Report of the Implementation Group on Ind AS in Insurance Sector in India
Introduction and Approach
1. The need for uniform reporting of financial statements of business entities is an off shoot of globalization. India, being an important player, in the evolving world economy, needs to respond to international trends. With several businesses operating across borders and reaching international capital markets, there is a need for establishing globally recognised standards and uniformity in reporting and analysis of information. The International Financial Reporting Standards (IFRS) envisage a reporting system which meets these requirements.
2. The steps to move towards IFRS issued by the International Accounting Standards Board (IASB) were initiated in India way back in 2006 with ICAI setting up a task force to examine convergence with IFRS, which was a significant step towards bringing Indian financial reporting at par with global financial reporting standards.
This was aimed at ensuring that the Indian markets become more attractive to global players. The initiative, however received a fillip after India’s commitment at G20 held at Pittsburgh, post 2008 crisis where the focus was placed on issues relating to accountancy, including the aspect of reducing the complexity of accounting standards for financial instruments; clarity and consistency in the application of standards; moving towards one set of high quality globally acceptable accounting standards.
3. However, considering the nuances of Indian business environment the Government of India decided to converge with IFRS instead of adoption. This decision was taken after a detailed analysis of IFRS requirements and extensive discussion with various stakeholders.
4. To keep up the commitment, the initial tentative steps to implement Indian Accounting Standards (Ind AS) were taken in 2011 when 35 Ind AS were notified under the Companies Act, 1956. In order to prepare the insurance industry to meet all the requirements of IFRS and to position various policy measures, the Insurance Regulatory and Development Authority of India (IRDAI/the Authority) constituted a Committee on IFRS compliance in Indian insurance sector in August 2008 under the Chairmanship of Dr. R. Kannan, the then Member (Actuary). The Committee submitted the report on IFRS Compliance in the Indian Insurance Industry covering various provisions of IFRS and their status in India; the international experience in implementing IFRS; and specific issues in the Indian context, which need to be addressed in the implementation of IFRS.
5. However, the Ministry of Corporate Affairs (MCA) took a decision not to implement the Ind AS at that time for various reasons including tax issues.
6. Two important accounting standards for insurance sector are Financial Instruments and Insurance Contracts. The complexity in the standard on insurance contracts is well known and is arising out of the current insurance Standard, IFRS 4, which is an interim standard. IFRS 4 Phase I permits continuation of diverse accounting practices and provided a temporary exemption from the general requirements of IFRS that accounting policies should be relevant and reliable leading to almost negligent comparability between insurance companies around the world.
IASB has been working to address various issues in the existing IFRS 4 for many years now aiming to enhance comparability of financial reporting between entities, jurisdictions and capital markets. Phase II of IFRS 4 which will replace the existing standard on completion will also provide stipulations for presentation and disclosure to enhance comparability between entities across jurisdictions.
7. After around twelve years of rigorous study and analysis, IASB finally issued the Exposure Draft on Insurance Contracts in the year 2010 and sought the views of the public and other stakeholders on the same. The Authority had constituted a “Workng Group on convergence to IFRS” under the Chairmanship of Shri RKNair, the then Member (F&I) in September 2010 which deliberated on the Exposure Draft of IASB on Insurance Contracts. The Authority, based upon the recommendation of the Working Group, had forwarded its comments to IASB. Based on the feedback received from various stakeholders, a revised Exposure Draft was issued by the IASB in the year 2013. More recently in the IASB’s meeting held on 16th November 2016, the effective date of the new insurance contracts Standard, numbered as IFRS 17 is indicated to be 1st January 2021
8. In July 2014, the IASB issued the completed version of IFRS 9 Financial Instruments setting out the requirements for recognising and measuring financial assets and financial liabilities and replacing IAS 39 Financial Instruments:
Recognition and Measurement. The said standard has an effective date of 1st January 2018.
9. Pursuant to the announcement of the Finance Minister in July 2014 to adopt the Ind AS from the financial year 2015-16 on voluntarily basis and from the financial year 2016-17 on mandatory basis, various steps were taken by MCA, various regulatory bodies and the accounting profession to facilitate the implementation of Ind AS. The MCA notified 39 Ind AS through the Companies (Indian Accounting Standards) Rules, 2015 vide Notification dated February 16, 2015. The road map for the implementation of Ind AS for companies was also notified which intended to bring companies meeting specified criteria into full compliance with Ind AS from April 1, 2017. Banks, Insurance companies and NBFCs were, however, exempt from the applicability of the said notification.
10. Further, the MCA vide notification dated March 30, 2016 has laid down the road map for implementation of Ind AS for Scheduled Commercial Banks, Insurance companies and NBFCs from 1st April, 2018 onwards with one year comparatives. Post the notification, the Government of India has advised the Authority to take steps to ensure that the insurance industry is Ind AS compliant effective the said date.
11. The IRDAI had taken the stand that insurance sector in India would be converged with IFRS after the revised standard on Insurance Contracts viz., IFRS 4 is pronounced by IASB. The same was also conveyed to MCA; considering the stand of the Authority, the MCA vide its notification dated 16th February 2015 had exempted the insurance sector from the applicability of Ind AS (equivalent of IFRS in India) till 31st March 2018. While the revised standard IFRS 4 is still under finalisation, in order to prepare the Indian insurance sector towards convergence with Ind AS, the Authority, constituted an Implementation Group under the Chairpersonship of Smt. V. R. Iyer, Member-F&I vide order reference IRDA/F&A/ORD/ACTS/201/1 1/2015 dated 17th November 2015 to examine the implications of implementing Ind AS, address the implementation issues and facilitate formulation of operational
guidelines to converge with Ind AS in the Indian Insurance sector
12. The terms of reference of the Implementation Group are as under:
i. Review the applicability of Ind AS notified by MCA in the insurance sector
ii. Study the impact of Ind AS on the insurance sector
iii. Identify issues involved in implementation of Ind AS
iv. Provide the roadmap in addressing the IT system requirements on an ongoing basis
v. Identify IRDAI Regulations/stipulations which need to be reviewed in the light of Ind AS implementation
vi. Identify legislative amendments, if any, which may be required to converge towards Ind AS
vii. Prepare formats for the financial statements of insurers under Ind AS
viii. Draft application guides/education material to facilitate smooth convergence
ix. Recommend measures for capacity building among various stakeholders for implementation
x. Suggest measures to deal with any other tasks related to implementation of Ind AS
13. During the first meeting of the Implementation Group held on 9th December 2015, Shri P.R. Ramesh, was designated as Group Head for the Implementation Group by Smt. V.R. Iyer, Member (F&I). Various Sub-Groups were constituted to examine the Ind AS in detail. The group / subgroups comprise of Chartered Accountants, Actuaries, Industry Experts, Representatives of ICAI, IAI and officials of IRDAI.
14. The Implementation Group adopted a consultative approach. Outreach meetings were held with insurers to understand the various issues as regards implementation and concerns with regard to Ind AS, especially in the context of current accounting practices. The Implementation Group also reviewed the extant stipulations and guidelines as well as Ind AS notified by the MCA to identify potential issues with regard to Ind AS implementation. While legislation, regulations, circulars and guidelines which have a bearing on the preparation of financial statements have been reviewed and are suitably considered in the report, it is recommended that any other provisions in the context of preparation and presentation of financial statements shall be consistent with the recommendations in this report. Further, from the date of implementation of Ind AS, circulars/master circulars issued by IRDAI on preparation of financial statements and on aspects which will now be governed by Ind AS for eg., circulars on accounting/valuation of interest rate swaps will have to be suitably modified/repealed.
15. The report takes into consideration suitably, various aspects discussed with stakeholders. The recommendations made in this report are generic in nature and are applicable to the insurance industry as whole. As the insurance sector in India has passed through the cycle of free unregulated market, nationalized scenario and opening up of the sector, there could be entities in existence which have passed through these phases and have issues unique to them arising out of legacy practices/products or governing legislation. For such specific aspects, it is recommended that the IRDAI may consider, in the interest of policyholders, to provide regulatory relief, if need be.
16. This Report does not deal with the impact on taxation arising due to transition to Ind AS. However, the Group recognises that taxation of insurance companies is as per specific provisions of the Income Tax Act, 1961 that do not apply to non-insurance entities. It is recommended that merely by transition to a new accounting framework the taxation of insurance companies should not change. The Authority, may take up the matter with the concerned authorities
17. Key recommendations of the Implementation Group are summarized in the Executive Summary.
18. The Implementation Group also formulated Ind AS compliant Formats for Preparation of Financial Statements of insurers and also summarizes the Regulatory stipulations which need to be reviewed in light of the issues considered in the report.
19. It may be noted that various recommendations made in this report are based on the collective views of the members of the Implementation Group and the Sub‑Groups which were tasked with the examination of the specific Ind AS at the time of finalization of report. These views are not intended to be authoritative interpretations of accounting standards.
20. As the changes to the IT systems of the insurers are part of the process of implementation of Ind AS and are to be worked upon after the approach of implementation is laid down and the formats for the presentation of financial statements are ready, the report is being released excluding the roadmap for addressing the IT system requirements on an ongoing basis. This reference point of the Implementation Group is being attended to by the Group that has been formed to address the issues in studying the Technology Impact on Implementation of Ind AS in Insurance Sector.
21. As the insurance sector in India is heading towards its first step on implementation of Ind AS, there is a need for organizing outreach programmes with the Industry for a smooth transition. Also, the Authority may engage with ICAI to publish an application guide/education material for the benefit of industry enabling them to have detailed guidance on preparation of Ind AS compliant financial statements.
Acknowledgements
22. The Implementation Group wishes to place on record its gratitude to Shri T. S. Vijayan, Chairman, IRDAI for his encouragement and support, Smt. V. R. Iyer, Member (F&I) for her continuous support and guidance and Smt. Pournima Gupte, Member (Actuary), IRDAI for her valuable inputs.
23. The Implementation Group acknowledges the efforts and contributions of each and every member of the Implementation Group and members and invitees of various Sub-Groups.
24. The Implementation Group benefitted from the efforts and the results of test run on the draft of formats for preparation of financial statements carried out by certain insurance companies including Star Union Dai-chi Life Insurance Co. Ltd., Bajaj Allianz Life Insurance Co. Ltd., ICICI Prudential Life Insurance Co. Ltd., HDFC Standard Life Insurance Co. Ltd., LIC of India; Reliance Nippon Life Insurance Co. Ltd., ICICI Lombard General Insurance Co. Ltd., Bajaj Allianz General Insurance Co. Ltd., New India Assurance Co. Ltd., and General Insurance Corporation of India.
25. The Implementation Group places on record the efforts and support extended by nominees of ICAI and IAI in finalizing this report. In addition, the presentation made by Munich Re also enabled the Group to appreciate the concerns relating to the Reinsurance companies.
26. The Implementation Group is grateful to Shri V. Manickam, Secretary, Life Insurance Council and Shri R. Chandrasekaran, Secretary, General Insurance Council, for organizing and facilitating the outreach meetings with insurers, which brought out various concerns/ issues on implementation.
27. The Implementation Group places on record its appreciation for the support received from all the officials of Finance, Investments and Actuarial departments of IRDAI in finalizing the Report.
Executive Summary of the Recommendations
1. Ind AS 40: Investment Property: – The existing stipulations should be continued, i.e., life companies to revalue investment property at a minimum every three years and general insurance companies not to revalue investment property.
2. In order to continue with the existing stipulations on revaluation of investment property in case of life insurance companies, unless Ind AS 40 is amended providing for fair value option, it may be appropriate that the IRDAI may give a regulatory override requiring life insurance companies to continue the existing practice of revaluing the investment property.
3. Ind AS 7: Cash Flow Statements: – With a view to comply with the existing legal requirements, continuation of the existing prescription under IRDAI Regulations to prepare cash flow statement (Receipts and Payments Account) as per the direct method under Ind AS 7, Statement of Cash Flows, is recommended even though the option of preparing cash flow statement as per indirect method is available under Ind AS 7. However, IRDAI may consider allowing the option of the indirect method to reinsurance companies.
4. Products where the death benefit cannot be less than 105% of the premiums paid are recommended to be considered to have the significant risk cover.
5. The present Regulations in effect require that all obligations and rights of an insurance contract are recognized on the balance sheet. These obligations and rights are recognized in separate line items either as liabilities, insurance reserves etc. Hence, all the linked products (unit linked products and variable insurance products) and all the non-linked products (including variable insurance products classified as non-linked products) are recommended not to be unbundled.
6. The insurer while submitting a new product or modification to the existing product, in its File & Use document or use and file system, should specify whether for the purpose of accounting it falls under the definition of insurance contract or other financial instrument along with the specific criteria which determines it as an insurance contract or other financial instrument.
7. In order to comply with the disclosure requirements an insurance company will need to determine the data available with it and then it will need to collate it suitably. In case the information required to be disclosed is not available then it is suggested that insurance companies embark on the task of collating the same and then vetting it for completeness, accuracy and appropriateness.
8. Cost may be mandated as the basis for the accounting for investments in subsidiaries, associates and joint ventures in the separate financial statements.
9. Trade date accounting may be prescribed as the uniform basis of initial recognition of securities by all insurers.
10. IRDAI may provide specific guidance to insurers on the following key matters relating to the treatment for solvency, allocation / attribution to policyholders and dividend capacity
a. Treatment of OCI balances for FVTOCI debt unrealized gains or losses
b. Treatment of OCI balances for FVTOCI equity for both realized and unrealized gains and losses
c. Treatment of unrealized gains and losses of FVTPL instruments
d. Adjustments arising from First Time Adoption of Ind AS
The IRDAI may also consider the impact of actuarial practices on the valuation of liabilities while determining the treatment of the unrealized gains and losses balances stated above.
11. The IRDAI may consider permitting insurance companies to hedge their FVTOCI investments (debt and equity) to mitigate accounting and economic volatility.
12. FIMMDA or a similar body may be entrusted with the responsibility to formulate a valuation approach for illiquid, hard to price and unquoted securities.
13. With a view to comply with the requirements of the Insurance Act 1938 as well as the requirements of Ind AS 1, the following should be the complete set of financial statements for the purpose of the Ind AS-compliant IRDAI Regulations for the reasons stated hereinafter:
a. Balance Sheet (including Statement of Changes in Equity), in accordance with Ind AS 1: Presentation of Financial Statements.
b. Statement of Profit and Loss for the period, in accordance with Ind AS
1: Presentation of Financial Statements.
c. Revenue Account (Policyholders’Account) and Profit and Loss Account (Shareholders’Account), as required by the Insurance Act, 1938.
d. Receipts and Payments Account [Cash Flow Statement as per the direct method in accordance with Ind AS 7: Statement of Cash Flows].
e. Notes including:
♦ Summary of significant accounting policies
♦ Other explanatory notes annexed to, or forming part of, any document referred to in Sub-clause (a) to Sub-clause (d) above
f. Comparative information in respect of the preceding period.
14. Since the Statement of Changes in Equity is an extension of the balance sheet and gives detailed information with regard to the share capital, reserves etc., it is recommended to be included as a part of the balance sheet even though under Ind AS 1, it is prescribed as a separate financial statement.
15. Since the Revenue Account (Policyholders’Account) and the Profit and Loss Account (Shareholders’Account) are required to be prepared under the Insurance Act 1938, while the statement of profit and loss as per Ind AS 1 should be prepared to reflect the financial performance for the period for both policyholders and shareholders, the Revenue Account (Policyholders’Account) and the Profit and Loss Account (Shareholders’Account) should be prepared along with the Statement of Profit and Loss. The Revenue Account and the Profit and Loss Account should be presented in a columnar form with the totals of individual items of the two reconciling with those in the Statement of Profit and Loss. The allocation or the apportionment of income and expense items, in the Revenue Account and Profit and Loss Account should be done as per the existing practice.
16. Instead of identifying, as a separate financial statement as required under Ind AS 1, a balance sheet as at the beginning of the preceding period when an entity applies an accounting policy retrospectively or makes a retrospective restatement of items in its financial statements or when it re-classifies items in its financial statements as specified in Ind AS 1, it would be sufficient that a requirement in this regard is included as a note to the balance sheet.
17. Section 11 of the Insurance Act 1938 should be amended to change the requirements related to financial statements in accordance with Ind AS.
18. Separate formats for entities carrying on life insurance business and those carrying on general insurance business are recommended. General insurance business includes reinsurance and health insurance businesses.
19. Manner of presentation of various items of assets, liabilities and equity in the balance sheet:
(a) The presentation order in the balance sheet of assets, liabilities and equity should be based on the concept that equity represents residual interest in the assets of the entity after deducting liabilities.
(b) Paragraph 60 of Ind AS 1 requires that entities present current and noncurrent assets, and current and non-current liabilities, as separate classifications in the Balance Sheet except where a presentation based on liquidity provides information that is reliable and more relevant. In the case of the insurance industry, given its nature of business, the liquidity-based presentation would provide more reliable and relevant information. Accordingly, the recommended balance sheet format follows liquidity based presentation.
20. In order to promote comparability, it has been recommended that components of OCI be disclosed before tax related effects with a separate line item giving the aggregate amount of income tax relating to those components.
21. Considering the nature of the insurance business, and the requirements contained in Ind AS 1 that the expenses shall be reflected nature-wise, format of statement of profit and loss have been prepared in a manner to
a. clearly identify gross premium and gross claims incurred; with reinsurance cessions on premium reinsurance recoveries and reinsurance payments shown separately
b. investment income and net gain/loss on fair value changes and gain/loss on de-recognition of financial assets at amortised cost;
c. to segregate benefits/ incurred claims and change in insurance contract liabilities;
d. acquisition costs as an item of expense; and
e. exceptional items and gain or loss on discontinued operations to be presented separately.
22. In order to comply with the requirements of Ind AS 108, Operating Segments, in addition to segments specified in the Regulations, the insurer should also provide operating segment information as per the aforesaid Ind AS, wherever applicable.
23. At present, Part I of Schedule ‘A’ and Schedule ‘B’ of IRDAI Regulations contain ‘Accounting Princples for Prepaation of Financial Statements . It is recommended to continue with this part. Keeping in view the fact that Ind AS 104, Insurance Contracts, largely allows independence in adopting accounting policies with regard to liabilities, income and expenses related to insurance contracts, the same have been continued, although certain modifications have been made in respect of those areas where Ind AS specifically provide for accounting treatments.
24. A summary of financial statements for the last five years in the manner as may be prescribed by the authority should be provided as at present. In the initial years, Ind AS financial statements would be available for less than five years, e.g., for the year 2018-19, with comparatives for the year 2017-18, information would be available for two years. The Authority needs to decide the regulations for prescribing the presentation of summary of the remaining three years.
25. Information presently required to be disclosed in the Management Report may be presented along with the Board of Directors’Report in a manner similar to that of Corporate Governance Report by companies other than those carrying on insurance business. As in the case of Corporate Governance Report for companies other than insurance companies, the same may be separately audited and, accordingly, the auditor may give a separate report.
26. As per the existing Regulations, fund-wise Revenue Account, Balance Sheet and additional disclosures are to be annexed to the annual financial statements. The nature of disclosures required therein are primarily relevant to the policyholders. Accordingly, such information may be presented by insurers on their respective websites instead of annexing these to financial statements. The formats of the Revenue Account and the Balance Sheet should be the same as per the draft Regulations to the extent applicable and subject to audit.
27. At present, Schedule ‘C’of the IRDAI Regulations contains the requirements with regard to the Auditors’Report. The ICAI may be requested to provide the format for the same in view of the fact that of late various Standards on Auditing have also been revised.
28. The draft regulations recommended by the Sub-Group are as follows:
(i) Draft notification containing short title of commencement, definitions and preparation of financial statements as per Schedule ‘A’and Schedule ‘B’.
(ii) Schedule A (for Life Insurance business); and Schedule B (for General Insurance business) comprising of
Part I: Accounting Principles for Preparation of Financial Statements.
Part II: General Instructions for Preparation of Financial Statements.
Part III: Balance Sheet including Statement of Changes in Equity.
Part IV: Statement of Profit and Loss, Revenue (Policyholders) and Profit and Loss (Shareholders) Accounts.
Part V: Other Disclosures
Chapter I: Indian Accounting Standards (Ind AS)
1.1 Introduction to Ind AS
The accounting standards as specified in the Annexure I to this report called the Indian Accounting Standards (Ind AS) are the accounting standards applicable to classes of companies specified under the Companies (Indian Accounting Standards) Rules, 2015. With the notification of these IFRS converged accounting standards, India can now claim to have financial reporting standards that are contemporary and at par with the global standards.
1.2 While all of those standards are applicable to the insurance sector, the following Ind AS are not applicable:
a) Ind AS 106: Exploration for and Evaluation of Mineral Resources
b) Ind AS 114: Regulatory deferral accounts
c) Ind AS 11: Construction Contracts
d) Ind AS 41: Agriculture
1.3 Ind AS 18: Revenue does not deal with revenue arising from insurance contracts within the scope of Ind AS 104: Insurance Contracts; but it would be applicable for other forms of revenue of insurers as specified in the standard.
1.4 The following Ind AS are not applicable in the current regulatory framework in India:
a) Ind AS 2: Inventories
In some countries insurance companies purchase spare parts etc., when they provide replacement option in their indemnity contracts. As such a practice is not prevalent in India, in the current scenario, this standard will not be applicable.
b) Ind AS 29: Financial Reporting in Hyperinflationary Economies. In the current environment in India, this standard is not applicable. It may however be noted that for entities that operate businesses in countries that have a hyperinflationary economy, the standard will need to be applied to those business units.
1.5 The following standards shall be applicable in modified form to the insurance sector:
a) Ind AS 7: Statement of Cash Flows
1. While the standard provides option for the entities to provide cash flow statements under both direct as well as indirect method, the present IRDA (Preparation of Financial Statements and Auditor’s Report of Insurance Companies) Regulations, 2002 (the Regulations), mandate that only direct method be followed for insurance companies. There is nothing specific in the insurance business that renders either method invalid or less relevant while it is international practice that indirect method is permitted. Specifically, big reinsurance companies used the indirect method.
2. With a view to comply with the existing legal requirements, continuation of the existing prescription under IRDAI Regulations to prepare cash flow statement (Receipts and Payments Account) as per the direct method under Ind AS 7, Statement of Cash Flows, is recommended. However, IRDAI may consider allowing the option of the indirect method to reinsurance companies.
b) Ind AS 40: Investment Property
1. For life companies, it is mandatory to revalue the investment property at least once in three years and the difference between the fair value and carrying amount is treated as revaluation reserve under Equity. However, no such revaluation is allowed for non-life companies.
2. Such treatment of revaluation for life companies is not permitted under Ind AS 40 which requires entities to follow cost model with disclosures of fair value.
3. Given that the benefit to policyholders, especially for the participating business, depends on the value of the investment assets, accounting property at historical cost would render property as an asset class meaningless in the
policyholder funds. While this would be a deviation from the Ind AS 40, the Group believes that such deviation is warranted given the underlying business model.
4. Based on the above, it is recommended that life companies continue the current practice of valuing investment property at Fair Value. The change in the carrying amount of the investment property shall be recognised in Fair Value Changes on Investment Property on account of policyholders as a liability and those on account of shareholders in the Statement of Changes in Equity forming part of Balance Sheet.
For ‘Other than’Life companies’(viz., general, health and reinsurance):
5. The treatment of Investment property relating to ‘other than life’insurance companies was also reviewed. Currently, as per the Regulations, revaluation is not allowed and investment property should be valued at cost subject to impairment provisions and fair value disclosure requirement.
6. The aspect that the ‘other than life insurance contracts are mostly short term in nature and hence the investment pattern should match the liability profile that pertains to the policyholders and the perceptible differences between the life industry and the ‘other than life’industry in Asset Liability Management were also considered.
7. It was highlighted that moving from the current cost based model to a fair value model could result in significant tax liabilities without the cash flow to bear it.
8. It was brought out that there are certain elements of ‘other than life’liability which are long tailed and that property as an asset class would form an important part of the investment portfolio of such liabilities. It was highlighted that allowing for investment return from property at fair value even if netted down for tax could be adding value in pricing of such contracts.
9. In the aforesaid background, the issue that came up was whether ‘other than life’companies should also be allowed to revalue or to continue on cost based measurement.
10. With due consideration of the above points, it is recommended that cost based measurement should continue for ‘other than life’companies.
Chapter II: Ind AS 101: First-time Adoption of Indian Accounting Standards
2.1 From the perspective of Ind AS 101: First-time Adoption of Indian Accounting Standards, in case Ind AS 40: Investment Property, continues to allow only cost model, the life insurance companies which are mandated to revalue investment property every three years under the existing IRDA (Preparation of Financial Statements and Auditors’Report of Insurance Companies) Regulations, 2002, would have the following two options available to them to adopt cost model for investment property under Ind AS:
a) The carrying amount of investment property under the previous GAAP can be considered to be the deemed cost under paragraph D7AA of Ind AS 101; or
b) Cost of investment property on the date of transition can be arrived by retrospectively following the cost model.
2.2 A view was expressed that it would be imperative for life insurance companies to continue the existing practice of revaluing their investment property at fair value and recognizing the gains/losses in equity in view of the fact that such companies pay bonus to the policyholders on the basis of fair value changes in such property. It was felt that while the disclosure of fair values as required in Ind AS 40 may be used for solvency purposes, the disclosures cannot be used for the purpose of declaration of bonus to the policyholders since the changes in the fair values in investment property should be recognized in the financial statements for this purpose. In order to continue with the existing stipulations on revaluation of investment property in case of life insurance companies, unless Ind AS 40 is amended providing for fair value option, it may be appropriate that the IRDAI may give a regulatory override requiring life insurance companies to continue the existing practice of revaluing the investment property.
2.3 It was also discussed that in case the discount rate to measure insurance contracts liability is required to be changed on adoption of Ind AS, transitional provision for the difference arising in the measurement of insurance contract liabilities on the date of transition may be required. It was noted that IRDAI has set up a Committee on Risk Based Capital Approach and Market Consistent Valuation of Liabilities in June 2016 to examine this aspect which is still to give its recommendations. Accordingly, whether to provide for transitional provisions in this regard was not decided at this stage.
Chapter III: Ind AS 104: Insurance Contracts
3.1 The current accounting standards and practices in India have not laid down any specific standards on the manner of recognition, presentation and disclosure with respect to accounting of insurance contracts. This gap is now being bridged through Ind AS 104, as part of IFRS convergence process. Ind AS 104: Insurance Contracts is an accounting standard that lays down the principles of accounting to be followed with respect to an insurance contract. The principles of accounting to be followed by an insurer vary based on whether the contract meets the specific requirements defined for an insurance contract or for a financial instrument. The insurance companies will have to follow the accounting principles relevant to either the insurance contracts, if the contracts offered by them fall within the definition of insurance contracts or financial contracts, if the contracts offered by them fall within the definition of financial contracts.
3.2 It is worth to briefly touch upon the long history of development of this standard. The project for having an accounting standard began in the IASB in 1997. In March 2004, IFRS 4 Insurance Contracts Phase I was issued. During the research and development phase of IFRS 4 Phase I, IASB realised that a wholesome standard is required for accounting of insurance contracts. Accordingly, IFRS 4 Phase I was released as an interim standard that permitted continuation of diverse accounting practices and provided a temporary exemption from the general requirements of IFRS that accounting policies should be relevant and reliable. IFRS 4 Phase I mainly covers identification of components of an insurance contract; does not prescribe any particular method of recognising revenue; does not contain measurement criteria for claims and acquisition costs and is closely linked with IAS 39 Financial Instruments – Recognition & Measurement. IFRS 4 Phase I has prescribed disclosures that identify and explain amounts used in an insurer’s financial statements and enables users to understand the amount, timing and uncertainty of the future cash flows from insurance contracts. It is applicable to insurance contracts issued (including re- insurance contracts issued and held) and financial instruments issued with a discretionary participating feature. The IASB is still continuing research and development on IFRS 4 Phase II. Recently, the IASB has announced amendments to IFRS 4: Applying IFRS 9 Financial Instruments with IFRS 4 Insurance Contracts. This standard which permits an insurer to have an overlay approach or a temporary exemption approach known as the deferral approach is not considered necessary as it is proposed to apply Ind AS 109 (equivalent to IFRS 9). As far as India is concerned, Ind AS 104 corresponds to IFRS Phase I standard.
3.3 Ind AS 104 which is consistent with IFRS 4 Phase I is focused upon in this Chapter. However, it is being placed on record that Ind AS 104, in the current structure, may have a limited implementation period, as implementation of Ind AS for insurance companies is expected to start from April 2018 and also the expected commencement of IFRS 4 Phase II is after January 2020. This leaves a time period of two years to switch over to Phase II, if India intends to adopt or converge with the Phase II standard in 2020 itself. Hence, any decision being taken on the principles of accounting applicable to insurers based on the current provisions of Ind AS 104 need to be weighed considering the impending IFRS 4 Phase II also. This recommendation is given taking into consideration the limited period of time Ind AS 104 will apply. The Phase II standard is to be numbered as IFRS 17.
Product Mapping – Insurance Risk, Unbundling, Derivatives, etc.
3.4 Definition of Insurer: In accordance with the provisions of the Ind AS 104, insurer is defined as the party that has an obligation under an insurance contract to compensate a policyholder if an insured event occurs. The definition of insurer varies from the provisions of Insurance Act, 1938. The definition of an insurer as per section 2(9) read along with 2(7A) of the Insurance Act, 1938 is as under: –
Section 2(9) “insurer” means—
(a) an Indian Insurance Company,
(b) a statutory body established by an Act of Parliament to carry on insurance business, or
(c) an insurance co-operative society, or
(d) a foreign company engaged in re-insurance business through a branch established in India.
Explanation—For the purposes of this sub-clause, the expression “foreign company” shall mean a company or body established or incorporated under a law of any country outside India and includes Lloyd’s established under the Lloyd’s Act, 1871 (United Kingdom) or any of its Members;
Section 2 (7A): “Indian insurance company” means any insurer, being a company which is limited by shares, and —
(a) which is formed and registered under the Companies Act, 2013 as a public company or is converted into such a company within one year of the commencement of the Insurance Laws (Amendment) Act, 2015;
(b) in which the aggregate holdings of equity shares by foreign investors, including portfolio investors, do not exceed forty-nine per cent. of the paid up equity capital of such Indian insurance company, which is Indian owned and controlled, in such manner as may be prescribed.
Explanation —For the purposes of this sub-clause, the expression “control” shall include the right to appoint a majority of the directors or to control the management or policy decisions including by virtue of their shareholding or management rights or shareholders’agreements or voting agreements;
(c) whose sole purpose is to carry on life insurance business or general insurance business or re-insurance business or health insurance business;
3.5 Significant Insurance Risk
3.5.1 Ind AS 104 defines a variety of terms including insurance contracts, financial risk, insurance risk, insured event, insurance liability, financial guarantee contract, financial instruments, guaranteed benefits amongst others. As per para B10, some contracts expose the issuer to financial risk, in addition to significant insurance risk. For example, many life insurance contracts offer both a guaranteed minimum rate of return to policyholders (creating financial risk) and promise of death benefits that sometimes significantly exceed the policyholder’s account balance (creating insurance risk in the form of mortality risk). Such contracts are insurance contracts. The sole criterion that needs to be applied in determining whether a contract is an insurance contract is the existence of significant insurance risk. Insurance risk is risk other than financial risk, transferred from the holder of the contract to the issuer. Financial risk is defined as the risk of a possible future change in one or more of specified interest rate, financial instrument price, commodity price, forex rate, index of prices, credit rating or credit index or other variables. An Insurance Contract is
defined to mean a contract under which one party (insurer) accepts significant insurance risk from another party (policy holder) by agreeing to compensate the policy holder if a specified uncertain future event (insured event) adversely affects the policy holder.
3.5.2 “Significant” as per Ind AS 104 means that an insured event causes an insurer to pay significant additional benefits in any scenario, excluding scenarios that lack commercial substance. Additional benefits are amounts that exceed those that would be payable if no insured event occurred and include claim handling and assessment costs, but exclude amounts such as potential loss of future management fees to the insurer on the death of the insured in case of a linked product, waiver of charges on death of the policyholder etc. From this definition, the principles of accounting laid down in Ind AS 104 apply to contracts which provide for significant additional benefits payable on any insured event, when compared to the amounts that may be paid if no insured event occurs. For example, surrender or cancellation of the policy can be considered as an uninsured event. Hence, Ind AS 104 will become applicable to all insurance contracts offered by insurers provided the benefits payable on any insured event individually or collectively for all insured events within a policy exceed the amount payable on surrender / cancellation significantly (as uninsured events in an insurance policy is the surrender/cancellation of the policy). For general insurance policies, the claim amounts can be spread across various claims of small size throughout the policy period.
3.5.3 In accordance with the provisions of B19 (g), it is mentioned that a contract is not considered as an insurance contract if it requires a payment based on a climatic, geological or any other physical variable that is not specific to a party to the contract (commonly described as weather derivatives). However, in the insurance contracts offered by general insurers, climatic, geological or other physical variables are the mechanisms used to determine a loss to the crop and these are not preconditions for payments. There could be cases where there are substantial changes in the
climate, but there may not be any loss and hence there would be no payment. The event covered in a contract is loss to the crop and not changes in the weather. The mechanism to determine the loss could be based on various methods as prevalent at that time. In accordance with para B14, the definition of an insurance contract refers to an uncertain event for which an adverse effect on the policy holder is a contractual precondition for payment. This contractual precondition does not require the insurer to investigate whether the event actually caused an adverse effect, but permits the insurer to deny payment if it is not satisfied that the event caused an adverse effect. Hence, an insurer will need to examine / analyse whether such contracts issued require payment of benefit only if there is an adverse impact to the policyholder and if so, recognise it as an insurance contract. If not the contract will be a financial instrument and recognised under Ind AS 109.
3.5.4 Insurance products with the above features offered by the general insurance companies, health insurance companies and reinsurance companies will have to comply with the principles of accounting under Ind AS 104.
3.5.5 With regard to the insurance products offered by the life insurance companies, there are various generations of insurance policies available with different levels of benefits payable on various insured events. The IRDAI has notified IRDA (Linked Insurance Products) Regulations, 2013 and IRDA (Non-Linked Insurance Products) Regulations, 2013. In accordance with the provisions of these regulations, all life insurance products should have the minimum amount of death benefit as notified in the said regulations and for all pension products (for all individual pension products and group pension products), it should have minimum amount of benefit guaranteed at the outset which becomes payable either on death or on maturity Such products can be recognised as insurance contracts under Ind AS 104. All other pension products, group gratuity and group leave encashment products could be construed as not having significant insurance risk and would need to be recognised as financial instruments under Ind AS 109. In case the group
products have any features that mean to cover a significant insurance risk, then such products will need to be classified as insurance contracts.
3.5.6 Product Mapping – industry survey and other deliberations:
Information was collected from a few insurance companies who may be presently reporting their financial performance to their promoters based on IFRS or US GAAP. These companies were requested to list their existing products based on the definition of insurance contracts as per Ind AS 104. Four life insurers and two general insurers viz., ICICI Prudential Life Ins. Co. Ltd.; Birla Sun Life Insurance Co Ltd. HDFC Standard Life Co. Ltd.; SBI Life Insurance Co. Ltd.; Bajaj Allianz Life Insurance Co. Ltd.; ICICI Lombard General Insurance Co. Ltd.; and HDFC Ergo General Insurance Co. Ltd. responded.
3.5.7 As per the information collected from the general insurance companies, it was noticed that all the products currently offered by the general insurance companies fall under the definition of insurance contract of Ind AS 104. However, the information collected from the life insurers indicated a diverse practice. One of the insurers has taken a stand that where the risk is more than 5% of the premium the product could be classified as an insurance contract under Ind AS 104. It was also discussed that in UK insurers follow the threshold of 5% to decide the classification of an Insurance Contract. It was accepted that the approach of 5% appears reasonable to determine whether a significant insurance risk exists and hence, whether the product fits in the definition of an insurance contract.
3.5.8 It was noted that post new product regulations all the products being offered currently have the stipulated risk coverage which cannot be less than 105% of the premiums paid except the pension products where risk coverage is an option. In any insurance product, in the initial years, the amount of risk cover is substantial as compared to the premiums paid. When the product moves towards maturity proportions of risk coverage reduces as compared to total premiums paid. But, as per the product regulations, the death benefit cannot be less than 105% of the premiums paid. Therefore, all such products can be considered to have the significant risk cover. However, in the products covering child lives risk may start within say, two years from the date of commencement. In such cases in the initial two years’significant risk may not be covered. In the earlier products, prior to product regulations, risk was not covered till the child attained certain years of age, say seven years of age. In all such cases, on the start of risk coverage, significant risk transfer may not happen at the inception of the contract. In these contracts after the
commencement of the policy, there is no option for the insurer or the insured to select the rates, terms and conditions with respect to the risk to be commenced. The terms and conditions, including the risk coverage to be transferred is already accepted at the outset and would be part of the policy terms and conditions of the children policy. Hence, in accordance with the provisions of para B29, if the contract specifies the rates (or a basis for setting the rates), the contract transfers insurance risk to the insurer at inception. Hence, in all, such policies qualify as insurance contracts. 3.5.9 A minimum threshold may be considered by IRDAI while issuing its application guide on preparation of financial statements. The threshold could be a satisfaction of one of the following three criteria:
- at least 5% of the Fund Value at any time during the life on the contract for unit linked products, or
- at least 5% of the annualized premium or Single Premium, as the case may be, at any time during the life on the contract for other than unit linked products
- Ratio of Expected Present Value (EPV) of death benefits to EPV of Other than death benefits is at least 5% measured at the inception of the policy
Further, wherever death benefit is mentioned above the morbidity benefits provided in these contracts, it could also be included in the determination of significance of insurance. Pure endowment and Immediate or deferred Life Annuity products where the annuities are guaranteed at the inception of the contract can be treated as insurance contracts. An entity may be permitted to classify a contract as an insurance contract even when its product is below the minimum criteria specified above provided it concludes and discloses in the financial statements the factors that give rise to significant insurance risk as defined in Ind AS 104.
