Chapter 22

Insurance
Contracts
Introduction

The interim standard on insurance contracts were issued for to make limited improvements to
accounting for insurance contracts and to require an entity issuing contracts (an insurer) to disclose
information about those contracts. The basic issue with an insurance contract under IFRS 4 is
determining the risks and rewards in the contract and who in substance owns them, and in addition
how to treat payments received and made within the contract.

Effective as of January 1, 2023, IFRS 17 Insurance Contracts replaces IFRS 4, the interim

standard issued by the IASB in 2004
Insurance Contracts – PFRS 4

Definition

The PFRS defines an insurance contracts as “a contract under which one party (the insurer) accepts
significant insurance risks from another party (the policyholder) by agreeing to compensate the
policyholder if a specified uncertain future event (the insured event) adversely affects the
policyholder”.

Several terms used in the above definition are also defined in PFRS 4:
• Insurance risk is defined as “risk”, other than financial risk, transferred from the holder of a
contract to the issuer”.
• Insured event is defined as “an uncertain future event that is covered by an insurance
contract and creates insurance risk”.
A risk is the essence of an insurance contract and as such at least one of the following will be
uncertain at the inception of the contract:
1. Whether an insured event will occur
2. When it will occur
3. How much wills the insurer will need to pay for if it occurs.
Example 1: Insurance Contract
Insurance contract against theft or damage to property is an insurance contract as 1 and 2 above are uncertain and the contract
will compensate the policy holder for the loss or damage, although generally to a limited amount. Life insurance is also deemed
an insurance contract under PFRS 4, as although death is certain, the timing is uncertain.

As an accounting policy, PFRS 4 represents the first phase (second phase – latter part) of the project
on insurance contracts; it exempts an insurer temporarily during this phase for some requirements of
the other PFRSs, including the requirement to consider the Conceptual Framework in selecting
accounting policies for insurance contracts.

For instance, PFRS 9 requires that embedded derivatives shall be separated from the host contracts
and measured at fair value with changes in fair value recognized as gain or loss in the income
statement.
This standard exempts and insurer from the need to separate and measure at fair value, a
policyholder’s option to surrender an insurance contract for a fixed amount, even if the exercise price
differs from the carrying amount of the host insurance liability.

However, PFRS specifically:

a. Prohibits provision for possible claims under contracts that are not in existence at the reporting
date (such as catastrophe and equalization provisions);
b. Requires a test for the adequacy of recognized insurance liabilities and an impairment test for
reinsurance assets; and
c. Requires an insurer to keep insurance liabilities in its statement of financial position until they
are discharged or cancelled, or expire, and to present insurance liabilities without offsetting
them against related reinsurance assets.
Scope

An entity applies PFRS 4 to:

• applies to almost all insurance contracts (including reinsurance contracts) that an entity
issues and to reinsurance contracts that it holds.

A reinsurance contract is defined as an insurance contract issued by one insurer (the reinsurer) to
compensate another insurer (the cedant) for losses on one or more contracts issues by the cedant.

• covers most motor, travel, life, and property insurance contracts as well as most reinsurance
contracts. However, come policies that transfer no significant insurance risk such as savings
and pension plans, are covered by PFRS 9 and accounted for as financial instruments
irrespective of their legal form.

• This standard does not apply to other assets and liabilities of an insurer, such as financial
assets and financial liabilities within the scope of PFRS 9: Financial Instruments. Similarly, it
does not address accounting by policyholders.
PFRS 4 does not also apply to:
• Product warranties, which are covered by PFRS 15 and PAS 37;
• Employer’s assets and liabilities under employee benefits plans, which are covered by PAS 19 and PFRS 2;
• Contingent consideration payable or receivable in a business combination, which is covered by PFRS 3, Business Combinations;
• Contractual rights or contractual obligations that are contingent on the future use of, or right use to use, a non-financial item (e.g.
some license fees, royalties, contingent lease payments and similar items), as well as lessee’s residual value guarantee embedded in
a finance lease;
• Financial guarantee contracts are outside the scope of PFRS 4 unless the issuer elects to apply PFRS 4 to such contracts.

Financial guarantees into which an entity enters or retains on transferring to another party financial assets or financial liabilities,
within the scope of PFRS 9 regardless of whether the financial guarantees are described as financial guarantees, letters of credit or
insurance contacts.

• Direct insurance contracts that the entity holds (i.e. direct insurance contracts in which the entity is the policyholder). However, a
cedant shall apply this PFRS to reinsurance contracts that it holds.

Example 2: Insurance Contract

Anton sells computer hardware and offer to its customers an extended warranty for a fixed period covering servicing, repairs and maintenance for an annual fixed
fee.
 
Is this an insurance contract requiring disclosure under PFRS 4?
 
Answer: Anton is accepting significant insurance risks under this contract as neither the number of services that Anton will be required to perform nor their
nature is predetermined,
However so this does meet
PFRS 4 specifically the definition
excludes of an warranties
product insurance contract.
by a retailer, so this falls outside the scope of PFRS 4. If the extended
warranty had been provided by a third party, e.g. a specialist repair firm or even a competing manufacturer or retailer, then the
exclusion would not apply and PFRS 4 would need to be applied
Other Main Features

Other main features of PFRS4 are that the Standard:

1. Exempts an insurer temporarily from some requirements of other PFRSs;
2. Permits an insurer to change its accounting policies, but only if the resulting financial
statements would be more relevant but no less reliable or vice versa;
3. Permits insurers to introduce an accounting policy that would see the insurance liabilities in
each period reflected at market interest rates;
4. Does not require the insurer to change its accounting policies even if they are excessively
prudent.

When an insurer changes its accounting policies for insurance liabilities, it may reclassify some
or all financial assets as “at fair value through profit or loss”, i.e. at the date of change the
financial asset is measured at fair value with any gain or loss from the carrying amount reflected in
profit or loss.
Changes in Accounting Policies

PFRS 4 permits an insurer to change its accounting policies for insurance contracts only if, as a
result:
• its financial statements present information that is more relevant and
• no less reliable, or more reliable and
• no less relevant.

An insurer may continue using accounting policies that involve them: measuring insurance
liabilities on an undiscounted basis measuring contractual rights to future investment
management fees at an amount that exceeds their fair value as implied by a comparison with
current market-based fees for similar services using non-uniform accounting policies for the
insurance liabilities of subsidiaries.
Unbundling of Deposit Components

Some insurance contracts contain both an insurance component and a deposit component. A deposit
component is defined by PFRS 4 as:

“A contractual component that is not accounted for as a derivative under PFRS 9 and would be within
the scope of PFRS if it were a separate instrument. This requirement ensures that assets and liabilities
are not omitted from the statement of financial position. “

The term “unbundle” is defined as “account for the components of a contract as if they were
separate contracts”. Some insurance contracts contain both an insurance component and a deposit
component.
In some cases, an insurer is required or permitted to unbundle those components, as follows:
1. Unbundling is required if both of the following conditions are met:
a. the insurer can measure the deposit components (including any embedded surrender options) separately (i.e. without
considering the insurance component).

The purpose of which is to avoid the omission of assets and liabilities from its balance sheet which clarifies the
applicability of the practice sometimes known as “shadow accounting”.

Under the “shadow accounting” practice, it allows insurers to adjust their liabilities for any changes that have arisen if
any unrealized gains and losses on assets have been realized.

b. the insurer’s accounting policies do not otherwise require it to recognize all obligations and rights arising from the
deposit component

2. Unbundling is permitted, but not required, if the insurer can measure the deposit component separately as in (1)(a) but its
accounting policies require it to recognize all obligations and rights arising from the deposit component, regardless of the
basis used to measure those rights and obligations.

3. Unbundling is prohibited if an insurer cannot measure the deposit component separately as in (1)(a).

To unbundle a contract, an insurer component shall:

4. Apply PFRS 4 to the insurance component.
5. Apply PFRS 9 to deposit component.
Shadow Accounting

Shadow accounting is an approach that enables an entity to adjust aggregate insurance liabilities to
reduce accounting mismatches that can arise if:
• unrealized gains and losses on assets held by an entity are recognized in the financial
statements (in profit or losses or in OCI), and
• realization of those gains and losses would have a direct effect on the measurement of insurance
liabilities

Shadow accounting may be applicable if an entity applies the overlay approach.

Overlay Approach

When applying PFRS 9, an entity will be permitted to reclassify between profit or loss and OCI the
difference between the amounts recognized in profit or loss under PFRS 9 for designated financial
assets.
Eligibility Criteria

A financial asset is eligible for designation if:

- it is held for an activity that is unconnected with contracts in the scope of PFRS 4; and
- it is measured at FVTPL under PFRS 9.

An entity is required to present the effect of the overlay adjustment:

- profit or loss; as a separate line item (pre-tax);
- in OCI; as a separate component – this item is grouped with other items that will be reclassified subsequently
to profit or loss
Example 3: Overlay Approach Presentation
Statement of Comprehensive Income:
Earned premiums, net of reinsurance………………………………………………………………………P xxx
Investment income under PFRS 9………………………………………………………………………….... xxx
Overlay adjustment…………………………………………………………………………………………….( xxx)
Benefits and claims……………………………………………………………………………………………..( xxx)
Other charges……………………………………………………………………………………………….......( xxx)
Profit or loss (Net income or loss)……………………………………………………………………………..P xxx
Overlay adjustment…………………………………………………………………………………………….. xxx
Total comprehensive income………………………………………………………………………………...P xxx
Designation of Financial Assets

The overlay approach may be elected only when an entity first applies PFRS 9, including:
- when it first applied PFRS 9 after applying the temporary exemption; or
- after applying only the requirements in PFRS 9 to the presentation of gains and losses on financial liabilities designated
as FVTPL

Financial assets are eligible for the overlay approach if they:

- are not held in respect of an activity that is unconnected with contracts in the scope of PFRS 4 – e.g. financial assets held
in funds relating to investment contracts that are outside the scope of PFRS 4 are not eligible; and
- are measured at FVTPL under PFRS 9;

After electing this approach, an entity:

- may designate financial assets for the overlay approach on their initial recognition;
- may designate a previously recognized financial asset for the overlay approach if it now meets the criteria above but
previously did not; and
- is required to de-designate a financial asset if it no longer meets those same criteria.

When an entity de-designates a financial asset, any balance in accumulated OCI associated with it is reclassified to profit or
loss.
An entity is permitted to stop the overlay approach at the beginning of any annual reporting period before the entity
implements the forthcoming insurance contracts standard. If it does, then the change in accounting policy is accounted
retrospectively to the extent practicable.
Example 4: Overlay Approach Interaction with Shadow Accounting
Yvette and Bernie Insurance Company issues contracts for which policyholders participate in 90% of realized profits. The financial assets associated with these
contracts do not meet solely payments of principal and interest (SPPI) test under PFRS 9 and therefore measured at FVTPL.
 
Yvette and Bernie’s policy is to apply shadow accounting to these insurance liabilities and it designates the associated financial assets to the overlay approach
under PFRS 9.
 
The fair value of the assets at the start of the period is P100,000 and the fair value at the end of the period is P150,000. Therefore, the increase in value of
P50,000 that would have been recognized in profit or loss under PFRS 9.
 
Applying its accounting policy choice, Yvette and Bernie first records the increase in value of the financial assets, with corresponding increase in profits or
loss, and then applied overlay adjustment to reclassify the unrealized gain of P50,000 from profit or loss to OCI. Then, Yvette and Bernie applies a shadow
adjustment to recognize a loss in OCI and a remeasurement of the policyholder share in the unrealized gain (90% x P50,000).
Recognition and Measurement

Liability Adequacy Test

PFRS 4 defines a liability adequacy test as:

“an assessment of whether the carrying amount of an insurance liability needs to be increased (or the carrying
amount of related deferred acquisition costs or related intangible assets decreased), based on a review of future
cash flows. It prescribes that “an entity shall assess at the end of each reporting period, whether it’s recognized
insurance liabilities are adequate, using current estimates of future cash flows under its insurance contracts. If
that assessment shows that the carrying amount of its insurance liabilities (less related deferred acquisition
costs and related intangible assets) is inadequate in the light of the estimated future cash flows, the entire
deficiency shall be recognized in profit or loss”

The minimum requirements for the liability adequacy test are as follows:
a. The test considers current estimates of all contractual cash flows, and of related cash flows such as
claims handling costs, as well as cash flows resulting from embedded options and guarantees.
b. If the test shows that the liability is inadequate, the entire deficiency is recognized in profit or loss.
Impairment of Reinsurance Assets

Reinsurance assets are defined as a cedant’s (policyholder under a reinsurance contract) net contractual
rights under a reinsurance contract. A reinsurance contract is 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.

PFRS 4 requires that if a cedant’s reinsurance asset is impaired; the cedant shall reduce its carrying amount
accordingly and recognized that impairment loss in profit or loss. A reinsurance asset is impaired if, and only if:
a. there is objective evidence as a result of an event that occurred after initial recognition of the
reinsurance asset , that the cedant may not receive all amounts due to it under the terms of the contract;
and
b. that event has a reliably measurable impact on the amounts that the cedant will receive from the
reinsurer].
General Insurance Business

Generally, the standard applies equally to insurance entities. However, items that are peculiar to
insurance business are as follows:
1. Premiums;
2. Reinsurance;
3. Claims; and
4. Acquisition costs.

Note that under the current standard, the underwriting results in the revenue account are now
incorporated in the income statement.

Accounting for Premiums: Premium Income

Premiums received and receivable on insurance policies represent a primary source of revenue for an
insurance company conducting general insurance business.
The Standard requires that:
Premium income shall be recognized from the date of the assumption of risk in relation to each policy
of insurance because insurers earn premium by assuming risks on behalf of the insured parties from
that date. This date is known as the inception date, which is defined in the standard as “the date from
which an insurer effectively assumes the risk insured in respect of an insurance policy”.

For practical reasons, a date that approximates the date if risks assumed is often used. For example, a
direct insurer may assume that for policies of a class of insurance written in month, the risks assumed
for all the policies are from the middle of the month.

Similarly, a reinsurer may assume, in relation to premiums ceded to it that risks attaches from the
assumed attachment date of the underlying direct insurance policies, or of the indemnity periods.
Every reporting date, usually some premiums written for which the inception dates are prior to the statement of
financial position date, but for which information may be insufficient for the insurer to accurately identify the
premiums written.
Example 5: Pipeline Premiums
Premiums could have been written by insurance agents close to the end of the reporting period, but the policies may not have been booked-in at the
end of the reporting period by the insurer due to administrative delays in the submission of returns by the agents. These are known as pipeline
premiums.
 
In such cases, the insurer shall estimate and recognize the pipeline premiums to account for all risks assumed during the financial period. Such
estimates may be made by using information from prior periods and adjusting for the impact of recent trends and events. Additionally, the estimates
of the pipeline premiums may be corrected by information received in the post-statement of financial position period.
Premiums are regarded as being earned evenly over the period of the policy from the inception date, which is the date with effect from which the insurer
assumes the risk insured in respect of an insurance policy. However, for practical purposes, as and when premiums are written, they may first be recognized as
revenue by the following journal entries:

Cash / Premium receivable…………………………………………………. xxx

Premium revenue………………………………………………………….. xxx

At the end of each accounting period, any portion of the premium which represents the unexpired period of the policy relating to future periods is considered
unearned at that date, and is taken to an unearned premium reserve account, as follows:

Premium revenue……………………………………………………………... xxx

Unearned premium reserve …………………………………………….. xxx

The unearned premium reserve brought forward from the previous period would be earned in the current period. This is recognized by a reversal of the entries as
follows:

Unearned premium reserve………………………………………………… xxx

Premium revenue………………………………………………………….. xxx

A general insurer normally spreads its risks by ceding out a portion of the risks assumed under policies to a reinsurer. As consideration, a specified portion of the
premium is ceded to the reinsurer.

The portion of the premium ceded is regarded as an expenditure of the insurer and should be excluded in the computation of the unearned premium reserve. The
journal entries to recognize the premium ceded are as follows:

Premium revenue……………………………………………………………... xxx

Cash/payable to reinsurer……………………………………………… xxx

At the end of each reporting period, the unearned premium reserve is included in the insurance contract liabilities in the statement of financial position.
Illustration 1

Bernie Pilares Insurance is an insurer which conducts general insurance business. During the year ended December 31. 20x7,
its total gross premiums written on motor insurance policies were P2,500,000, of which P250,000 was ceded out to
reinsurers.

As at the end of the previous financial year, the unearned premium reserve was P800,000. As of December 31, 20x7, an
unearned premium reserve amount of P1,000,000 is considered necessary.

To compute the motor premium income earned during the year ended December 31, 20x7, are as follows:

Gross premium written in the year……………………………………….. P2,500,000

Less: Premium ceded on reinsurance…………………………………… ( 250,000)
Net premium………………………………………………………………….. P2,250,000
Less: Increase in unearned premium reserve (P1,000,000 –  
P800,000)…………………………………………………………………. __200,000
Earned premium……………………………………………………………… P2,050,000
Unearned Premium Reserve

These are two primary methods of computing the unearned premium reserve, as follows:
1. Fixed percentage method; and
2. Time apportionment method.

Fixed Percentage Method. This method measures the unearned premium reserve by applying a
specified percentage to the total premiums written in each class of business insurance. The percentages
usually applied in the Philippines are:
• 10% - 15% in the case of cargo – marine and aviation and inland transit policies; and
• 55% in the case of other general insurance policies (such as fire and motor policies).
Time Apportionment Method. The time apportionment method may be applied to calculate the unearned premium reserve
both for policies that are annual (one year) and non-annual (more than or less than one-year).

There are several apportionment methods that may be used in computing the circumstances of the policies in question. The
main methods for annual policies are: the 1/365th (daily) method; the 1/24th (monthly) method; and the 1/8th (quarterly)
method.
• The 1/365th method: The 1/365th method computes the unearned premiums, policy by policy, on a pro-rata basis in
respect of the unexpired periods of the respective insurance policies at the end of each period.

Example 6: The 1/365th method

A one-year motor insurance policy with a premium of P30,000 is written on August 1, 20x7 and the risk covered is up to July 31, 20x8, then for an insurer with a financial year
that ends on December 31, the unexpired risk period of this policy at the year-end is from January 1, 20x8 to July 31, 20x8.

Analysis:
Under the 1/365th method, the unearned premium is respect of this policy is computed at [212 days (1/1/x8 – 7/31/x8)/365 days] x P30,000 = P17,425 (for August 1, 20x7 policy).
 
If the insurer has another similar policy that is written on November 1, 20x7, the unearned premium is computed at [304 days (1/1/x8-10/31/x8)/ 365 days] x P30,000 = P24,986.
The amount of unearned premium reserve required is the aggregate of the unearned premiums of the respective policies at the end of the financial period.

This method accords most closely to the need to recognized premiums as being earned evenly over the periods of the
respective policies.
 
On the other hand, it is not always used in practice mainly because it requires substantial cost and effort to determine the
individual amounts of unearned premiums for each unexpired policy
• The1/24th method: This method represents a practical simplification of the time apportionment method but can only be
applied for insurance policies which have a term of one year.

As an alternative of assessing each individual policy for the unexpired period, this method assess total monthly premiums
by assuming that the average date of issue of all policies written during any one month is the middle of that month.

Thus, at the end of the financial period, the unearned premium reserve is the aggregate of unearned premiums,
calculated on a monthly pro-rata basis, in respect of the unexpired periods of the insurance policies at that date.

A financial year is divided into 24 half-monthly periods. Premiums written in the first month of the financial year would
thus have an unexpired period at the year-end of one half-monthly period; premiums written in the second month would
have an unexpired period of three-half monthly periods; and so on; while premiums written in the last month of the year
would have an unexpired period of 23 half-monthly periods.

• The 1/8th method: This method is based on the general assumption that the premiums are spread uniformly over the
quarter and the average date of all policies written in quarter is in the middle of the quarter.
Illustration 22 - 2: The 1/24th method

The following relates to insurance premiums – fire, written by Fred and Pam Esquillo’s Insurance Company for
the year ended December 31, 20x7:

  Premiums Written
January………………………………………………………………………. P 15,000
February……………………………………………………………………… 12,500
March………………………………………………………………………… 10,000
April…………………………………………………………………………… 7,500
May…………………………………………………………………………… 10,000
June…………………………………………………………………………… 7,500
July……………………………………………………………………………. 12,500
August………………………………………………………………………… 17,500
September…………………………………………………………………… 17,500
October……………………………………………………………………… 15,000
November……………………………………………………………………. 20,000
December…………………………………………………………………… 17,500
Total amount written for the year…………………………………......... P 162,500

As of January 1, 20x7, the unearned premium reserve balance amounted to P45,000.

Using the 1/24th method, the unearned premium reserve as of December 31, 20x7 amounted to P89,895.82, computed as follows:

  Unearned Premium
Premiums Unexpired period
Reserve
January………………………………….. P 15,000 1/24 P 625.00
February…………………………………. 12,500 3/24 1562.50
March……………………………………. 10,000 5/24 2,083.33
April………………………………………. 7,500 7/24 2,187.50
May………………………………………. 10,000 9/24 3,750.00
June……………………………………… 7,500 11/24 3,437.50
July……………………………………….. 12,500 13/24 6,770.83
August…………………………………… 17,500 15/24 10,937.50
September………………………………. 17,500 17/24 12,395.83
October…………………………………. 15,000 19/24 11,875.00
November………………………………. 20,000 21/24 17,500.00
December………………………………. __17,500 23/24 _16,770.83
  P162,500   P 89,895.82
In contrast, under the fixed percentage method, using the usual rate for fire insurance, which is 35%, the unearned premium reserve as of
December 31, 20x7 amounted to P56,875 (P162,500 x 35%). Incidentally, the summarized journal entries to recognize the premiums written
for the year and the unearned premium reserve are presented as follows:

  1/24th method Fixed percentage method

Pesos Pesos
Cash/premium receivable………… 162,500.00   162,500.00  
Premium revenue……………..   162,500.00   162,500.00
* The UPR balance brought forward from the previous year amounted to P45,000; P89,895.82 – P45,000.00 = P44,895.82.
Premium revenue……………………. *44,895.82   11,875.00  
** The UPR balance brought forward from the previous year amounted to P45,000; P56,875.00 – P45,000.00 = P11,875.00.
Unearned premium reserve…   *44,895.82   11,875.00
Illustration 22 – 3: The 1/8th method

The following relates to motor insurance premiums written by Yvette Tingin-Atienza Insurance Company for its financial year ended December 31, 20x7:

First Quarter……………………………………………………………………. P 25,000

Second Quarter……………………………………………………………… 20,000
Third Quarter…………………………………………………………………. 75,000
Fourth Quarter……………………………………………………………….. __50,000
  P170,000
Using the 1/8th method, compute the unearned premium reserve as of December 31, 20x7 amounted to P101,250, computed as follows:

    Unexpired Unearned Premium

Premiums Period Reserve
First Quarter P 25,000 1/8 P 3,125
Second Quarter 20,000 3/8 7,500
Third Quarter 75,000 5/8 46,875
Fourth Quarter __ 50,000
Note that PFRS 4 does not prescribe a specific method (or methods) for computing the unearned 7/8 __ 43,750
premium reserve but requires that the method used must
  P 170,000
reflect most accurately the actual liability at the statement of financial position date.   P 101,250

Similarly, for non-annual policies, the method or methods applied must reflect the best estimate of the actual liability at the statement of financial position date.
This may include the time apportionment method as adjusted for the period covered.

Example 7:
Premiums on short term marine and aviation cargo insurance (normally for four-month
coverage) may be recognized evenly by monthly installment over the four month period.
Insurance Receivables

To the extent that the premium income has not been received, whether from the insured parties, agents
or cedant insurers, it is recognized as financial asset (such as insurance receivable) and is recognized
as financial asset (such as insurance receivable) and is subsequently accounted for in accordance with
PFRS 9.

In general, insurance receivables are measured on the amortized cost basis using the effective interest
method and are subject to the impairment test
Accounting for Claims

An insurance claim is a demand by any party for payment by the insurer of a policy benefit on account of an
alleged loss resulting from an event or events alleged to be covered by a policy of insurance.

Therefore, claims are liabilities or losses incurred and payable under the terms of an insurance contract when
the specified risk of loss occurred.

The term “claims” is often used interchangeably with the term “policy benefits” or “losses”.

Example 8: Insurance Claim

In a fire insurance policy, a claim will rise when a fire occurred at any time in the period covered by the policy. A
liability for outstanding claims shall be recognized in respect of both direct insurance and inward reinsurance. The
amount of outstanding claims shall be the best estimate of the expenditure required to settle the present obligation at
the statement of financial position date.
Provisions made for claims would inevitably require estimates and judgment of management in making those
estimates. They are excluded in the insurance contract liabilities at the end of the reporting period.

In general insurance business, the types of claims are normally classified based on their degree of
uncertainty, as follows:
• Losses incurred, reported, agreed but not paid (ABNP)
• Losses incurred and reported but settlement amounts and uncertain (SAAU)
• Losses incurred and reported but not agreed (RBNA)
• Losses which have been incurred but not reported (IBNR)

In general insurance business, most of the losses reserved for claims are normally settled or paid within a period
of time as compared to those arising on life insurance business. However, for long tailed liabilities and for IBNR
claims, significant uncertainty may exists regarding the losses.
There are various methods of providing for loss reserves in general insurance business. These include:
• Case-basis method – a provision for loss is made on the estimated cost of claims arising from each individual
reported claim.
• Average-value method – an average loss per claim is established for each category of claim within each class of
insurance.
• Formula method – application of a mathematical formula

Estimating Cost of Claims Reported

The total cost of a claim when settled and paid will consist of the following elements:
• actual claims paid to the insured party, less recoveries for salvage and re-insurance;
• allocated claims expense; and
• unallocated claims expenses

Allocated claims expenses are those expenses incurred directly in an individual claim and these include surveyors’ fees, loss-
adjusters’ fees, and legal fees.

Unallocated claims expenses (“UCE”) are expenses other than allocated claim expenses which relate to the reporting,
recording and adjustment of claims.

This may include the entire expense of the claims department such as office overheads, salaries of staff and a proportion of
senior management overheads.
Estimating IBNR Claims Provision

Loss provisions for IBNR claims require the compilation of statistics of past experience. These statistics are
used to establish the value and the number of late reported claims for each year and for each class of insurance
business.

Data relating to past experience of late reported claims for up to seven years are normally required.

This IBNR claims provision is the most difficult to estimate, especially when there is insufficient past experience
of late reported claims. Despite the difficulty, IBNR loss revenue must be made in accordance with the accruals
assumption.

Accounting for Acquisition Costs

Acquisition costs are commissions and agency related expenses incurred in securing premiums on general
insurance policies. These are costs incurred that vary with, and are primarily related directly to, the securing of
premiums on issue and renewal of insurance policies. A substantial portion of the acquisition costs relates to
underwriting and agents’ commissions, management fees and other allowances
Premium Deficiency

At the end of each accounting period, the insurance entity must make an assessment to determine
whether the unearned premium reserves carried forward, are sufficient to meet anticipated claims and
related claims expenses to be incurred during the unexpired period of the risk.

A premium deficiency arises when the unearned premium reserve is less than the anticipated claims
and related expenses. In such a case, a provision should be made for that premium deficiency in the
revenue account and accounted for as an additional reserve for losses.
Accounting for Reinsurance

Reinsurance is an arrangement whereby the reinsurer, in consideration of a premium, agrees to indemnify the principal
ceding insurer against the loss, or part of the loss, which the latter may sustain under the policy or policies that the
insurer has written.

Reinsurance is a means whereby insurance companies spread their exposures to losses from claims by ceding and accepting
premiums amongst themselves.

A “ceding insurer” is an insurer that reinsures part or the whole of a risk with one or more reinsurers. The risk reinsured
is referred to as an outward reinsurance.

A “reinsurer” is an insurer which accepts part of a risk from ceding insurer by way of reinsurance. The risk accepted is
referred to as an inward reinsurance.
Example 9: Reinsurance
If Ronella Ocampo Company cedes and Amabella Caceres Saker Company accepts the risk of loss from a class of
policies, Ronella Ocampo is the ceding insurer with an outward reinsurance while Amabella Caceres Saker is the
reinsurer with an inward reinsurance.
A reinsurer may, in turn, reinsure part of the risk which it has accepted to another reinsurer. This process is
known as “retrocession”, which is defined as “a reinsurance of reinsurance assumed where the reinsurer will
retrocede a whole or a part of the risk accepted from the direct insurer to another reinsurer”.

Example 10: Retrocession

If Francis Bautista Company accepts reinsurance from Juliet Mindanao Company, and in turn
reinsures it with Ella Tejada Guerrero Company, a whole or a part of the reinsurance accepted from
Juliet Mindanao Company; the reinsurance ceded to Ella Tejada Guerrero Company by Francis
Bautista Company is known as a retrocession.
The two basic types of reinsurance are:
• A proportional reinsurance is a reinsurance whereby the ceding insurer and reinsurer share premiums
and claims relating to the original contracts of insurance in the same proportion as the share of the
reinsurer(s).
• A non-proportional reinsurance is a reinsurance whereby the ceding insurer undertakes payment of all
losses up to a pre-agreed amount. The balance of any loss that exceeds that agreed limit will be met by
the reinsurers, usually up to a contractual maximum.

Other forms of reinsurance include:

• Treaty reinsurance, which is defined as a form of reinsurance where business is ceded on the basis of an
agreement between the ceding insurer and the reinsurer, whereby the ceding insurer agreed to cede and
the reinsurer agrees to accept automatically the reinsurance of the risk written by the ceding insurer,
which fall within the scope of the treaty, subject to the limits and terms specified therein.

• Facultative reinsurance, which is defined as a form of reinsurance offered on an individual risk basis,
and where the ceding insurer makes the offer of reinsurance and the reinsurer has the option to accept or
reject the risk and to quote the terms for acceptance.
Inward Reinsurance

With regard to inward reinsurance, it shall be accounted for in a manner similar to direct insurance. Thus, inward
reinsurance and retrocession premiums should be recognized by the accepting reinsurer in the basis of risks
assumed. This means that the premiums shall be earned evenly over the period of the risk coverage, and that the
portion of the premium that relates to the unexpired periods shall be carried forward as unearned premium
reserve.

However, for treaty reinsurance, the premiums are recognized on the basis of the periodic advices received from
the ceding insurer.

Outward Reinsurance

In an outward reinsurance arrangement, premium and commission shall be accounted for in the same accounting
period as the original policy to which the reinsurance relates.

Similarly, claims recoveries and any related expenses should be accounted for in the same accounting period as
the original policy and claims to which the reinsurance relates.
Financial Guarantee Contracts

Financial guarantee contract is a contract that requires the issue to make specified payments to
reimburse the holder for a loss it incurs because a specified debtor fails to make payment when due in
accordance with the original or modified terms of a debt instrument. These could also be regarded as
insurance contracts.

However, PFRS 9 states that these financial guarantee contracts are within its scope but permits an
issuer to elect to apply either PFRS 4 or PFRS 9 on those contracts where it has previously asserted
explicitly that it regards such contracts as insurance contracts.

As PFRS 9, requires that such contracts are initially measured at fair value and subsequently amortized
and recorded as income over the period of the guarantees applies unless the liability measured in terms
of PAS 37 exceeds the carrying amount.
Disclosure – Insurance Contract

PFRS 4 requires disclosure of information that:

1. Identifies and explains the amounts in its financial statements arising from insurance
contracts.
2. Helps users to understand the amount, timing and uncertainty of future cash flows from
insurance contracts.

Under 1, accounting policies recognized assets, liabilities, income and expense will be disclosed as
well as processes used to determine assumptions within these amounts and the effects of changer in
these assumptions.

Under 2, terms and conditions of the insurance contract that have a material effect on the cash flows of
the insurer, and actual claims compared with previous estimates, will be disclosed.
PFRS 17, Insurance Contracts (Effective January 1, 2023)

PFRS 17, Insurance Contracts, was issued in May 2017 to create a comprehensive standard to
deal with the identification, recognition, measurement, presentation and disclosure of
insurance contracts. PFRS 17 is effective for annual reporting periods beginning on or after
January 1, 2023. PFRS 17 will replace PFRS 4. Earlier adoption is permitted provided that the
entity also applies PFRS 9, Financial Instruments and PFRS 15, Revenue from Contracts with
Customers on or before the date of initial application of PFRS 17.
Objective

PFRS 17 Insurance Contracts establishes the principles for the recognition, measurement, presentation and disclosure of
Insurance contracts within the scope of the Standard. The objective of IFRS 17 is to ensure that an entity provides relevant
information that faithfully represents those contracts. This information gives a basis for users of financial statements to assess
the effect that insurance contracts have on the entity's financial position, financial performance and cash flows.

An entity shall apply PFRS 17 Insurance Contracts to:

• Insurance contracts, including reinsurance contracts, it issues;
• Reinsurance contracts it holds; and
• Investment contracts with discretionary participation features it issues, provided the entity also issues insurance
contracts

Some contracts meet the definition of an insurance contract but have as their primary purpose the provision of services for a
fixed fee. Such issued contracts are in the scope of the standard, unless an entity chooses to apply to them PFRS 15, Revenue
from Contracts with Customers and provided the following conditions are met:
a. the entity does not reflect an assessment of the risk associated with an individual customer in setting the price of the
contract with that customer
b. the contract compensates the customer by providing a service, rather than by making cash payments to the customer;
and
c. 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.
PFRS 17 vs. PFRS 4. The key difference between PFRS 17 and PFRS 4 is the consistency of application of accounting treatments to areas such as
revenue recognition and liability valuation. Under PFRS 4, entities were free to derive their own interpretations of revenue recognition and calculation
of reserves. For example, it was at the discretion of the companies to include risk adjustment in the liabilities under PFRS 4, whereas it is now
mandatory under PFRS 17. The table below provides more detail around the fundamental differences between PFRS 4 and PFRS 17.

IFRS 4 IFRS 17
Profit recognition at the start of the contract Upfront revenue recognition is not permitted. Mandatory early
recognition of losses on onerous contracts

Revenue includes premium and may include an investment Revenue excludes any investment component and represents
component the reduction of the liabilities held as the entity provides
insurance service and respective risk is released.

Reinsurance is calculated on a net basis. Reinsurance is calculated separately

Discretion in determining separation of components. Separation of components is required only if distinct.

Disclosures help users understand amounts in the insurer’s Disclosures are more detailed and granular
financial statements
Different accounting policies per insurance contract One insurance policy for all contract

Lack of comparability of insurance versus non-insurance Insurance companies across countries become comparable
companies
Lack of comparability of insurance companies across Similar accounting methods for insurance and non-insurance
countries companies
Estimates not updated Estimates are updated each reporting period
Difficult to see key drives of profit Key drives of profit (Investment versus underwriting) are
made transparent
Discount rate based on investment Discount rate based on the cash flows of the contract
PFRS 17 in principle transfers all the requirements to identify an insurance contract from PFRS 4. New rules are
created for the unbundling of deposits and non-insurance revenue components. The following process is
followed for unbundling:
1. Identify and account for embedded derivatives by applying PFRS 9.
2. Separate from a host insurance contract an investment component when that investment component is
distinct and then apply PFRS 9 to the investment component.
3. Separate from the host insurance contract any promise to transfer distinct goods or non- insurance
services to a policyholder by applying PFRS 15.

The benchmark approach in PFRS is based on the principle that insurance contracts create a bundle of rights and
obligations that work together to generate a package of cash inflows (premiums) and outflows (benefits and
claims). An insurer would apply to that package of cash flows a measurement approach, called the fulfilment
value approach that uses the following building blocks:
1. A current estimate of the expected future net cash flows premium, claims, benefits and expenses
2. An explicit risk adjustment for uncertainty about the amount of future cash flows.
3. A discount rate that adjusts those cash flows for the time value of money.
4. A contract service margin
Components of the building block approach are defined in PFRS 17 as follows:
Component Definition
Fulfilment cash flows An explicit, unbiased and probability-weighted estimate (i.e., expected value)
of the present value of the future cash outflows minus the present value of
future cash inflows that arises as the entity fulfils insurance contracts,
including a risk adjustment for non-financial risks.
Risk adjustment for non- The compensation an entity requires for bearing the uncertainty about the
financial risks amount and timing of the cash flows that arises from non-financial risk as the
entity fulfils the insurance contracts.
Contract service margin A component of the carrying amount of the asset or liability for a group of
insurance contacts presenting the unearned profits the entity will recognise as
it provides services under the insurance contract

The first three building blocks are regarded to be the fulfilment cash flows and the contract service margin reflects the
entity’s risk-adjusted expected profit from the contract. The contract services eliminate the recognition of any gain at
inception of the contract. The contractual service margin is therefore the unearned profits on the contract and is reduced as
the profits are earned over the duration of the contract. The contract service margin is updated for changes in future service-
related estimations. The effect of the fulfilment value approach is that the profit from a group of insurance contracts is spread
over the period.
Under the fulfilment value approach, the liability for remaining coverage is the fulfilment value determined for a group of contracts,
while for the premium allocation approach it is the revenue received in advance (unearned premium received) minus deferred
acquisition cost (if not expensed). Under the fulfilment value approach acquisition cost is deducted from the contract service margin
and spread as the net profit is recognised. The liability for incurred claims includes both claims reported but which are not paid or
settled and incurred claims not reported (IBNR).

The presentation of an insurance entity’s performance is divided into insurance service results and financial results to separate them.
The financial results are further divided in finance (investment) results and finance expense. The presentation in the income
statement will then be as follows:

Insurance revenue xx
Incurred claims and other expenses (xx)
Insurance service results xx
Investment income xx
Insurance finance expenses (xx)
Net financial result xx
Profit or loss xx
Insurance finance expenses resulting from changes in interest rates may be transferred to Other Comprehensive Income (OCI).
Income and expenses from reinsurance contracts should be presented separately. The new format of the income statement is
applicable to both entities that previously were regarded as short-term or long-term insurers. The IASB wants to create comparability
between insurance and other entities. Revenue is regarded as the amount charged for insurance coverage as it is earned. Revenue
should therefore specially be calculated when the fulfilment value approach is followed. Under the premium allocation approach
revenue represents the earned premiums.
Re-insurance contracts issued by the insurance entity is threated similarly to other direct insurance business and included in
the liability for remaining coverage and the liability for incurred claims. Re-insurance contracts held by the insurance entity
are threated similarly but opposite. However, if the fulfilment value approach is followed, no contract service margin is
created since the profit in the contract is regarded as part of the cost of re-insurance.

PFRS 17 also deals with contracts with participation features. For insurance contracts with direct participation features the
entity’s share of the changes in the fair value of the underlying items is included in the contract service margin.

For investment contracts with discretionary participation features, the requirements for insurance contracts are modified as
follows:
• The date of initial recognition is the date the entity becomes a party to the contract (similar to IFRS 9).
• Cash flows are regarded to be within the contract boundary when they result from a substantive obligation of the
entity to deliver cash at a present r future date. No substantive obligation to deliver cash is regarded to exist when the
entity has the practical ability to set a price for the promise to deliver the cash that fully reflects the amount of cash
promised and related risks.
• The contractual service margin is recognised over the duration of the group of contracts in a systematic way that
reflects the transfer of investment services under the contract.
Entity provides insurance coverage, and therefore is released from insurance risks. However, if a group of contracts loss-
making, the loss is recognised immediately.

A simplified premium allocation approach is also available for entities who:

• expect that the liability for future coverage would not sufficiently differs from the fulfilment value approach; and
• the coverage period for each contract in the group is one year or less.

The premium allocation approach allows an entity to measure the amount relating to remaining service by
recognising the unearned premiums received as a liability. The coverage period of one year and less is, however,
problematic since in unclear instance the assessment is based on when the boundary of insurance contracts ends. The
boundary of insurance contracts ends when the substantive rights in the contracts end:

• for individual policyholder: when a practical ability to reassess risks of the contract and reset benefits (prices)exists.
• for portfolio of contracts: a practical ability exists to (1) reassess the risks of the contracts and reset benefits (prices)
and (2) pricing of the contracts is only determined to the next reset date.
Insurance contracts are classified in different portfolios to apply the applicable measurement basis based on three steps:

1. Whether the contracts have similar risks and are managed together.
2. Each portfolio of contracts must then be further divided at initial recognition in:
• onerous contracts (loss-making contracts);
• contracts that have no significant possibility of becoming onerous (profitable contracts);
• remaining contracts in the portfolio (less profitable contracts).
3. Each portfolio of contracts is further limited to a yearly grouping (yearly cohort).

PFRS 17 determines that a group of insurance contracts are recognised at the earlier of:
• the beginning of the coverage period;
• the date when the first payment from a policyholder becomes due;
• when a group of contracts become onerous.

Under both the fulfilment value approach and the premium allocation approach a liability for remaining coverage and a liability for incurred
claims must be recognised. These terms are defined as follows:

Liability for remaining An entity’s obligation to investigate and pay valid claims under existing insurance
coverage contacts for insured events that have not yet occurred (i.e., the obligation that relates to
the unexpired portion of the coverage period).
Liability for incurred claims An entity’s obligation to investigate and pay valid claims for insured events that have
already occurred, including events that have occurred but for which claims have not been
reported and other incurred insurance expenses.

PFRS 17 provides detailed disclosure requirements. PFRS 17 should be applied retrospectively on transition. However, if impracticable a
modified retrospective approach or a fair value approach may be applied.
US GAAP COMPARISON

The US GAAP guidance at ASC 944, Financial Services – Insurance covers insurance contracts issued by
insurance type companies that are they have qualified as an insurance company through registration of their
insurance domiciling state. If you are an insurance company then you would comply with ASC 944 with respect
to insurance activities, acquisition costs, claim costs and liabilities for future policy benefits, policyholder
dividends and separate accounts. If you do not fall under ASC 944 then your revenue and expense are accounted
for under other US GAAP codification. Additionally, US GAAP does not consider an insurance contract to be a
financial instrument whereas IFRS does.

ASC 944 lists four methods for recognition of premium revenue and contract liabilities, one method was
developed for short-duration contract accounting and three methods for long-duration contract accounting (i.e.,
traditional life, universal life and participating contracts). Generally, the four methods reflect the nature of the
insurance entity’s obligations and policyholder rights under the provisions of the contract. Acquisition costs are
amortised over the life of the policy and subject to impairment based on the adequacy of premiums for policies
in light of circumstances at the balance sheet date.
Short-duration contracts, which are for a short period, usually one year, generally require revenue recognition on
a straight-line basis. Long-duration contracts, in most cases, require offsetting of receivables or cash against
unrecognised revenue. This revenue is recognised commensurate with the risk insured. Another feature of long-
duration contract accounting is that for each reporting period, liabilities for coverage risk are assessed and
increased if needed. The offset is recognised in the current period expense.

US GAAP contains a provision to ensure there are adequate reserves to cover premiums under what is called a
premium deficiency test which is required. The premium deficiency test would be adequate if used for the
PFRS’s “liability adequacy test”

US GAAP also covers accounting for reinsurance contracts. These arrangements transfer some or all of the risk
of insurance to a third party (not the insured). Generally, the accounting is similar to insurance contracts,
although these are specific criteria for determining if the original insurer has transferred the risks to the reinsurer.

The concept of separate accounts specifies accounting when assets are specifically segregated for a particular
policyholder, for example, variable annuity contracts that guarantee some minimum level of benefits.