a business line, even if the assets and liabilities are classified as held for sale applying AASB 5 Non-current Assets Held for Sale and Discontinued Operations. A plan to sell a business line could change the entity’s activities and give rise to a reassessment in the future but has yet to affect the liabilities recognised on its statement of financial position.

If an entity no longer qualifies for the temporary exemption from AASB 9 as a result of a reassessment (see paragraph 20G(a)), then the entity is permitted to continue to apply the temporary exemption from AASB 9 only until the end of the annual period that began immediately after that reassessment. Nevertheless, the entity must apply AASB 9 for annual periods beginning on or after 1 January 2023. For example, if an entity determines that it no longer qualifies for the temporary exemption from AASB 9 applying paragraph 20G(a) on 31 December 2018 (the end of its annual period), then the entity is permitted to continue to apply the temporary exemption from AASB 9 only until 31 December 2019.

An insurer that previously elected to apply the temporary exemption from AASB 9 may at the beginning of any subsequent annual period irrevocably elect to apply AASB 9.

A first-time adopter, as defined in AASB 1 First-time Adoption of Australian Accounting Standards, may apply the temporary exemption from AASB 9 described in paragraph 20A if, and only if, it meets the criteria described in paragraph 20B. In applying paragraph 20B(b), the first-time adopter shall use the carrying amounts determined applying Standards at the date specified in that paragraph.

AASB 1 contains requirements and exemptions applicable to a first-time adopter. Those requirements and exemptions (for example, paragraphs D16–D17 of AASB 1) do not override the requirements in paragraphs 20A–20Q and 39B–39J of this Standard. For example, the requirements and exemptions in AASB 1 do not override the requirement that a first-time adopter must meet the criteria specified in paragraph 20L to apply the temporary exemption from AASB 9.

A first-time adopter that discloses the information required by paragraphs 39B–39J shall use the requirements and exemptions in AASB 1 that are relevant to making the assessments required for those disclosures.

Paragraphs 35–36 of AASB 128 Investments in Associates and Joint Ventures require an entity to apply uniform accounting policies when using the equity method. Nevertheless, for annual periods beginning before 1 January 2023, an entity is permitted, but not required, to retain the relevant accounting policies applied by the associate or joint venture as follows:

(a) the entity applies AASB 9 but the associate or joint venture applies the temporary exemption from AASB 9; or

(b) the entity applies the temporary exemption from AASB 9 but the associate or joint venture applies AASB 9.

When an entity uses the equity method to account for its investment in an associate or joint venture:

(a) if AASB 9 was previously applied in the financial statements used to apply the equity method to that associate or joint venture (after reflecting any adjustments made by the entity), then AASB 9 shall continue to be applied.

(b) if the temporary exemption from AASB 9 was previously applied in the financial statements used to apply the equity method to that associate or joint venture (after reflecting any adjustments made by the entity), then AASB 9 may be subsequently applied.

An entity may apply paragraphs 20O and 20P(b) separately for each associate or joint venture.

An insurer applying the temporary exemption from AASB 9 shall apply the requirements in paragraphs 5.4.6‒5.4.9 of AASB 9 to a financial asset or financial liability if, and only if, the basis for determining the contractual cash flows of that financial asset or financial liability changes as a result of interest rate benchmark reform. For this purpose, the term ‘interest rate benchmark reform’ refers to the market-wide reform of an interest rate benchmark as described in paragraph 102B of AASB 139.

For the purpose of applying paragraphs 5.4.6–5.4.9 of the amendments to AASB 9, the references to paragraph B5.4.5 of AASB 9 shall be read as referring to paragraph AG7 of AASB 139. References to paragraphs 5.4.3 and B5.4.6 of AASB 9 shall be read as referring to paragraph AG8 of AASB 139.

Paragraphs 22–30 apply both to changes made by an insurer that already applies IFRSs and to changes made by an insurer adopting Australian Accounting Standards for the first time.

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 AASB 108.

To justify changing its accounting policies for insurance contracts, an insurer shall show that the change brings its financial statements closer to meeting the criteria in AASB 108, but the change need not achieve full compliance with those criteria. The following specific issues are discussed below:

(a) current interest rates (paragraph 24);

(b) continuation of existing practices (paragraph 25);

(c) prudence (paragraph 26);

(d) future investment margins (paragraphs 27–29); and

(e) shadow accounting (paragraph 30).

An insurer is permitted, but not required, to change its accounting policies so that it remeasures designated insurance liabilities^[3] 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 AASB 108 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.

An insurer may continue the following practices, but the introduction of any of them does not satisfy paragraph 22:

(a) measuring insurance liabilities on an undiscounted basis.

(b) measuring contractual rights to future investment management fees at an amount that exceeds their fair value as implied by a comparison with current fees charged by other market participants for similar services. It is likely that the fair value at inception of those contractual rights equals the origination costs paid, unless future investment management fees and related costs are out of line with market comparables.

(c) using non-uniform accounting policies for the insurance contracts (and related deferred acquisition costs and related intangible assets, if any) of subsidiaries, except as permitted by paragraph 24. If those accounting policies are not uniform, an insurer may change them if the change does not make the accounting policies more diverse and also satisfies the other requirements in this Standard.

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.

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:

(a) using a discount rate that reflects the estimated return on the insurer’s assets; or

(b) 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:

(a) current estimates and assumptions;

(b) a reasonable (but not excessively prudent) adjustment to reflect risk and uncertainty;

(c) measurements that reflect both the intrinsic value and time value of embedded options and guarantees; and

(d) a current market discount rate, even if that discount rate reflects the estimated return on the insurer’s assets.

In some measurement approaches, the discount rate is used to determine the present value of a future profit margin. That profit margin is then attributed to different periods using a formula. In those approaches, the discount rate affects the measurement of the liability only indirectly. In particular, the use of a less appropriate discount rate has a limited or no effect on the measurement of the liability at inception. However, in other approaches, the discount rate determines the measurement of the liability directly. In the latter case, because the introduction of an asset-based discount rate has a more significant effect, it is highly unlikely that an insurer could overcome the rebuttable presumption described in paragraph 27.

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’.

To comply with AASB 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 (a). The subsequent measurement of this asset shall be consistent with the measurement of the related insurance liability.

An insurer acquiring a portfolio of insurance contracts may use the expanded presentation described in paragraph 31.

The intangible assets described in paragraphs 31 and 32 are excluded from the scope of AASB 136 Impairment of Assets and AASB 138. However, AASB 136 and AASB 138 apply to customer lists and customer relationships reflecting the expectation of future contracts that are not part of the contractual insurance rights and contractual insurance obligations that existed at the date of a business combination or portfolio transfer.

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 Standard 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 AASB 101 Presentation of Financial Statements).

(d) shall, if the contract contains an embedded derivative within the scope of AASB 9, apply AASB 9 to that embedded derivative.

(e) shall, in all respects not described in paragraphs 14–20 and 34(a)–(d), continue its existing accounting policies for such contracts, unless it changes those accounting policies in a way that complies with paragraphs 21–30.

The requirements in paragraph 34 also apply to a financial instrument that contains a discretionary participation feature. In addition:

(a) if the issuer classifies the entire discretionary participation feature as a liability, it shall apply the liability adequacy test in paragraphs 15–19 to the whole contract (ie both the guaranteed element and the discretionary participation feature). The issuer need not determine the amount that would result from applying AASB 9 to the guaranteed element.

(b) if the issuer classifies part or all of that feature as a separate component of equity, the liability recognised for the whole contract shall not be less than the amount that would result from applying AASB 9 to the guaranteed element. That amount shall include the intrinsic value of an option to surrender the contract, but need not include its time value if paragraph 9 exempts that option from measurement at fair value. The issuer need not disclose the amount that would result from applying AASB 9 to the guaranteed element, nor need it present that amount separately. Furthermore, the issuer need not determine that amount if the total liability recognised is clearly higher.

(c) although these contracts are financial instruments, the issuer may continue to recognise the premiums for those contracts as revenue and recognise as an expense the resulting increase in the carrying amount of the liability.

(d) although these contracts are financial instruments, an issuer applying paragraph 20(b) of AASB 7 to contracts with a discretionary participation feature shall disclose the total interest expense recognised in profit or loss, but need not calculate such interest expense using the effective interest method.

The temporary exemptions in paragraphs 20A, 20L and 20O and the overlay approach in paragraph 35B are also available to an issuer of a financial instrument that contains a discretionary participation feature. Accordingly, all references in paragraphs 3(a)–3(b), 20A–20Q, 35B–35N, 39B–39M and 46–49 to an insurer shall be read as also referring to an issuer of a financial instrument that contains a discretionary participation feature.