Insurance contracts specifically excluded from the scope of IFRS 17
In the March 2021 edition of Accounting News, we discussed the key definitional features of an insurance contract. Typically, an arrangement that has all of the definitional features of an insurance contract will be considered to be ‘within the scope’ of IFRS 17 Insurance Contracts, in which case the arrangement will be required to be accounted for in accordance with the applicable requirements in IFRS 17.
However, not all arrangements that exhibit all of the definitional features of an insurance contract are within the scope of IFRS 17. From time-to-time the Accounting Standard Setters consider it appropriate to include exceptions (‘scope exclusions’) in Accounting Standards, and IFRS 17 is no exception to this rule.
When are scope exceptions made to IFRS Standards?
A scope exception could be included in an Accounting Standard for one or more of the following reasons:
- Accounting for the particular transaction or event under another Standard will facilitate the provision of more useful information to users, or
- It is more cost-beneficial for entities to account for the particular transaction or event under another Standard, or
- Both a and b.
Scope exceptions in IFRS 17
IFRS 17 permits or requires a number of types of contracts that might otherwise meet the definition of an insurance contract to be accounted for under another IFRS Standard. These scope exceptions typically relate to contracts that, prior to the publication of IFRS 17, were required to be accounted for under an accounting standard other than IFRS 4 Insurance Contracts, and include the following:
- Warranties provided by a manufacturer, dealer or retailer in connection with the sale of its goods or services to a customer, which are accounted for under IFRS 15 Revenue from Contracts with Customers
- Residual value guarantees provided by a manufacturer, dealer or retailer and a lessee’s residual value guarantees when they are embedded in a lease, which are accounted for under IFRS 15 or IFRS 16 Leases
- Financial guarantee contracts, which are accounted for under IAS 32 Financial Instruments: Presentation, IFRS 7 Financial Instruments: Disclosures and IFRS 9 Financial Instruments (collectively described as the Financial Instrument Standards), unless the issuer has previously asserted explicitly that it regards such contracts as insurance contracts and has applied IFRS 4, in which case the entity is permitted to apply either IFRS 17 or the Financial Instrument Standards to the insurance contracts
- Contingent consideration payable or receivable in a business combination, which is accounted for under IFRS 3 Business Combinations, and
- Insurance contracts in which the entity is the policyholder, unless those contracts are reinsurance contracts held by the entity, which are accounted for under IFRS 17.
Concerns with the scope of IFRS 17
During the development and following the publication of IFRS 17, a number of stakeholders expressed concerns that IFRS 17 would require entities to account for some loan contracts that transfer significant insurance risk in their entirety as insurance contracts. Examples of such loan contracts include:
|Type of contract
Mortgage contracts with death waivers
Such contracts comprise a retail mortgage loan with a promise to waive the outstanding contractual payments in the event the borrower become deceased. Accordingly, the ‘premium’ is considered to be included within the interest rate charged on the mortgage.
Student loan contracts
The student loan contract contains the following features:
- The contract is a loan made to a student to fund their tertiary education under the terms of a government scheme
- The loan bears a specified interest rate but interest is paid only if a repayment trigger is met, and
- The repayment trigger is typically the student’s annual income, in which case repayments may never be made if the student’s income never exceeds the repayment threshold and/or the student becomes deceased before the loan is repaid in full.
Lifetime mortgage contracts (sometimes referred to as ‘home equity release’ or ‘reverse mortgage’ contracts)
Such contracts typically have the following features:
- The contract is a retail mortgage offered to customers approaching retirement age, and
- When the borrower becomes deceased or moves into long-term care, the property subject to the mortgage is sold and the proceeds used to repay, in the first instance, the outstanding balance of the mortgage. Any proceeds received in excess of the outstanding mortgage balance are provided to the customer or to their estate, as applicable.
Notwithstanding that IFRS 17 initially carried forward from IFRS 4 most of the scope exclusions in the predecessor Standard (i.e. IFRS 4), and that many entities had previously accounted for these arrangements under IFRS 4, some stakeholders expressed a number of concerns with the prospect of accounting for such contracts as insurance contracts, including:
- IFRS 4 permitted entities to separate the loan component from the insurance contract, and to account for the loan component under IFRS 9, whereas the corresponding requirements in IFRS 17 were not as permissive
- The loan contracts sometimes do not have the legal form of an insurance contract
- The requirement that such loan contracts would be accounted for under IFRS 17 would necessitate many non-insurers to implement new systems (for instance, to calculate the applicable risk adjustment and contractual service margin), which would, in turn, impose additional costs on these entities without a commensurate improvement in the quality of information disclosed in respect to these contracts, and
- Although the contracts transfer substantial insurance risk, the main risk to which the issuer was exposed to under these contracts is credit risk, which is more appropriately accounted for under IFRS 9.
IASB’s response to concerns regarding the scope of IFRS 17
Prior to and following the publication of IFRS 17, the International Accounting Standards Board (IASB) deliberated on whether a number of other arrangements that met the definition of an insurance contract, and that had previously been within the scope of IFRS 4 or IFRS 17, might be better accounted for under another standard.
As a consequence of these deliberations, the IASB agreed to provide (accounting policy) choices in respect to the following types of insurance contracts:
|Type of contract
Accounting policy choice
Fixed fee service contracts
Can be accounted for under IFRS 15 or IFRS 17, subject to specific conditions being met.
Credit card contracts that provide insurance coverage for which the entity does not reflect an assessment of the insurance risk associated with an individual customer in setting the price of the contract with that customer
Can be accounted for under IFRS 9 instead of IFRS 17.
Loan arrangements for which the only insurance component is for the settlement of some or all of the obligation created by the contract
Can be accounted for under
IFRS 17 or IFRS 9.
In next month’s Accounting News we will consider the implications for non-insurers with arrangements that meet the definition of an insurance contract that are not otherwise scoped out of AASB 17.