Five scope exclusions for non-insurers applying IFRS 17 <em>Insurance Contracts</em>

Five scope exclusions for non-insurers applying IFRS 17 Insurance Contracts

Entities that are not insurance companies (non-insurers) may be unaware that they have issued ‘insurance contracts’ and therefore that they must comply with the new accounting standard for insurance, IFRS 17 Insurance Contracts. This new standard applies to annual periods beginning on or after 1 January 2023.

What is an ‘insurance contract’?

For non-insurers to determine whether they have issued ‘insurance contracts’, they need to consider some key IFRS 17 definitions shown in the table below:

Term	Definition from IFRS 17
Insurance contract	A contract 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.
Insurance risk	Risk, other than financial risk, transferred from the holder of a contract to the issuer.
Financial risk	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.

Contracts that transfer only financial risk are not insurance contracts. While contracts to pay cash flows that vary with respect to movements in an interest rate, commodity price, exchange rate, share price etc., may transfer significant risk, they only transfer financial risk. They are therefore accounted for under IFRS 9 Financial Instruments rather than IFRS 17.

Scope exclusions – Insurance contracts not accounted for under IFRS 17

The following types of contracts potentially transfer significant insurance risk but are excluded from the scope of IFRS 17:

Insurance contracts held
Warranty contracts
Fixed fee service contracts
Financial guarantee contracts issued
Indemnifications issued by the seller in a business combination.

These are either specifically required to be accounted for under other Accounting Standards, or there is an accounting policy choice to account for these under other Accounting Standards or IFRS 17. Each scope exclusion is discussed further below.

Insurance contracts held

Non-insurers may hold some form of insurance to mitigate risk in their general business operations, such as insurance against property damage, corporate liability, errors and omissions, etc.

Although these contracts meet the definition of an insurance contract because they transfer significant insurance risk from the policyholder to the issuer of the policy, the non-insurer policyholder does not account for these insurance contracts under IFRS 17 because they are specifically excluded from its scope (see IFRS 17.7(g)). Instead, the policyholder applies other Accounting Standards which in many cases results in the contract being recognised as an expense over the applicable coverage period.

Please note, however, that reinsurance contracts held are not excluded from the scope of IFRS 17. If an entity holds an insurance contract that provides compensation for an insurance contract that it issues itself, the contract held is a reinsurance contract and, therefore, within the scope of IFRS 17.

Warranty contracts

Manufacturers typically provide warranties when selling goods to customers.

Example

Entity A manufacturers refrigerators. When it sells units to customers, Entity A includes a 5-year warranty whereby it will repair or replace the unit if it malfunctions due to normal ‘wear and tear’ during that period.

These types of warranties meet the definition of an insurance contract because they transfer significant insurance risk. However, under IFRS 17.7(a), the warranty provided by Entity A would be accounted for under IFRS 15 Revenue from Contracts with Customers rather than IFRS 17 if:

Entity A is a ‘manufacturer, dealer or retailer’, and
The warranty is provided ‘in connection with the sale of its goods or services’.

Meaning of ‘manufacturer, dealer or retailer’

It may be challenging in practice to determine whether the warranty is provided by a ‘manufacturer, dealer or retailer’, particularly when the entity offering the warranty and the entity supplying the good or service are different parties. IFRS 17 does not contain definitions for these terms, so preparers need to refer to other sources, such as their dictionary meanings.

Meaning of ‘in connection with the sale of its goods or services to a customer’

Entities must exercise judgement whether the warranty provided by an entity is ‘in connection with the sale of its goods or services to a customer’. Indicative factors may be the time when customers purchase the warranties, and when they are priced. This is illustrated in the following examples.

In connection with the sale of its goods or services to a customer

Not in connection with the sale of its goods or services to a customer

Retailer sells washing machines to its customers.

Retailer offers an extended two-year warranty for $100 to the customer when it purchases the washing machine.

The customer has three months from purchase date to decide whether to purchase the extended warranty.

Retailer sells washing machines to its customers.

Retailer offers an extended two-year warranty for the washing machine after the initial warranty period elapses. The extended warranty is priced at that point.

Fixed-fee service contracts

A contract whereby an entity offers roadside assistance to customers for a fixed monthly or annual fee meets the definition of an insurance contract because it transfers significant insurance risk (risk the customer may suffer from loss due to tyre damage, faulty battery, etc.) from the customer (policyholder) to the entity.

IFRS 17.8 permits entities providing this type of insurance a choice to account for these contracts under IFRS 15 instead of IFRS 17 provided all the following conditions have been met:

The entity does not reflect an assessment of the risk associated with the individual customer in setting the price of the contract with the customer
The contract compensates the customer by providing services, rather than by making cash payments to the customer
The insurance risk transferred by the contract arises primarily from the customer’s use of services rather than from uncertainty over the cost of those services.

Financial guarantee contracts issued

Certain financial guarantee contracts may meet the definition of an insurance contract. However, IFRS 17.7(e) excludes financial guarantee contracts from the scope of IFRS 17 unless the issuer has previously asserted explicitly that it regards such contracts as insurance contracts and has used accounting applicable to insurance contracts.

The issuer therefore chooses to account for financial guarantee contracts under either:

IFRS 17 as an insurance contract, or
IAS 32 Financial Instruments: Presentation, IFRS 7 Financial Instruments: Disclosures and IFRS 9 Financial Instruments.

The choice is made on a contract-by-contract basis and is irrevocable.

Issuers that previously accounted for financial guarantee contracts under IFRS 4 Insurance Contracts and recognised losses on an ‘incurred loss’ basis may, in our view, on the transition to IFRS 17, redesignate these and apply IFRS 9 measurement (i.e. expected credit losses) instead of insurance accounting under IFRS 17.

Indemnifications issued by a seller in a business combination

The vendor in a business combination may provide the buyer with an indemnification relating to contingent liabilities of the sold entity. In such cases, the vendor agrees to reimburse the buyer if a contingency results in the buyer being required to make a payment.

While prima facie, this scenario appears to meet the definition of an insurance contract because the vendor is accepting significant insurance risk from the buyer, IFRS 17.B11 notes that the entity (vendor) must accept from the policyholder (the buyer) a risk to which the policyholder was already exposed. As the buyer was not exposed to the contingent liabilities before the purchase and sale agreement, there is no insurance risk; therefore, this is not an insurance contract.

Instead, the vendor can account for the indemnification in one of two ways:

Continue to account for the contingent liabilities because it is in the same economic position as before the purchase and sale agreement. The rationale for this treatment is that IAS 37 Provisions, Contingent Liabilities and Contingent Assets has no derecognition requirements or requirements for when a potential liability should be accounted for under a different Accounting Standard.
Account for the indemnification as a financial liability within the scope of IFRS 9 because it has a contractual liability to pay cash in the future due to the purchase and sale agreement.

More information

Please refer to our publication on the Implications of IFRS 17 for non-insurers for more information.

Need help?

IFRS 17 is a new and complex standard for insurance accounting. Determining whether non-insurer transactions are in or out of the scope of IFRS 17 can be complicated and judgemental. Please contact our IFRS & Corporate Reporting team if you require assistance.