Chapter 1: Introduction
This chapter provides guidance on IFRS 17 which is effective for annual periods beginning on or after 1 January 2021. In June 2018, the IASB tentatively decided to propose certain minor amendments to IFRS 17; where relevant, these proposed amendments are discussed in this chapter’s illustrative text. In November 2018, the IASB tentatively decided that the mandatory effective date of IFRS 17 should be deferred by one year, to periods beginning on or after 1 January 2022. The IASB is considering certain other potential amendments to IFRS 17 based on criteria for evaluation that were tentatively agreed at the October 2018 IASB meeting. These potential amendments were published in an exposure draft in June 2019 and, as yet, these have not been included within this chapter.
Scope of IFRS 17, classification of contracts by insurers
IFRS 17 applies to:
- insurance contracts that an entity issues;
- all reinsurance contracts (that is, those that an entity issues and those that an entity holds); and
- investment contracts with discretionary participation features, provided that an entity also issues insurance contracts.
Insurance contracts
IFRS 17 defines insurance contracts as contracts under which one party (the issuer) accepts significant insurance risk from another party (the policyholder) by agreeing to compensate the policyholder if a specified uncertain future event (the insured event) adversely affects the policyholder.
A contract is an agreement between two or more parties that creates enforceable rights and obligations. The enforceability of rights or obligations is a matter of law. Contracts can be written, oral or implied by customary business practices. Contractual terms can be either explicit or implicit, including those terms that are imposed by law or regulation. In applying the standard, an entity should consider its substantive rights and obligations arising from a contract, law or regulation. However, contractual terms that confer no discernible effect on the economics of the contract should be disregarded, since they lack commercial substance.
Contracts that are insurance contracts
Examples of insurance contracts (if the transfer of insurance risk is significant) are as follows:
· Insurance against theft or damage to property.
· Insurance against product liability, professional liability, civil liability or legal expenses.
· Life insurance and pre-paid funeral plans.
· Life-contingent annuities and pensions.
· Disability and medical cover.
· Travel insurance.
· Surety bonds, or performance bonds (that is, contracts that compensate for failure to perform a contractual obligation).
· Title insurance.
· Catastrophe bonds that provide for reduced payment if a specified adverse event that creates significant insurance risk adversely affects the issuer.
· Insurance swaps that relate to climatic, geological or physical variables that are specific to a party to the contract.
The key requirement for an insurance contract is that there is a transfer of significant insurance risk arising from an uncertain future event that adversely affects the policyholder and results in the payment of significant additional benefits.
Specified uncertain future event
Uncertainty (or risk) is the essence of an insurance contract. At least one of the following is uncertain at the inception of an insurance contract:
- the probability of an insured event occurring;
- when it will occur; or
- how much the entity will need to pay if it occurs.
Significant insurance risk
The risk accepted from the policyholder must be insurance risk. Insurance risk is any risk other than financial risk transferred from the holder of the contract to the issuer.
Financial risk is “the risk of a possible future change in one or more of a specified interest rate, financial instrument price, commodity price, currency exchange rate, index of prices or rates, credit rating or credit index or other variable, provided in the case of a non-financial variable that the variable is not specific to a party to the contract”.
Equity release mortgage with a ‘no negative equity’ guarantee
Question
How should an entity account for an equity release or ‘reverse’ mortgage with a ‘no negative equity’ guarantee?
Background
An entity issues an equity release or ‘reverse’ mortgage with a ‘no negative equity’ guarantee. The contractual terms secure the mortgage against the borrower’s property. Interest is accrued. Principal and accrued interest are payable when the borrower dies or moves into long-term care. The property is then sold and the proceeds used to repay the mortgage balance (including any accrued interest). The entity is not entitled to any excess of the sales proceeds over the amount due, but it bears any shortfall where the sales proceeds are not sufficient to repay the principal and accrued interest. Assume that the entity holds the equity release mortgage within a ‘hold to collect’ business model, and that the contract contains no other features that could cause it to fail the ‘SPPI’ test in IFRS 9.
Answer
The contract exposes the entity to the risk of changes in fair value of the borrower’s property (a non-financial asset). That is not a financial risk, because the fair value of the property reflects not only changes in market prices for properties in general (a financial variable) but also the physical condition of the specific asset (a non-financial variable). The contract therefore transfers insurance risk, as well as financial risk, from the borrower to the entity. Under IFRS 17, a contract is treated as an insurance contract only if it transfers significant insurance risk, which arises if an insured event could cause an insurer to pay significant additional benefits in at least one scenario with commercial substance. If that is the case and the entity could pay significant additional benefits to the policyholder/mortgagee in at least one scenario with commercial substance, the instrument is an insurance contract within the scope of IFRS 17.
If the contract does not transfer significant insurance risk, it is within the scope of IFRS 9. Since the entity holds the equity release mortgage within a ‘hold to collect’ business model, the classification and measurement of the contract under IFRS 9 is determined based on the contractual cash flow characteristics of the financial asset (the ‘SPPI’ test) in accordance with IFRS 9. In performing the SPPI test, the entity needs to consider whether the possible effect of the ‘no negative equity’ guarantee is more than ‘de minimis’ and is genuine. In doing so, important considerations are that:
· The ‘significant additional benefits’ threshold in IFRS 17 is not the same as the ‘de minimis’ threshold in IFRS 9. ‘De minimis’ is a stricter threshold with regard to cash flow variability, and it is only met when the possible effects on cash flows are clearly trivial or negligible.
· In assessing whether the cash flows under the guarantee could arise only on the occurrence of an extremely rare, highly abnormal or very unlikely event, so are not genuine, it should be questioned why the clause was included in the contract if it has no apparent commercial purpose. The remainder of this FAQ assumes that the clause is genuine.
As a result, the equity release or ‘reverse’ mortgage will be measured in one of three ways, depending on the extent of the possible cash flow variability arising from the ‘no negative equity’ guarantee:
· as an insurance contract under IFRS 17, where significant additional benefits accrue to the borrower (in the form of forgiveness of a shortfall that would otherwise be due) in at least one scenario with commercial substance;
· as a financial instrument under IFRS 9 at fair value through profit or loss, where the additional benefits will not be significant in any scenario with commercial substance but could be more than ‘de minimis’ (that is, cash flows received are not SPPI, because losses are borne by the lender if proceeds on sale of the property are insufficient to repay outstanding principal and interest); or
· as a financial instrument under IFRS 9 at amortised cost, where the additional benefits could never be more than ‘de minimis’. Each individual contract should be analysed based on its specific facts and circumstances.
Contracts can contain both financial and insurance risk; such contracts are not excluded from being insurance contracts, provided that the insurance risk is significant.
Classification of a reinsurance contract which covers the movement in value of a death benefit as a result of the change in an index
Question
Does a reinsurance contract which covers the movement in value of a death benefit as a result of the change in an index transfer significant insurance risk, such that it is within the scope of IFRS 17?
Background
Insurer A sells life coverage products, where the insured value is indexed by inflation (measured as the change in CPI) for the duration of the product. The insured value can grow in excess of CPI, up to a maximum of 25% per annum, linked to the return of a chosen overseas index or basket of indices or exchange rates. The policies have no surrender values; amounts are paid under a policy on death or disability only. The policy issued meets the definition of an insurance contract in IFRS 17.
The original insurance contract value consists of the following components:
Contract value = original sum insured + CPI + (index movement if > 0 to a max of 25% pa).
Insurer A has entered into a reinsurance contract which hedges the index return portion of the policy in the event of death of the policyholder. The reinsurance contract is not for the full value, but only for the risk that the index option will be ‘in the money’. The reinsurance contract value is as follows:
Contract value = index movement if > 0 to a max of 25% pa. Both the insurance and the reinsurance contracts pay on death or disability only.
Is the reinsurance contract within the scope of IFRS 17?
Answer
Yes. The reinsurance contract transfers insurance risk, as defined in Appendix A to IFRS 17, and that insurance risk is significant. The reinsurance contract will only pay in the case of an insured event (death or disability of the policyholder). The payment is not based solely on changes in one or more financial risk, but rather on the combination of an insurance risk and financial risk. Paragraph B9 of IFRS 17 states that some contracts expose the issuer to financial risk in addition to significant insurance risk, and that such contracts are insurance contracts.
Under some contracts, an insured event triggers the payment of an amount linked to a price index. Such contracts are insurance contracts, provided that the payment contingent on the insured event could be significant. The payment, being dependent on the death or disability of the policyholder, transfers insurance risk. The resulting transfer of insurance risk is significant, because it is possible that index returns in excess of CPI will form a significant portion of the total contract value. Therefore, the reinsurance contract meets the definition of an insurance contract.
Insurance risk is ‘significant’ if, and only if, the occurrence of an insured event could cause the entity to pay additional amounts that are “significant in any scenario, excluding scenarios that lack commercial substance (i.e., no discernible effect on the economics of the transaction)”.
IFRS 17 does not set a numerical threshold for ‘significant’ insurance risk.
The definition of insurance risk refers to risk that the entity accepts from the policyholder. That is, insurance risk must be a pre-existing risk that is transferred from the policyholder to the entity as a result of the contract, and it must not be a new risk created by the contract.
Do terms in a contract that waive premiums in specified circumstances create insurance risk?
Question
Do such terms as ‘premium waiver’ in a contract, that allow a policyholder to avoid paying premiums, represent a pre-existing risk of the policyholder transferred to the entity (and hence insurance risk) or a new risk created by the contract (and hence not insurance risk)?
Background
Some contracts include terms that allow a policyholder to avoid paying premiums in specified circumstances (for example, if the policyholder has been disabled for six consecutive months). In this situation, the policyholder continues to receive the benefits originally promised under the contract. This contractual term can sometimes be known as a ‘premium waiver’.
Answer
At the September 2018 meeting of the IASB Transition Resource Group for IFRS 17 Insurance Contracts (‘TRG’), it was concluded that there is insurance risk if the event that gives rise to the premium waiver (for example, becoming disabled) adversely affects the policyholder and is a risk transferred to the issuer of the contract (that is, the risk that waives the premiums existed prior to the contract). Therefore, the risk that the issuer of the contract is obligated to continue to provide the same benefits (for example, other insurance coverage or investment services) to the policyholder, without receiving any consideration, is insurance risk.
The existence of a premium waiver in a contract that otherwise would be an investment contract could result in a contract being classified as an insurance contract in its entirety (unless the investment component separation criteria are met) if the premium waiver constitutes significant insurance risk.
The existence of a premium waiver in insurance contracts (for example, a term life insurance policy with a premium waiver on disability) is likely to provide different patterns of coverage, and it could also impact the coverage period to the extent that the coverage period for the waiver differs from that of the base insurance contract.
A scenario with commercial substance can be one that is extremely unlikely. An entity needs to consider whether the benefits are greater in a scenario with commercial substance in which the insured event occurs than in any other scenario. The entity will then have to determine whether the difference between the benefits under this scenario and the benefits if no insured event occurred is significant. If that is the case, the contract is an insurance contract.
This assessment should be made on a present value basis. The discount rate used to calculate the present value should reflect the time value of money, the characteristics of the cash flows and the liquidity characteristics of the insurance contract. The same rate is also used for measurement purposes if the contract meets the definition of an insurance contract.
Can an insurance contract exist if the probability of the insured event is low?
Yes. An entity has a contract which requires an insurer to reimburse it for the value of a property that it owns in the event of the property being destroyed by a hurricane. The likelihood of a hurricane destroying a building is low (although the scenario has commercial substance), but the payment by the insurer would be substantial. In all other scenarios, a similar payment would not be made. The contract is therefore an insurance contract, because the insurance risk is significant.
Classification of ‘whole of life unitised with-profit’ contracts
Question
Does a ‘whole of life unitised with-profit’ discretionary participating contract with a market value adjustment (MVA) meet the definition of an insurance contract?
Background
Insurer A issues a discretionary participating contract with no maturity date (‘whole of life’ policy) and with unitised discretionary benefits (‘unitised with-profit’). Insurer A determines the death benefits under the policy as a unit price based on the unitised value of a specified investment fund that it holds. The insurer applies its discretion to determine a minimum death unit price, to smooth the fluctuations in the fair value of the underlying assets. Insurer A cannot reduce the minimum death unit price determined in previous periods. In the event of the policyholder’s death, the benefits are based on this minimum death unit price, even if the fair value of the underlying assets is particularly low at that time.
If the holder elects to surrender the contract, insurer A can apply an MVA to pay a benefit equal to the fair value of the underlying assets. However, if the fair value of the underlying assets at the date of surrender or death is higher than the minimum death benefit, insurer A pays the higher amount. In this scenario, the benefits payable on death and on surrender are identical.
Answer
It depends. If the expected volatility of the assets held in the specified investment fund creates scenarios where the adjusted value of the death benefits, determined on a present value basis, could be significantly higher than the fair value of the underlying assets, the contract is an insurance contract, as defined in Appendix A to IFRS 17.
Contracts that offer, on death, the greater of unit value and return of premiums
Question
Are contracts that offer, on death, the greater of unit value and accumulated premiums classified as insurance contracts under IFRS 17?
Background
An insurer issued a contract that provides a death benefit, being the greater of unit account value or payment of accumulated premiums paid to date on the contract if the policyholder dies. The policyholder has the right to surrender the contract, and he will receive the unit value if he exercises that option.
This feature is presented in the graphic below:
Answer
Yes, provided that there is a scenario with commercial substance in which the present value of death benefits (based on the accumulated premiums) is significantly higher than the unit value benefits. The graphic above shows that, during market downturns, there is the possibility that the insurer has mortality risk, in the event that the cumulative premiums are in excess of the unit account value at the time of death. In this case, there is an additional benefit, which is the difference between the unit value and the accumulated premiums.
The insurer must determine at inception whether the insurance risk that the contract transfers is significant – that is, whether the underlying assets are sufficiently volatile to create a scenario with commercial substance in which the present value of death benefits (based on the accumulated premiums) is significantly higher than the unit value benefits.
Classification of a last survivor deferred annuity where the annuitants are the immediate family
Question
How should an insurer classify a deferred annuity contract where the beneficiaries entitled to receive the annuity payments are the policyholder and, on his death, any surviving members of his immediate family?
Background
Insurer X issues deferred annuity contracts. In accordance with local pension tax laws, a policyholder has to select one of the following three options at the inception of the contract:
Option 1: The annuity will be payable for as long as the policyholder survives.
Option 2: The annuity will be payable for as long as the policyholder and any other surviving members of his immediate family (that is, the policyholder, the policyholder’s spouse, and the policyholder’s children up to a certain age) survive. This option requires the insurer to pay the annuity also on death of the policyholder prior to the annuity vesting date if there are surviving members of his immediate family.
Option 3: The annuity will be payable for as long as the policyholder and any other surviving members of his immediate family (that is, the policyholder, the policyholder’s spouse, and the policyholder’s children up to a certain age) survive, up to a maximum fixed period of time selected by the policyholder at the inception of the contract, subject to a minimum period of five years.
Annuity rates are guaranteed at inception. However, for option 3, no mortality risk is considered by the insurer in determining the premium that the policyholder pays for the annuity.
Answer
Contracts with either option 1 or 2 qualify as insurance contracts. In both cases, the annuity is life-contingent (either on the life of the policyholder in option 1, or on the life of the policyholder or his surviving family members in option 2), and it has been issued at rates guaranteed at inception. Such contracts normally transfer significant insurance risk in accordance with IFRS 17.
Under option 3, insurer X should assess whether there are scenarios with commercial substance that would transfer significant insurance risk. The insured event is survival until the date when the annuity is payable. One scenario is that at least one of the family members remains alive throughout the term of the annuity. The annuity payments represent the benefits payable for the insured event occurring – that is, the beneficiaries survive throughout the annuity term (scenario A).
This should be compared with the benefits payable under another scenario: where all of the family members die before the end of the contract (scenario B). Under scenario A, the insurer has to make greater annuity payments than under scenario B, and the difference (determined, in both scenarios, on a present value basis) is likely to be significant.
Insurer X needs to assess whether or not both of these scenarios have commercial substance. This means that insurer X determines whether they have a discernible effect on the economics of the contract. Although mortality risk was not taken into account when pricing the contract under option 3, in the event of scenario B occurring, there will be a discernible effect on the profits of the insurer. For example, if the whole family were to die in the same incident, such as a motor car accident, before the end of the annuity term, there would be a discernible impact on the insurer’s profitability. Therefore, scenario B has commercial substance, and the contract in option 3 is an insurance contract.
‘Additional benefits’ exclude payments conditional on an event that does not cause a significant loss to the policyholder.
Is there a transfer of significant insurance risk if only insignificant payments arise when the insured event occurs?
No. For example, if a contract requires the issuer to pay CU1 million to the holder if an asset suffers physical damage causing an insignificant economic loss of CU1 to the holder, the holder transfers to the insurer only the insignificant loss of losing CU1. In addition, the requirement in the contract that the issuer also needs to pay CU999,999 if the physical damage occurs creates non-insurance risk. Because the issuer does not accept significant insurance risk from the holder, this contract is not an insurance contract.
The significance of the insurance risk is assessed on a contract-by-contract basis. Accordingly, the insurance risk can be significant, even if there is minimal probability of significant losses for a portfolio or a group of contracts.
Adversely affects the policyholder
A contract requiring payment to the policyholder if a specified uncertain event occurs is only insurance if the event creates insurance (as opposed to financial) risk and that event adversely affects the policyholder.
Are saving contracts, where the holder enters into periodic lotteries that award cash prizes, insurance contracts?
Question
Is a saving plan, with rights to receive cash awards based on lottery-type draws, an insurance contract under IFRS 17?
Background
An entity issues a contract whereby the customer pays monthly deposits of CU100 under a 60-month saving plan, with a guaranteed annual interest of approximately 6% (equivalent to market rates applicable to saving accounts or other inflation index). Interest is only accrued for those monthly deposits which are not withdrawn after the first 12 months of the plan. These plans are sometimes referred to as ‘capitalisation plans’. Customers are entered, during the term of the plan, into monthly lotteries that award a cash prize equivalent to 1,000 times the amount of the last deposit made (that is, cash prize equals CU100,000). Each customer receives a certificate with a numerical identification that might coincide with the winning numbers from the National Lottery. Every month, there will be one winner amongst all participants in the plan. The deposits are redeemable in full, plus interest, only after one year. If the customer redeems the monthly deposits before one year, it will be subject to a surrender penalty. Surrender penalties are applied during the whole term of the contract, and they vary from 90% at inception of the contract to 0% after the 60 months, in order to encourage customers to keep their funds with the entity for a longer period of time. At inception of the contract, all customers nominate a beneficiary that will receive the prize or the accumulated surrender value of the deposits in the event of the customer’s death.
Answer
No, this is not an insurance contract, as defined in Appendix A to IFRS 17. Although it is clear that there is a substantial benefit to be paid to a customer who wins the monthly lottery, the fact that the customer has the winning lottery numbers does not qualify as an insured event, because the event does not affect the customer adversely. This is a gambling contract.
Payments under insurance contracts can be predetermined, and they do not need to exactly compensate the policyholder for the financial impact of the adverse event.
Payments under insurance contracts can be more than the loss suffered. One such case is ‘new for old’ policies, where the entity pays for the replacement cost of a new asset, rather than capping the compensation to the value of the old and damaged asset.
Another party
Entities must accept risk from another party (a separate entity), in order for insurance risk to exist.
Captive insurance subsidiaries
Question
If a non-insurance group self-insures through a captive insurance subsidiary, is this arrangement within the scope of IFRS 17?
Answer
A non-insurance group can self-insure, using a captive insurance subsidiary to give insurance cover to all of the members of the group for risks to which those group members are exposed through their business activities. This allows the captive insurer to pool the risks of the members of the group. The pooled risk might mean that the captive can insure (or reinsure) the pooled risks more cheaply with an insurer (or reinsurer) external to the group. If the captive insurance subsidiary presents separate financial statements and assumes significant insurance risks under the contracts with the other members of the group, it treats those as insurance contracts under IFRS 17. The transactions between the captive and the other members of the group are eliminated on consolidation, as are all other intra-group transactions. If the captive holds a reinsurance contract with a third-party reinsurer, the group is the policyholder in that relationship, and so IFRS 17 does not apply to this contract in the group’s consolidated financial statements.
Changes in the level of insurance risk
Some contracts transfer insurance risk to the issuer only after a period of time. An entity therefore has to make an assessment as to whether there is a transfer of significant insurance risk from the policyholder resulting from cash flows that are within the boundary of the contract. A contract meets the definition of an insurance contract from the point at which there is a transfer of significant insurance risk arising from cash flows within the boundary of the contract.
Classification of contracts where the holder has not received any insurance guarantees other than the option to buy a life-contingent annuity at a future date
Question
When does a contract, where the holder has received no insurance guarantees other than the option to buy a life-contingent annuity at a future date, transfer insurance risk?
Background
An insurer regularly issues contracts which do not provide the holder with any insurance guarantee other than an option exercisable at a future date to convert the capital created by his premium payments (and associated interest) into a life-contingent annuity. The insurer operates in a number of different legal jurisdictions. In some jurisdictions, annuity rates are established at inception by law or regulation and are guaranteed at maturity. However, in other jurisdictions, the insurer issues contracts stipulating that the annuity rates will be those in force at the date when the option are exercised.
Answer
It depends. According to paragraph B24 of IFRS 17, if the contract specifies the annuity rates (or a basis other than market rates for setting the annuity rates), the contract transfers insurance risk to the issuer, because the issuer is exposed to the risk that the annuity rates will be unfavourable to the issuer when the policyholder exercises the option. In that case, the cash flows that would occur when the option is exercised are within the boundary of the contract. If the life-contingent payment is significant, in scenarios with commercial substance, the contract meets the definition of an insurance contract.
However, if the contract stipulates that the annuity rate will be that in force at the date when the option is exercised, there is no transfer of insurance risk, and the contract will not meet the definition of an insurance contract until the option to receive the annuity is exercised. According to paragraph B24 of IFRS 17, such a contract transfers insurance risk to the insurer only after the option is exercised, because the insurer remains free to price the annuity on a basis that reflects the insurance risk that will be transferred to the entity at that time. Consequently, the cash flows that would occur on the exercise of the option fall outside the boundary of the contract, and before exercise there are no insurance cash flows within the boundary of the contract.
Where a contract meets the definition of an insurance contract, it remains an insurance contract until all of the rights and obligations under the contract are extinguished, unless a contract is derecognised as a result of contract modification.
Reinsurance contracts
IFRS 17 defines a reinsurance contract as an insurance contract issued by one entity (the reinsurer) to compensate another entity for claims arising from one or more insurance contracts issued by that other entity (underlying contracts).
The requirements for the assessment of significant insurance risk in a reinsurance contract are the same as for an insurance contract. However, a reinsurance contract transfers significant insurance risk if it transfers substantially all of the insurance risk resulting from the reinsured portion of the underlying insurance contract, even if it does not expose the reinsurer to the possibility of a significant loss.
Investment contracts with discretionary participation features
IFRS 17 defines an investment contract with discretionary participation features as a financial instrument that provides a particular investor with the contractual right to receive, as a supplement to an amount not subject to the discretion of the issuer, additional amounts:
- that are expected to be a significant portion of the total contractual benefits;
- the amount or timing of which is contractually at the discretion of the issuer; and
- that are contractually based on either:
- the returns on a specified pool of contracts or a specified type of contract,
- realised and/or unrealised investment returns on a specified pool of assets held by the issuer, or
- the profit or loss of the entity or fund that issues the contract.
Investment contracts with discretionary participation features are only within the scope of IFRS 17 if the entity also issues insurance contracts. Otherwise, they are accounted for as compound instruments containing a financial liability component (within the scope of IFRS 9) and an equity component, if applicable.
Investment contracts with discretionary participation features in consolidated financial statements and individual financial statements of a subsidiary
Question
Can contracts be accounted for differently in consolidated and individual financial statements?
Background
Entity S is a subsidiary of entity P, and it has issued investment contracts with discretionary participation features but no insurance contracts. Entity P issues insurance contracts.
Answer
Yes. The investment contracts are accounted for as liabilities or as compound instruments within the scope of IFRS 9/IAS 32 in the separate financial statements of entity S; but they are accounted for as investment contracts with discretionary participation features within the scope of IFRS 17 in the consolidated financial statements of the group.
Scope exemptions
IFRS 17 does not apply to the following (even if the definition of an insurance contract is met), because other standards apply:
- Product warranties provided by a manufacturer, retailer or dealer in connection with the sale of its products (either a good or a service) to a customer are within the scope of IFRS 15 and IAS 37.
- Employers’ assets and liabilities from employee benefit plans are within the scope of IAS 19 and IFRS 2; and retirement benefit obligations reported by defined benefit retirement plans are within the scope of IAS 26.
- Contractual rights or obligations that are contingent on the future use of, or the right to use, a non-financial item are within the scope of IFRS 16, IFRS 15 and IAS 38.
- Residual value guarantees provided by a manufacturer, dealer or retailer are within the scope of IFRS 15.
- Residual value guarantees for lessees embedded in a lease are within the scope of IFRS 16.
- Financial guarantee contracts, unless the issuer has previously asserted explicitly that it regards such contracts as insurance contracts and has used the accounting guidance applicable to insurance contracts.
- Contingent consideration payable on a business combination is within the scope of IFRS 3. Insurance contracts in which the entity is the policyholder, unless those contracts are reinsurance contracts held.
Warranty contracts: eligibility for scope exception IFRS 17
A consumer electronics company provides its customers, at the time of the sale of its electronics products, with a 3- year free of charge warranty to cover repairs due to manufacturing defects. In addition, for a fixed price, the customer can purchase a further 2 year extended warranty repair cover, which is offered through a warranty subsidiary of the manufacturing company.
Question 1:
Are either of these two warranty products insurance products that are in scope of IFRS 17 at the consolidated group level?
Answer
No. From a group perspective, the electronic products, the 3-year warranty, and the 2-year extended warranty are provided by the same reporting entity. There will be insurance risk in the contract, as either the number of services to be performed or the nature of those services, or both, is uncertain. Both the warranty and the extended warranty contracts provide protection to the customer against an ‘uncertain future event’ and assuming that risk is significant, would meet the insurance contract definition. However, as both types of warranty are available at the time of the sale, they will meet the scope exclusion in IFRS 17 which notes that an entity does not apply IFRS 17 to “warranties provided by a manufacturer, dealer or retailer in connection with the sale of its goods or services to a customer” and references IFRS 15, ‘Revenue from contracts with customers’, for further guidance.
Question 2:
Would the answer change if the extended warranty contract is provided at a later date and the terms of the original sale did not provide for the future purchase of the warranty at a fixed price?
Answer
If the extended warranty is provided at a later stage and not in conjunction with the sale (that is, the terms of the original sale did not provide for the future purchase of the warranty at a fixed price), it will not meet the exemption in IFRS 17 as it is not ‘in connection with the sale’. However, if the product meets the paragraph 8 fixed fee service criteria (no risk assessment in the price determination, the provision of service rather than cash payments to the customer, and frequency risk rather than severity risk), it is eligible for voluntary exemption from IFRS 17.
Question 3:
Would the answer change at the level of the subsidiary providing the extended warranty services?
Answer
For the separate financial statements of the subsidiary that provides the extended warranty cover, the scope exclusion in paragraph 7(a) would not apply, as the repairs and maintenance are provided by a party other than the manufacturer, retailer or dealer. The paragraph 8 fixed fee service considerations would apply at the subsidiary level, as discussed above.
Financial guarantee contracts that require the issuer to make specified payments, to reimburse the holder for a loss that it incurs because a specified debtor fails to make a payment when due, meet the definition of an insurance contract. They are, however, outside the scope of IFRS 17, unless the issuer has previously asserted explicitly that it regards such contracts as insurance contracts and has used the accounting guidance applicable to insurance contracts. For such contracts, the issuer can choose to apply either IFRS 17 or the guidance in IAS 32, IFRS 7 and IFRS 9. The issuer can make the election on a contract-by-contract basis, but the election for each contract is irrevocable.
Can the scope of financial guarantees be reassessed on transition to IFRS 17?
Background
IFRS 17 states that financial guarantee contracts are outside the scope of the standard, unless the issuer has previously asserted explicitly that it regards such contracts as insurance contracts and has used accounting applicable to these insurance contracts. If so, entities are given the irrevocable choice, on a contract-by-contract basis, to apply either IFRS 17 or IAS 32, IFRS 7 and IFRS 9.
Question 1
Can an entity, on transition to IFRS 17, reassess the scope of which standard it chooses to apply for financial guarantee contracts previously accounted for under IFRS 4?
Answer
Yes. Although the scope exemptions in IFRS 17 and IFRS 4 are similar, on transition to IFRS 17 an entity applies the requirements in IFRS 17 for the first time and, consequently, it can make the policy election for the first time. Therefore, at the transition date to IFRS 17, an entity currently applying IFRS 4 to existing financial guarantee contracts can choose to apply IFRS 17, or it can instead choose to apply IFRS 9 to such contracts. Either approach would result in a change in accounting policy and would require application of IAS 8 for such changes (or use of the transitional reliefs in IFRS 17, if that is selected).
Question 2
Is an entity that currently accounts for financial guarantee contracts as financial instruments under IAS 39 or IFRS 9 allowed to account for them under IFRS 17 when IFRS 17 is adopted?
Answer
No. For existing financial guarantee contracts currently accounted for under IAS 39 or IFRS 9, the criterion “unless the issuer has previously asserted explicitly that it regards such contracts as insurance contracts and has used accounting applicable to insurance contracts” will not be met.
Some contracts might meet the definition of an insurance contract but have as their primary purpose the provision of services to a customer for a fixed fee. An entity can make an irrevocable choice to apply IFRS 15 instead of IFRS 17 to these contracts if all of the following conditions are met:
- the price of the contract does not reflect an assessment of the risk with an individual customer;
- the contract compensates the customer by providing a service; and
- the insurance risk arises primarily from the customer’s use of services rather than from uncertainty over the cost of the service.
The choice can be made on a contract-by-contract basis, but the choice made for each contract is irrevocable.
Examples of ‘fixed-fee service contracts’
Question
What are some examples of a fixed-fee maintenance contract referred to in IFRS 17?
Answer
Examples are maintenance contracts under which the service provider is obliged to repair specified equipment after a malfunction, or car breakdown services in which the provider is obliged to provide roadside assistance or tow the car to a nearby garage. Because the level of service and thereby the obligation of the service provider depends on an uncertain future event, these kinds of contract might meet the definition of an insurance contract.
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