Insurance Contract
PFRS 17
Learning Objectives:
1. State the scope and applicability of PFRS 17.
2. Define an insurance contract.
3. Describe the level of aggregation and measurement of insurance contracts.
By:
Mr. Remark M. Montalban
Holy Name University
1
Scope
• PFRS 17 prescribes the principles for the recognition,
measurement, presentation and disclosure of insurance
contracts by an insurer. PFRS 17 applies to:
a. insurance and reinsurance contracts issued by an insurer;
b. reinsurance contracts held by an insurer; and
c. investment contracts with discretionary participation
features issued by an insurer.
2
• Insurer (issuer of insurance contract) is the party that has an
obligation under an insurance contract to compensate a
policyholder if an insured event occurs (e.g., insurance
company).
3
Insurance contract
• An insurance contract is “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.” (PFRS
[Link] A)
• Policyholder – “a party that has a right to compensation
under an insurance contract if an insured event occurs.”
• Insured event – “an uncertain future event that is covered
by an insurance contract and creates insurance risk.”
4
Essential elements in the definition of
an insurance contract
a. Transfer of significant insurance risk – there is a transfer of
significant insurance risk from the insured (policyholder)
to the insurer (insurance provider).
b. Payment from the insured (premium) – generally, the
insured pays to a common fund from which losses are
paid. However, not all insurance contracts have explicit
premiums (e.g., insurance cover bundled with some credit
card contracts).
c. Indemnification against loss – the insurer agrees to
indemnify the insured or other beneficiaries against loss or
liability from specified events and circumstances (i.e.,
insured event) that may occur or be discovered during a
specified period.
5
Significant insurance risk (Uncertain
future event)
• Risk (uncertainty) is an essential element of an
insurance contract. Risk is the possibility of loss
or injury when an uncertain future event occurs.
• Insurance risk – is “risk, other than financial risk,
transferred from the holder of a contract to the
issuer.”
• A contract that transfers only an insignificant
insurance risk is not an insurance contract.
• A contract that exposes the issuer to financial risk
is not an insurance contract, unless it also
exposes the issuer to significant insurance risk.
6
Examples of insurance contracts
a. Insurance against theft or damage.
b. Insurance against product liability, professional liability, civil
liability or legal expenses.
c. Life insurance and prepaid funeral plans.
d. Life-contingent annuities and pensions.
e. Disability and medical cover.
f. Surety bonds, fidelity bonds, performance bonds and bid
bonds.
g. Product warranties issued by another party for goods sold by a
manufacturer, dealer or retailer. Product warranties issued
directly by a manufacturer, dealer or retailer are outside the
scope of PFRS 17.
h. Title insurance.
i. Travel insurance.
j. Insurance swaps and other contracts that require a payment
depending on changes in physical variables that are specific to a
party to the contract. (PFRS 17.B26)
7
The following are examples of items that are not
insurance contracts:
a. Contracts that do not transfer significant insurance risk
to the issuer.
b. Self-insurance.
c. Gambling contracts
d. Derivatives that expose a party to financial risk but not
insurance risk, including weather derivatives.
e. Credit-related guarantees (e.g., letter of credit, credit
derivative default contract or credit insurance
contract) that require payments even if the holder has
not incurred a loss on the failure of the debtor to make
payments when due. (PFRS 17.B27)
8
Legal principles of insurance
• The principal objective of every insurance
contract is to provide financial protection to
the insured in case of occurrence of an
uncertain future event. Neither the “insured”
nor the “insurer” shall misuse an insurance
contract to unjustly enrich himself at the
expense of the other.
9
Legal principles of insurance
1. Principle of Insurable Interest –The insured has an
insurable interest in the property if he is benefited by the
property’s existence and prejudiced by its destruction.
2.. Principle of Utmost Good Faith – all insurance contracts
must be negotiated with utmost honesty and fairness
because the contracting parties do not have the same access
to relevant information.
3. Principle of Indemnity – the insured is compensated for
the loss he incurred and reverted back to his previous
financial condition before the occurrence of the loss event.
The insured neither profits nor incurs loss due to the
occurrence of the loss event. This principle does not apply to
life insurance because the value of human life cannot be
measured in monetary terms.
10
Legal principles of insurance
4. Principle of Contribution –This principle applies when
the insured obtains insurance from more than one
insurer. In case of a loss event, the insured can only claim
compensation for the actual losses he incurred from
either insurer or both insurers on a proportionate basis.
There is no “double” compensation for actual losses
incurred by the insured. If any of the insurers,
compensates in full the insured, that insurer can claim
from the other insurers their shares on the losses
incurred by the insured.
5. Principle of Subrogation – Subrogation means
substituting one entity (e.g., the insurer) for another
entity’s (e.g., the insured) legal right to collect a debt or
damages.
11
Legal principles of insurance
6. Principle of Loss Minimization – in cases of sudden
loss events (e.g., fire), the insured should try his best to
minimize the loss of his insured property by taking all
necessary steps to control and reduce the losses and save
what is left of the property (e.g., calling the fire
department in case of fire). This prevents the insured
from neglecting the loss event just because the property
is insured.
7. Principle of Proximate Cause – when a loss is caused
by more than one loss events, the closest (proximate)
cause, not the furthest cause, is taken into consideration
when determining the extent of the insurer’s liability. This
principle does not apply to life insurance.
12
Types of insurance contracts
a. Direct insurance contract – an insurance contract where the insurer directly
accepts risk from the insured and assumes the sole obligation to compensate
the insured in case of a loss event.
b. Reinsurance contract – an insurance contract issued by one insurer (the
reinsurer) to compensate another insurer (the cedant) for losses on one or
more contracts issued by the cedant.
– Reinsurer – the party that has an obligation under a reinsurance contract
to compensate a cedant if an insured event occurs.
– Cedant – the policyholder under a reinsurance contract.
13
Separating components from an
insurance contract
• An insurance contract may contain one or
more non-insurance components (e.g.,
investment component and/or service
component) that need to be separated and
accounted for under other Standards. For this
purpose, an entity applies PFRS 9 to separate
an embedded derivative or a distinct
investment component from a host insurance
contract and applies PFRS 15 to allocate the
cash flows to the separated components.
14
Level of aggregation of insurance contracts
• Insurance contracts are combined into portfolios. A portfolio
consists of insurance contracts with similar risks and managed
together (e.g., contracts within a product line). Each portfolio is
then further subdivided into the following groups:
a. a group of contracts that are onerous at initial recognition, if
any;
b. a group of contracts that at initial recognition have no significant
possibility of becoming onerous subsequently, if any; and
c. a group of the remaining contracts in the portfolio, if any.
PFRS 17 prohibits the inclusion of contracts issued more than one year
apart in the same group.
(PFRS 17.16)
15
Accounting Models
• PFRS 17 prescribes the following
measurement models:
a. General model
b. Premium allocation approach
c. Modifications to the General model for:
i. Onerous contracts,
ii. Reinsurance contracts held, and
iii. Investment contracts with discretionary participation
features.
16
General model
Recognition
• A group of insurance contracts is recognized
from the earliest of the following:
a. the beginning of the coverage period of the group of contracts;
b. the date when the first payment from a policyholder in the group
becomes due; and
c. for a group of onerous contracts, when the group becomes onerous.
(PFRS 17.25)
17
Initial Measurement
• A group of insurance contracts is initially
measured at the total of
a. the fulfillment cash flows, and
b. the contractual service margin
18
Fulfillment cash flows
• Fulfillment cash flows comprise the following:
a. Estimates of future cash flows, which include all future cash flows
within the boundary of each contract in the group. Estimates may be
determined at a higher level of aggregation and then allocated to
individual groups of contracts.
b. Adjustment for time value of money and financial risks (if financial risks
are not included in the estimates of future cash flows).
c. Risk adjustment for non-financial risk.
19
Contractual service margin
• The contractual service margin is the
unearned profit in a group of insurance
contracts that the entity recognizes as it
provides services in the future.
20
Subsequent Measurement
• The carrying amount of a group of insurance
contracts at the end of each reporting period
is the sum of:
a. the liability for remaining coverage comprising:
i. the fulfilment cash flows related to future service
allocated to the group at that date;
ii. the contractual service margin of the group at that
date; and
b. the liability for incurred claims, comprising the fulfilment cash flows
related to past service allocated to the group at that date.
21
Onerous contracts
• An insurance contract is onerous if the total of its
fulfillment cash flows, any previously recognized
acquisition cash flows and any cash flows arising from
the contract at initial recognition date is a net outflow.
The net outflow is recognized as a loss in profit or loss.
This results to a carrying amount of the liability for the
group equal to the fulfilment cash flows and a zero
contractual service margin.
• On subsequent measurement, any excess net outflow
for a group of insurance contracts that becomes
onerous or more onerous is recognized in profit or loss.
22
Premium Allocation Approach
• PFRS 17 allows a simplified measurement of a
group of insurance contracts (called ‘premium
allocation approach’) if at the group’s
inception:
a. the entity reasonably expects that the simplification would result to an
approximation of the general model; or
b. the coverage period of each contract in the group is one year or less.
(PFRS 17.53)
23
Premium Allocation Approach
• Initial measurement
• Under the premium allocation approach, the
liability is initially measured at:
a. the premiums received at initial recognition, if any;
b. minus any insurance acquisition cash flows at that date, unless the
entity chooses to recognize the payments as an expense; and
c. plus or minus any amount arising from the derecognition at that date
of the asset or liability recognized for insurance acquisition cash flows.
(PFRS 17.55)
24
Premium Allocation Approach
• Subsequent measurement
• At the end of each subsequent reporting period, the carrying amount
of the liability is the carrying amount at the start of the reporting
period:
a. plus the premiums received in the period;
b. minus insurance acquisition cash flows, unless the entity chooses to
recognize the payments as an expense;
c. plus any amounts relating to the amortization of insurance
acquisition cash flows recognized as an expense in the reporting
period, unless the entity chooses to recognize insurance acquisition
cash flows as an expense;
d. plus any adjustment to a financing component;
e. minus the amount recognized as insurance revenue for coverage
provided in that period; and
f. minus any investment component paid or transferred to the liability
for incurred claims.
(PFRS 17.55)
25
Reinsurance contracts held
Initial measurement:
• Estimates of future cash flows include the risk of
the reinsurer’s non-performance.
• The risk adjustment for non-financial risk is
determined in such a way that it depicts the
transfer of risk from the holder of the reinsurance
contract to the reinsurer.
• The contractual service margin is regarded as a
net gain or loss on purchasing the reinsurance,
rather than an unearned profit.
26
Reinsurance contracts held -
continuation
Subsequent measurement:
• Changes in the fulfilment cash flows resulting
from changes in the reinsurer’s risk of non-
performance do not adjust the contractual
service margin but rather recognized in profit
or loss.
27
Derecognition
• An insurance contract is derecognized when:
a. it is extinguished, i.e., when the obligation in the insurance contract
expires or is discharged or cancelled; or
b. the contract is modified and the modification meets any of the
conditions for derecognition.
28
Presentation
Statement of financial position
• The carrying amounts of the following groups
are presented separately in the statement of
financial position:
a. insurance contracts issued that are assets;
b. insurance contracts issued that are liabilities;
c. reinsurance contracts held that are assets; and
d. reinsurance contracts held that are liabilities.
29
Presentation - continuation
Statement(s) of financial performance
• The amounts recognized in the statement(s) of
profit or loss and other comprehensive income
are disaggregated into to the following:
a. insurance service result, comprising insurance revenue and insurance
service expenses; and
b. insurance finance income or expenses.
30
Sample Statement of financial position
31
32
