Recognition and measurement of Insurance contract liability under NFRS 4,
For investment insurance companies in Nepal
When we go by the definition
Insurance contract
means –
“A contract under
which one party (the insurer) 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.
Now, The
major judgement required in insurance contract arrangement is recognition and measurement
of insurance contract liabilities based on NFRS 4.
Here are two basic area to be covered for recognition and measurement of the insurance contract liabilities while going
forward for the adaptation of NFRS 4:
Liability Adequacy Test:
Para 15 of NFRS 4 says that:
“An insurer shall assess at the end of each reporting period whether its recognized
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 recognized in profit or loss.”
So, as said
in above para, insurance companies are required to assess the liabilities recognized
by making in-depth assessment of the assumptions and estimate of future cash
flows used by actuarial.
Para 16 of NFRS 4 says that:
If an insurer applies a liability
adequacy test that meets specified minimum requirements, this NFRS imposes no
further requirements. The minimum requirements are the following:
a. 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. B. If
the test shows that the liability is inadequate, the entire deficiency is recognized
in profit or loss.
Hence
after testing all of the above requirements, it should be closely considered
that, is there any error or changes in factors used for estimation of future
cash flows including cash flows resulting from embedded options and guarantees,
the entire resulting figure due to such inadequacy shall be immediate
recognized in statement of profit or loss.
Besides
it, the standard itself states that, NFRS 4 do not imposes any mandatory
provision and guidelines regarding test of adequacy of insurance contact
liabilities to reflect the fairness.
Unbundling of Deposit Component:
Another big
hurdle for the adaptation of NFRS 4 is the “Unbundling
of deposit component”. Let’s have brief view;
Para 10 of NFRS 4 States that:
Some insurance contracts contain
both an insurance component and a deposit
component. In some cases, an insurer is required or permitted to unbundle those components:
A.
unbundling is required if both the
following conditions are met:
I)
the insurer can measure the deposit
component (including any embedded surrender options) separately (I. e. without
considering the insurance component).
II)
the insurer's accounting policies
do not otherwise require it to recognize all obligations and rights arising
from the deposit component.
B. unbundling
is permitted, but not required, if the insurer can measure the deposit
component separately as in (a)(i) but its accounting policies require it to recognize
all obligations and rights arising from the deposit component, regardless of
the basis used to measure those rights and obligations.
C. unbundling
is prohibited if an insurer cannot measure the deposit component separately as
in (a)(i).
Hence, when an insurer assesses separate
components (Viz Insurance liability and
deposit liability component) in any insurance contracts, and unbundling is
done, its accounting policies require it to recognize all obligations and
rights arising from the deposit component, regardless of the basis used to
measure those rights and obligations.
It’s not
an easy task to unbundle the deposit component even though we have reliable
basis for its measurement, it shall be deliberately supported by the IT system and
data analytics.
Thereafter,
once unbundling is done, an insurer shall apply NFRS 9 for classification, recognition
and measurement of deposit component and NFRS 4 for insurance component separately.
The standard
also has given privilege on unbundling stating that “Unbundling is permitted, not
required” , Hence, it’s a judgment from the insurer’s side whether to
unbundle the deposit component fulfilling 2 conditions as stated in para 10 by assessing the reliability of assumptions, observable inputs and other estimations
to be used for the measurement.
Article by:
Rohit Dhital, rohit.dhital@gmail.com
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