Separation of Insurance Contracts – Before the entity accounts for an insurance contract based on the guidance in IFRS 17, it should analyse whether the contract contains components that should be separated. Insurance contracts create a bundle of rights and obligations that work together to generate a package of cash flows. Some types of insurance contracts only provide insurance coverage – e.g. most short-term non-life contracts.
However, many types of insurance contracts – e.g. unit-linked and other participating contracts – contain one or more components that would be in the scope of another standard if the entity accounted for them separately. Separation of Insurance Contracts
For example, some insurance contracts contain: Separation of Insurance Contracts
- investment components: e.g. pure deposits, such as financial instruments whereby an entity receives a specified sum and undertakes to repay that sum with interest;
- good and service components: e.g. non-insurance services, such as pension administration, risk management services, asset management or custody services; and
- embedded derivatives: e.g. financial derivatives, such as interest rate options or options linked to an equity index.
An entity applies IFRS 17 to all remaining components of the contract. Separation of other non-insurance components is prohibited.
Under IFRS 17 separation of any components (except the three components above) is prohibited unless it is explicitly required under the standard. This might have a significant effect on some entities. For example, a bank might issue loans that are waived if the borrower dies. Under IFRS 4, the bank could have voluntarily separated the contract into a loan accounted for at amortised cost, similar to other loans, and the insurance component accounted for under IFRS 4. Under the new standard, the loan element is unlikely to qualify as a distinct investment component, and so the entire contract will be required to be accounted for as an insurance contract.
Insurance contracts with riders
Insurers often issue contracts with riders. A rider is an add-on provision to a basic insurance policy that provides additional benefits to the policyholder at an additional cost. Riders can be either part of a contract at inception or added subsequently. Irrespective of when the riders are issued they can be priced at inception or subsequently in line with the prices at the date when the rider is issued. The accounting for riders depends on the terms of the contracts. Separation of Insurance Contracts
Riders that are separate policies or insurance contracts
If riders are issued and priced separately from the base insurance contracts, they should be viewed as separate insurance contracts for IFRS 17, unless required to be bundled together under the combination guidance. Separation of Insurance Contracts
Riders that are issued together with the main insurance contract and form part of a single insurance contract
If there is only one insurance contract with multiple provisions, and all of the riders are within the boundary of that contract, the contract will be viewed as one contract for IFRS 17.
Identifying separate components
Investment components and goods and services components have to be separated from an insurance contract if they are distinct. [IFRS 17 11–12]
An entity is prohibited from applying IFRS 15 or IFRS 9 to components of an insurance contract when separation is not required. For example, some entities currently separate policy loans from the insurance contract to which they relate. If separation is not required because a component is not distinct, then separation is prohibited under IFRS 17. [IFRS 17 BC114]
Distinct and non-distinct investment components
An ‘investment component’ represents the amounts that an insurance contract requires the entity to repay to a policyholder even if an insured event does not occur.
An investment component is separated from the host insurance contract and accounted for in accordance with IFRS 9 if it is ‘distinct’. [IFRS 17 11(b), IFRS 17 B31–B32] The investment component is distinct if: Separation of Insurance Contracts
- it and the insurance component are not ‘highly inter-related’; and Separation of Insurance Contracts
- a contract with equivalent terms is sold or could be sold separately in the same market or jurisdiction.
There is no need to undertake an exhaustive search to identify whether an investment component is sold separately; however, all information that is reasonably available should be considered.
Investment and insurance components are ‘highly inter-related’ if: Separation of Insurance Contracts
- a policyholder cannot benefit from one component without the other being present – e.g. the lapse or maturity of one component causes the lapse or maturity of the other; or
- the entity cannot measure one component without considering the other – e.g. when the value of one component varies according to the value of the other.
For example, in some unit-linked contracts the death benefit is the difference between a fixed amount and the value of a deposit component – therefore, the components could not be measured independently. Separation of Insurance Contracts
IFRS 17.85 Investment components that are not distinct from the insurance contract are not separated from the insurance contract, but are accounted for together with the insurance component. However, receipts and payments from these investment components are excluded from insurance contract revenue and insurance service expenses presented in profit or loss
Distinct goods and non-insurance services components
A promise to provide goods or non-insurance services is distinct, and is separated from the insurance contract, if the policyholder can benefit from the goods or services either:
- on their own; or Separation of Insurance Contracts
- with other resources that are readily available to the policyholder – i.e. resources that were already obtained or are sold separately by the entity or any other entity. [IFRS 17 12, IFRS 17 B33–B34] Separation of Insurance Contracts
Activities that the entity has to undertake to fulfil the contract are not considered for separation if the entity does not transfer a good or a service to the policyholder as those activities occur.
However, goods or services are not distinct, and are accounted for together with the insurance component, if: Separation of Insurance Contracts
- the cash flows and risks associated with the good or service are highly interrelated with the cash flows and risks of the insurance component; and
- the entity ‘provides a significant service of integrating the good or service with the insurance components’. Separation of Insurance Contracts
Example – Separating components from a life insurance contract with an account balance
[IFRS 17 IE42–IE50]
A life insurance contract with an account balance has the following terms.
Another financial institution sells an investment product comparable to the account balance, but without the insurance coverage.
Separating the account balance
The fact that a comparable investment product is sold by another financial institution indicates that the components may be distinct. However, the insurance and investment components are highly inter-related because the right to death benefits provided by the insurance cover either lapses or matures at the same time as the account balance.
As a result, the account balance is not considered distinct and is not separated from the insurance contract.
Separating the asset management component
The asset management activities are not distinct and are not separated from the insurance contract because they are part of the activities that the entity has to undertake to fulfil the contract, and the entity does not transfer a good or a service to the policyholder because it performs those activities.
See paragraphs IE51–IE55 of IFRS 17 for another example that illustrates these considerations.
Investment component excluded from insurance revenue and insurance service expenses
Non-distinct investment components are excluded from insurance revenue and insurance service expenses in the statement of profit or loss.
‘Investment components’ are the amounts that the entity is required to repay to the policyholders or their beneficiaries regardless of whether an insured event occurs. Amounts such as some explicit account balances, some no claims bonuses, cash surrender values of whole-life contracts and other cash flows under endowment or annuity contracts may need to be considered for this purpose.
An entity applies IFRS 9 to determine when an embedded derivative is separated from the host insurance contract and to account for the separated embedded derivative. [IFRS 17.11(a)] Separation of Insurance Contracts
An embedded derivative is separated from the host insurance contract under IFRS 9 when: Separation of Insurance Contracts
- the economic characteristics and risks of the embedded derivative are not closely related to those of the host contract; and
- the embedded derivative would not be an insurance contract as a stand-alone instrument – i.e. a separate financial instrument with the same terms as the embedded derivative would meet the definition of a derivative and would be in the scope of IFRS 9. [IFRS 9 4.3.3] Separation of Insurance Contracts
Determining whether an embedded derivative is closely related to the host contract requires consideration of the nature – i.e. the economic characteristics and risks – of the host contract and the nature of the underlying of the derivative. If the natures of both the underlying and the host contract are similar, then they are generally closely related. [IFRS 9 4.3.3, IFRS 9 B4.3.5–B4.3.8]
An embedded derivative in an insurance contract is closely related to the host contract if it and the host insurance contract are so interdependent that an entity cannot measure the embedded derivative separately. Separation of Insurance Contracts
Embedded derivatives can meet the definition of an insurance contract in certain circumstances. For example, when the related payment that is affected by the derivative is made when the insured event takes place – e.g. a life-contingent annuity in which the insurance risk is the policyholder’s survival – and the amount paid is linked to a cost of living index (the embedded derivative). [IFRS 17 B10] Separation of Insurance Contracts
In this case, the embedded derivative also transfers insurance risk, because the number of payments to which the index applies depends on the policyholder’s survival – i.e. an uncertain future event. If the insurance risk being transferred is significant, then the embedded derivative is also an insurance contract and is not separated from the host contract. Separation of Insurance Contracts
The following table includes examples based on the illustrative guidance included in IFRS 4, which has not been carried forward to IFRS 17. However, it may provide some insight into the application of the above requirements. [IFRS 4 IG3–IG4] Separation of Insurance Contracts
Type of embedded derivative
Embedded derivatives that are not separated because they are insurance contracts
Death benefit that is:
Option to take a life-contingent annuity at a guaranteed rate.
Minimum annuity payments, if the annuity payments are linked to investment returns and:
Embedded derivatives that are not separated because they are closely related to the insurance contract
Minimum interest rate to be used in determining surrender or maturity value that is at or out of the money, and not leveraged.
Option to cancel a deposit component that triggers cancellation of the insurance component and that cannot be measured separately.
Minimum annuity payments, if the annuity payments are linked to investment returns and the policyholder can elect to receive a life-contingent payment or a fixed amount of payments at predetermined terms.
Embedded derivatives that have to be separated and accounted for under IFRS 9
Minimum interest rate to be used in determining a surrender or maturity value that is in the money when it is issued or leveraged (the embedded guarantee is not life-contingent).
Equity-linked return that is available on surrender or maturity.
Persistency bonus paid at maturity in cash.