pene TO 7 Chapter 12 Insurance Contracts (jearning ‘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. Introduction The accounting practices for insurance contracts have been diverse and often differed from practices in other sectors. Prior to the completion of PFRS 17, an interim standard - PFRS 4 Insurance Contracts - was issued to make limited improvements to the accounting for, and disclosure of, insurance contracts. PERS 4 basically allowed insurance companies to retain their accounting policies under their previous GAAP. PFRS 17 supersedes PFRS 4. PERS 17 prescribes the principles for the recognition, measurement, presentation and disclosure of insurance contracts by aninsurer (e.g., an insurance company). PFRS 17 applies to: a. ingurance and reinsurance contracts issued by an insurer; b. reinsurance contracts held by an insurer; and © investment contracts with discretionary participation features issued by an insurer. PERS 17 does not apply to contracts that are not insurance Contracts, induding financial guarantee contracts (unless the ‘ssuer explicitly regards them as insurance contracts) and insurance contracts whereby the entity is the policyholder rather than the issuer. t bib Contracts that meet the definition of an insurance contract fonts as their primary purpose the provision of services for a follow are accounted for under PFRS 15 instead of PFRS 17 if the ing conditions are met; a (ce540 Chapter 12 a. the price in the contract is not affected by an assessment of the tisk associated with the individual customer; b. the customer is compensated through services rather than cash payment; and c. the insurance risk primarily arises from the customer's use of services rather than from uncertainty over the cost of those services, 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.” (PERS 17,Appendix 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.” (PFRS 17.Appendix A) The definition of an insurance contract determines which contracts are within the scope of PFRS 17 rather than other PFRSs. Essential elements in the definition of an insurance contract 1. Transfer of significant insurance risk — there is a transfer of significant insurance risk from the insured (policyholder) to the insurer (insurance provider). 2. 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). 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.rr sarc COMERS is Zr | significant insurance risk (Uncertain future event) vaurance risk is “tisk, other than financial risk, transferred from iheholder of a contract to the issuer.” (PERS 17.Appendix A) Risk (uncertainty) is the possibility of loss or injury when an uncertain future event occurs. Risk can be speculative risk (i.e, results to either gain or loss) or pure risk (i.e., results only to loss). insurance risk includes only pure risk. At least one of the following is uncertain at the inception ofan insurance contract: a the occurrence of an insured event; b, the timing of the event; or c the amount of payment when the insured event occurs. | The risk must be pre-existing at the time the insurance contract was executed. A new risk created by the contract is not an insurance risk. The insurance risk must be significant. A contract that transfers only an insignificant insurance risk is not an insurance contract. Insurance risk is significant if an insured event could cause an insurer to pay significant additional benefits (ie, those that would exceed the amount payable if no insured event occurred). The significance of insurance risk is assessed on a contract by contract basis. A contract that exposes the issuer to financial risk is not an insurance contract, unless it also exposes the issuer to significant insurance tisk. Financial risk is “the risk of a possible future change MM one or more of a specified interest rate, financial instrument Price, commodity price, foreign exchange rate, index of prices or ‘ates, credit rating or credit index or other variable, provided in Case of a non-financial variable that the variable is not specific ‘0a party to the contract.” (PERS 17.Appendix A) A contract that exposes the issuer to lapse or persistency risk <) &tPense risk is not an insurance contract, unless it also exposes © issuer to significant insurance risk. Lapse or persistency risk is oe that the policyholder will cancel the contract earlier or “t than the issuer had expected in pricing the contract (the he542 Chapter 12 payment is not contingent on an uncertain future event that adversely affects the policyholder). Expense risk is the risk of unexpected increases in the administrative costs associated with the servicing of a contract, rather than in costs associated with insured events (the increase in expenses does not adversely affect the policyholder). (PFRS 15.514) Indemnification against loss Generally, indemnification on insurance contracts is in the form of cash. However, some insurance contracts require or permit payments to be made in kind (i.e, non-cash). For example, the insurer may indemnify the insured a. by replacing the insured property; or b. by providing services, such as medical, repair or other services. Examples of insurance contracts The following are examples of contracts that are insurance contracts if the transfer of insurance risk is significant: a. Insurance against theft or damage. b. Insurance against product liability, professional liability, civil liability or legal expenses. Life insurance and prepaid funeral plans. d. Life-contingent annuities and pensions (ie., contracts that provide compensation for the uncertain future event ~ the survival of the annuitant or pensioner — to assist the annuitant or pensioner in maintaining a given standard of living, which would otherwise be adversely affected by his or her survival). e. Disability and medical cover. f. Surety bonds, fidelity bonds, performance bonds and bid bonds (i.e, contracts that compensate the holder if another party fails to perform a contractual obligation; for example, an obligation to construct a building) 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 2ance Contracts Ins! 543, scope of PFRS 17. These are accounted for under PERS 15 or PAs 37. p, Title insurance (i.e, insurance against the discovery of defects in the title to land or buildings that were not apparent when the insurance contract was issued), ;, Travel insurance (i.e., compensation to policyholders for losses suffered while they are travelling). ;. Catastrophe bonds that provide for reduced payments of principal, interest or both, if a specified event adversely affects the issuer of the bond (except when the insured event is not specific to a party to the contract, e.g., changes in interest rates or foreign exchange rates, or climatic, geological or other physical variable). k. Insurance swaps and other contracts that require payment depending on changes in climatic, geological or other physical variables that are specific to a party to the contract. (PFRS.17.826) The following are not insurance contracts: a. Investment contracts that have the legal form of an insurance contract but do not transfer significant insurance risk to the issuer. b. Self-insurance (because there is no contract) © Gambling contracts d. Derivatives that expose a party to financial insurance risk, including weather derivatives. ; ® Credit-related guarantees (¢.§. letter of credit, credit derivative default contract or credit insurance contract) that tequire payments even if the holder has not incurred a loss on the failure of the debtor to make payments when due. (PFRS 17.827) | risk but not544 Chapter 12 Legal principles of insurance The principal objective of every insurance contract is to provide financial protection to the insured in case an uncertain future event occurs. Neither the “insured” nor the “insurer” shall misuse an insurance contract to unjustly enrich himself at the expense of the other. 1. Principle of insurable Interest — the insured must have an insurable interest in the property or life insured. The insured has an insurable interest in the property if he is benefited by the property’s existence and prejudiced by its destruction. The existence of an insurable interest is a requisite to the legal enforcement of an insurance contract in order to prevent the deliberate destruction of life or property for profit. 2. Principle of Utmost Good Faith (Uberrimae fidei) ~ all insurance contracts must be negotiated with utmost honesty and fairness because the contracting parties do not have the same access to relevant information. Material facts must be disclosed. 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. 4, Principle of Contribution — this principle is a consequence of the principle of indemnity and it applies when the insured obtains insurance from two or more insurers. In case of a loss event, the insured can claim full compensation from only one of the insurers or from all insurers but on a proportionate basis. There can be no “double” compensation. If one of the insurers fully compensates the insured, that insurer can claim from the other insurers for their shares on the losses incurred by the insuredfr sasarorce, a Contracts 545 — — - Example 1: Mr. John, an employee, has two health insurances provided under his employment contract — (1) Philippine Health Insurance Corporation (PhilHealth) (government requisite) and (2) Care Bear Insurance Co. (employer's discretion). Each of the insurances states clearly the types of insured sicknesses, the accredited hospitals where the insurances are applicable, “the amounts of indemnification in case of sickness, and all other relevant information. » Principle of Insurable Interest - the insurable interest is Mr. John’s health. > Principle of Utmost Good Faith - the insurance coverage is disclosed. A year later, Mr. John had an appendectomy (ie, the surgical removal of the vermiform appendix). This is covered under | both of Mr. John’s health insurances. The accredited hospital billed Mr. John a total of P65,000, P20,000 of which is covered by PhilHealth. Mr. John’s hospital bill was settled as follows: | Total hospital bill 65,000 | Less: Amount covered by PhilHealth (20,000) Balance 45,000 Less: Balance covered by CareBearInsurance (45,000) > Principle of Indemnity - Mr. John is indemnified only for the hospital bill. Mr. John did not gain any profit. > Principle of Contribution — Both insurers share in Mr. John’s hospital bill. Mr. John is prevented from collecting twice from his insurers in respect of the same loss event. 5 Principte of Subrogation — this principle is an extension and another consequence of the principle of indemmity. Subrogation involves substituting the insurer for the insured’s legal right to collect damages from another party. ; oo546 Chapter 12 | Example 2: | | A year after his appendectomy, Mr. John decided to change | | career. He opened a small bakery. Mr. John’s new business | | was a success that after operating for only one year, Mr. John | | was able to save enough money to build a house. Mr. John | i even changed his name from “John Doe” to “John Dough.” © | Mr. John insured his house for P2M. After a year, Mr. | John’s house was totally destroyed by fire due to the | “negligence his neighbor, Ms. Jane Glow. The insurance | company paid Mr. John P2M and at the same time filed a law | | suit against Ms. Jane for P2.4M, the fair value of the destroyed house. > Principle of Subrogation — Mr. John’s right to claim damages from Ms. Jane is transferred to the insurance company. If the insurance company wins the case and collects P2.4M from Ms. Jane, the insurance company shall retain P2M (the amount paid to Mr. John) plus other costs incurred on the lawsuit (e.g., attorney's fees). The balance, if any, is paid to Mr, John. The insurer can benefit out of subrogation rights only up to the amount paid to the insured plus other direct costs incurred. 6. Principle of Loss Minimization ~ in cases of sudden loss events, 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. This prevents the insured from neglecting the loss event just because the property is insured. Principle of Proximate Cause (Causa Proxima) — when a loss iS caused by more than one loss event, the closest (proximate) cause, not the furthest cause, is taken into consideration whenvv ve Contracts . sire CO 547 determining the extent of the insurer's liability. This principle does not apply to life insurance Example 3: A year after Mr. John’s house was destroyed, an earthquake collapsed an electrical post causing a short circuit that started fire on Mr. John’s bakery. With teary eyes and trembling hands, Mr. John called the fire department, and while waiting for the fire truck Mr. John got ‘timba’ and ‘tabo’ and made ‘saboy’ on the fire. (Principle of Loss Minimization) Mr, John’s bakery’s fire insurance coverage does not explicitly extend to earthquakes. When determining the extent of the insurer's liability, _ the closest cause to the destruction of the bakery, which is the | fire, must be taken into consideration. (Principle of Proximate Cause) | Types of insurers 1. Government insurance — operated and regulated by the government (eg., Government Service Insurance System (GSIS), which’ extends life insurance to government employees, and Social Security System (SSS), which extends life insurance to employees and employers in the private sector and other voluntary members. 2. Propriety insurance - owned by stockholders and operated for profit. Policyholders are not among the owners of the business. 3. Mutual insurance - owned by the policyholders themselves, who elect the board of directors, e.g, cooperative insurance. Types of insurance contracts For purposes of applying PERS 17, insurance contracts may be Classified as: 1. Direct insurance contract ~ an insurance contract where the imsurer directly accepts risk from the insured and assumes the548 Chapter 12 sole obligation to compensate the insured in case of a loss event. 2. 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. Examples: Case 1: Direct insurance contract Mr. Juan obtains fire insurance from ABC Insurance Co. In case of fire, ABC Insurance Co. indemnifies Mr. Juan for the losses. > This is an example of a direct insurance contract (or simply “insurance contract’). ABC Insurance Co. is the issxer while Mr. Juan is the policyholder. Case 2: Reinsurance contract ABC Insurance Co. is concerned about possible losses on the insurance contract with Mr. Juan. Accordingly, ABC Insurance Co. obtains insurance from XYZ Insurance Co. for protection against liability on the insurance contract with Mr. Juan. In case of fire, ABC Insurance Co. indemnifies Mr. Juan, but this time ABC Insurance Co. can claim payment from XYZ Insurance Co. > This is an example of a reinsurance contract (simply described as ‘insurance of an insurance’). ABC Insurance Co. is the cedant (or ceding company or primary insurer) while XYZ Insurance Co. is the reinsurer. By entering into the reinsurance contract, ABC Insurance Co. is managing the risk of loss from the direct insurance contract with Mr, Juan. Assuming ABC cedes only 40% of the risk in Mr. Juan’s contract to XYZ, that 40% risk ceded is calledyr eee | the cession, while the 60% risk retained by ABC is called the retention limit (or net retention), ge #3: Retrocession j cae that XYZ Insurance Co. also obtains insurance from | mother teinsurer, 123 Insurance Co, for protection against possible losses from the reinsurance contract with ABC Insurance Co. » This is an example of “retrocession” (simply described as ‘reinsurance of a reinsurance’). 123 Insurance Co. is referred to as the retrocessionaire and the risk transferred is referred to as the retrocession. 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. 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: 4 a group of contracts that are onerous at initial recognition, if any; ba 8roup of contracts that at initial recognition have no Significant possibility of becoming onerous subsequently, if any; and “ a group of the remaining contracts in the portfolio, if any. (PERS 17.16) )550 Chapter 12 PERS 17 prohibits the inclusion of contracts issued more than one year apart in the same group. 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) 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. Fulfillment cash flows ‘The fulfillment cash flows are “an explicit, unbiased and probability- weighted estimate (je., expected value) of the present value of the future cash outflows minus the present value of the future cash inflows that will arise as the entity fulfills insurance contracts, including a risk adjustment for non-financial risk.” (PFRS 17.Appdx.A) 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 coritracts. 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 Contractual service margin The contractual service margin is the unearned profit in a group of insurance contracts that=-the=entity ereeognizeswasityprovides:nsurance Contracts services in the future. This is initially measured at an amount that, unless the group of contracts is onerous, results in no income or expenses arising from: a. the initial recognition of the fulfilment cash flows; b. the derecognition at the date of initial recognition of any asset or liability recognized for insurance acquisition cash flows; and «. any cash flows arising from the contracts in the group at that date. (PFRS17.38) > Insurance acquisition cash flows — are “cash flows arising from the costs of selling, underwriting and starting a group of insurance contracts that are directly attributable to the portfolio of insurance contracts to which the group belongs. Such cash flows include cash flows that are not directly attributable to individual contracts or groups of insurance contracts within the portfolio.” (PFRS 17.Appendix A) Insurance acquisition cash flows are recognized as asset or liability (unless the entity elects to recognize them as expenses or income) when the entity pays or receives the cash flows before the group is recognized. When the group is recognized, the asset or liability is derecognized. Subsequent Measurement The carrying amount of a group of insurance contracts at the end of each reporting period is the sum of: 7 a. the liability for remaining coverage compnising: 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 ». the liability for incurred claims, comprising the fulfilment cash flows related to past service allocated to the group at that date.552 s Chapter 12 The contractual service margin at the end of the reporting period represents the balance of unearned profit relating to future service, >» For contracts without direct participation features, this is computed as the beginning carrying amount adjusted for: a. new contracts added to the group; b. changes in fulfilment cash flows relating to future service; c. effect of any currency exchange differences; d. the amount recognized as insurance revenue during the period; and e. interest on the contractual service margin. (PERS 17.44) » For contracts without direct participation features, this is computed as the beginning carrying amount adjusted for (a) to (d) above and the entity’s share of the change in the fair value of the underlying items Income and expenses are recognized as follows: : > From changes in the carrying amount of the liability for remaining coverage: a. Insurance revenue ~ for the reduction in the liability for remaining coverage because of services provided in the period; b. Insurance service expenses—for losses on groups of onerous contracts, and reversals of such losses; and c. Insurance finance income or expenses — for the effect of the time value of money and the effect of financial risk. (PFRS 1741) > From changes in the carrying amount of the liability for incurred claims: a. Insurance service expenses — for the increase in the liability because of claims and expenses incurred in the period, excluding any investment components;| | p. Insurance service expenses - for any subsequent changes | in fulfilment cash flows relating to incurred claims and | incurred expenses; and | ¢. Insurance finance income or expenses ~ for the effect of the | time value of money and the effect of financial risk. | onerous contracts ‘An insurance contract is onerous if the total of its fulfillment cash | gows, any previously recognized acquisition cash flows and any cash flows arising from the contract at initial recognition date is a set outflow. The net outflow is recognized as a loss in profit or Joss, 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. Premium Allocation Approach PERS 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. (PERS 17.53) The premium allocation approach is not applicable if at the §Toup’s inception, the entity expects significant variability in the {Ulfillment cash flows during the period before a claim is incurred. hnital measurement "der the premium allocation approach, the liability is initially Measured at; the premiums received at initial recognition, if any; i554 Chapter 12 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. (PERS 17:55) 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 amortization of insurance acquisition cash flows in the reporting period, unless the insurance acquisition cash flows were recognized as outright expenses; 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. (PERS 17.55) Other practical expedients under the Premium Allocation Approach , Insurance acquisition cash flows may be expensed when incurred, provided that the coverage period of each contract in the group at initial recognition is one year or less. The liability may not be adjusted for the time value of money and financial risKs if, at initial recognition, the time between providing each part of the coverage and the due date of the related premium is expected to be one year or less. Reinsurance contracts held To understand what a ‘reinsurance contract held’ is, let us recall the example provided earlier:fic Mr. Juan obtains insurance from ABC Insurance Insurance Co. then cedes the Co. Co. ABC insurance contract to XYZ Insurance Analyses: » As to ABC Insurance Co,, the reinsurance contract with XYZ. Insurance Co. is a reinsurance contract held ceded). > As to XYZ Insurance Co, (ie, reinsurance , the reinsurance contract with XYZ Insurance Co. is a reinsurance contract issued (ie, , reinsurance assumed). ABC Insurance Co. accounts for the reinsurance contract held using the principles discussed below. XYZ Insurance Co. accounts for the reinsurance contract issued similar to a direct insurance issued (ie, using the general model discussed earlier), The general model is modified for reinsurance contracts held as follows: » When subdividing portfolios of reinsurance contracts held, references to onerous contracts are replaced with a reference to contracts on which there is a net gain on initial recognition. Recognition: A group of reinsurance contracts held are tecognized as follows: a. if the reinsurance contracts held provide proportionate coverage — at the beginning of the coverage period of the group or at the initial recognition of any underlying contract, whichever is the later; and b. in all other cases — from the beginning of the coverage Period of the group. (PFRS 17.62) _ oS Initial measurement: a. Estimates of future cash flows include the risk of the Teinsurer's non-performance. Pee E556 Chapter 12 ' b. 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. c. The contractual service margin is regarded as a net gain or loss on purchasing the reinsurance, rather than an ‘unearned profit. & Subsequent measurement: a. 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. » Onerous contracts: Reinsurance contracts held cannot be onerous. Hence, the requirements of the general model for onerous contracts do not apply. » Premium Allocation Approach: The premium allocation approach may be applied to reinsurance contracts held, but modified to reflect the features of reinsurance contracts held that differ from insurance contracts issued, e.g., the generation of expenses or reduction in expenses rather than revenue. (PERS 17.69) Investment contracts with discretionary participation features An investment contract with discretionary participation features is a financial instrument that gives an investor a contractual tight to receive additional payments: a. that are a significant portion of the total contractual benefits; b. the timing or amount of which is contractually at the issuer's discretion; and ¢. are contractually base. i, _ on the returns of a specified pool of contracts or a specified type of contract it realized and/or unrealized investment returns on @ specified pool of assets held by the issuer; orr | juaurance Contr sit ii, the profit or loss of the entity or fund that issues the contract. (PFRS 17.Appendix A) Investment contracts with discretionary participation features do not transfer significant insurance risk. Accordingly, the general model is also modified for these contracts as follows: y Recognition — on the date the entity becomes party to the contract. Estimates of cash flows — “the contract boundary is modified so that cash flows are within the contract boundary if they result from a substantive obligation of the entity to deliver cash at a present or future date. The entity has no substantive obligation to deliver cash if it 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.” (PFRS 17.71.b) ¥ Contractual service margin - “the allocation of the contractual service margin is modified so that it is recognized over the duration of the group of contracts in a systematic way that reflects the transfer of investment services under the contract.” (PERS 1771.0) i Modification of an insurance contract If the terms of an insurance contract are modified, the original contract is derecognized and the modified contract is recognized as a new contract if the modification meets any of the following conditions: a if the modified terms had been included at the contract inception, this would have resulted to: exclusion of the contract from the scope of PERS 17; ii, separation of different components from the host insurance contract resulting to @ different insurance contract to which PFRS 17 would i applied; ii, ally different contract boundary; or * See contract to a different group of contracts.558 Chapter 12 b. the original contract qualified as an insurance contract with direct participation features, but the modified contract no longer qualifies as such, or vice versa; or c. the original contract was measured using the premium allocation approach, but the modified contract is no longer eligible for such measurement. Changes in cash flows caused by a modification that does not meet any of the conditions above are treated as changes in the estimates of fulfilment cash flows. Derecognition An insurance contract is derecognized when: a. it is extinguished, ie., 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. 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, The carrying amount of a group includes any asset or liability recognized for insurance acquisition cash flows. Statement(s) of financial performance The amounts recognized in the stalement(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.Income or expenses from reinsurance contracts held are presented separately from income or expenses from insurance contracts issued. Insurance service result Insurance revenue and insurance service expenses, comprising incurred claims and other incurred insurance service expenses, arising from groups of insurance contracts issued are presented in profit or loss. Insurance revenue and insurance service expenses exclude any investment components. Premium information is not presented in profit or loss if that information is inconsistent with the revenue presented. Insurance finance income or expenses Insurance finance income or expenses are changes in the carrying amount of a group of insurance contracts resulting from the consideration of the time value of money and financial risk, but excluding those relating to insurance contracts with direct participating insurance contracts that are adjustments to the contractual service margin and are presented as insurance service expenses. Insurance finance income or expenses may be a. recognized in profit or loss; or b. disaggregated into amounts recognized in profit or loss and in other comprehensive income (OCI). If an entity chose to disaggregate insurance finance income or expenses, the amount previously recognized in OCI is reclassified to profit or loss when the related contract is derecognized. However, in the case of insurance contracts with direct participation features, for which the entity holds = underlying items, the amount previously recognized in OCI is 10! reclassified to profit or loss.560 Chapter 12 Chapter 12: Summary * PFRS 17 applies to the accounting for insurance and reinsurance contracts, including investment contracts with discretionary participation features, by an insurer. © Insurance contract is a contract under which one party (the insurer) 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 is risk, other than financial risk, transferred from the holder of a contract to the issuer. « Acontract that transfers only an insignificant insurance risk is not an insurance contract. ¢ PFRS 17 provides a general measurement model and a simplified model called ‘premium allocation approach. The general model is modified for onerous contracts, reinsurance contracts held and investment contracts with discretionary participation features. * The following are presented separately in the statement of financial position: (a) insurance contracts issued that are assets; (b) insurance contracts issued that are liabilities; (co) reinsurance contracts held that are assets; and (d) reinsurance contracts held that are liabilities. ¢ The amounts recognized in the statement(s) of profit or loss and other comprehensive income are disaggregated into the following: (a) insurance service result, comprising insurance revenue and insurance service: expenses; and (b) insurance finance income or expenses. ¢ Insurance service result is recognized in profit or loss. * Insurance finance income and expenses are (a) recognized in full in profit or loss or (b) disaggregated into amounts that are recognized in profit or loss and OCI, as an accounting policy choice,Insurance Contracts sei ee - | PROBLEMS PROBLEM 1: TRUE OR FALSE 1, Maker Co, a manufacturer and dealer of household appliances, agrees to indemnify a customer for any loss or damage that the customer may sustain from the use of a purchased appliance. The contract to indemnify the customer in case Of a loss event is accounted for under PERS 17. 2. Under an insurance contract, the party that has a right to compensation if the insured event occurs is referred to as the insurer. Use the following information for the next three questions: Ms. Banana obtains a health insurance from Monkey Insurance Co. Monkey cedes the insurance contract with Ms, Banana to Bacchus Insurance Co. 3. The contract between Monkey and Bacchus is referred to as a teinsurance contract. 4. Ms. Banana is referred to as the cedant. 5. Monkey is referred to as the reinsurer. PROBLEM 2; MULTIPLE CHOICE - THEORY 1. The significant risk that is transferred from the policyholder to the issuer of an insurance contract is a. lapse or persistency risk. c. expense risk. b. financial risk. d. insurance risk. Use the following information for the next two questions: Entity A obtains life insurance for its key employee from Entity B (an insurance company). Entity B cedes the insurance contract with Entity A to Entity C, another insurance company, 2. The contract between Entity B and Entity Cis a(an) a, direct insurance contract. ¢, reinsurance contract.Chapter 12 562 b. indirect insurance contract. _d. retrocession. 3. How should Entity C account for the insurance contract with Entity B? a. using the general model or the premium allocation approach b. using the modified version of either the general model or the premium allocation approach applicable for reinsurance contracts held c. using the modified version of the general model applicable for onerous insurance contracts d. aor b, as an accounting policy choice 4, Which of the following statements is incorrect regarding the level of aggregation of insurance contracts under PFRS 17? a. Insurance contracts are combined into portfolios and each portfolio is subdivided into groups. b. Each group may form a separate unit of account for purposes of applying the recognition and measurement principles of PFRS 17. c. Contracts that are onerous at initial recognition form a separate group. d. Insurance contracts issued more than one year apart can be included in the same group if they have similar risks. 5, This refers to the legal principle that the insured must be benefited by the insured property's existence and prejudiced by its destruction. It is a requisite in the enforceability of an insurance contract. Principle of insurable interest Principle of utmost good faith Principle of contribution Principle of indemnity563 6, This refers to the legal principle that all material facts concerning an insurance contract must be made contracting, parties » known to the a. Principle of full disclosure b. Principle of utmost good faith ¢. Principle of contribution d. Principle of indemnity 7. Mr. Pyromaniac obtained fire insurance for his house. During the year, Mr. Pyromaniac’s house was burned. The legal principle that prohibits Mr. Pyromaniac from earning profit from the loss event is a. Principle of loss minimization, b. Principle of utmost good faith. c. Principle of insurable interest. d. Principle of indemnity. 8, Mr. Pyromaniac obtained two fire insurances for his house. During the year, Mr. Pyromaniac’s house was burned. The legal principle that prohibits Mr. Pyromaniac from collecting twice from his insurers in respect of the same loss event is a. Principle of subrogation. b. Principle of utmost good faith. c. Principle of contribution. d. Principle of indemnity. 9. Afternoon Insurance Co. issues a group of insurance contracts on Dec. 19, 20x1. The coverage period of the group starts on Jan. 1, 20x2 and the first premium from a policyholder in the group is due Dec. 30, 20x2. The group of insurance contracts is not onerous. When is the recognition date of the group of insurance contract issued? a. Dee. 19, 20x1 c. Jan. 1, 20x2 b. Dee. 30, 20x1 d. Jan. 4, 20x2564 Chapter 12 10. Which of the following does not form a separate presentation in the statement of financial position? a. reinsurance contracts issued that are liabilities b. insurance contracts issued that are assets ¢, insurance contracts issued that are liabilities d. reinsurance contracts held that are assets PROBLEM 3: FOR CLASSROOM DISCUSSION Definition of insurance contract 1. Which of the following is not one of the characteristics of an insurance contract? a. transfer of significant insurance risk from the policyholder to the issuer b. policyholder pays the issuer for the transfer of risk c. issuer indemnifies the policyholder for losses when the insured event occurs d. transfer of significant insurance risk from the igsuer to the policyholder Legal principles 2. Ms. GF broke up with Mr. BF. Mr. BE is. bitter and cannot move on with his life. Mr. BF goes to Love Hurts Insurance Co. and gets a life insurance on Ms. GF’s life, with Mr. BF as the beneficiary. Love Hurts rejects Mr. BF’s application and tells him to “get a life, not life insurance.” What is Love Hurts’ legal basis on the rejection? a. Principle of Contribution c. Love triangle principle b. Principle of Indemnity —_ d. Principle of Insurable Interest Types of insurance contracts Use the following information for the next two questions: Entity A obtains life insurance for its key employee from Entity B (an insurance company). Entity B cedes the insurance contract with Entity A to Entity C, another insurance company, 3. The contract between-Entity-A-and-Entity Bisia(an)Insurance Contracts 4. a. direct insurance contract. c. reinsurance contract. b. indirect insurance contract. d. retrocession. How should Entity B account for the insurance contract with Entity C? a, using the general model or premium allocation approach without modification b. using the general model or premium allocation approach with modification applicable to reinsurance contracts held c. using the modified version of the general model applicable to onerous insurance contracts d. any of these as a matter of accounting policy choice Level of aggregation of insurance contracts 5: PFRS 17 requires an entity to combine its insurance contracts into portfolios and further subdivide the insurance contracts comprising each portfolio into groups. Which of the following is not one of the groups of insurance contracts within a portfolio? a. those that are onerous at initial recognition b. those that, at initial recognition, have no significant possibility of becoming onerous in subsequent periods c. those that are not onerous at initial recognition but can become onerous in subsequent periods d. those that pay premiums at initial recognition which are to be measured using the simplified approach Recognition 6 Flyday Insurance Co. issues a group of insurance contracts on Dec. 19, 20x1. The coverage period of the group starts on Jan. 1, 20x2 and the first premium from a policyholder in the group is due Jan, 4, 20x2, The group of insurance contracts is not onerous. When is the recognition date of the group of insurance contract issued? c. Dec. 19, 20x1 ¢. Jan. 1, 20x2 d. Dec. 31, 20x1 d. Jan. 4, 20x2566 Chapter 12 Initial Measurement 7. Under the general mode! of PFRS 17, a group of insurance contracts is initially measured at a. the fulfillment cash flows. - caorb b. the contractual service margin. d.sum of a and b Subsequent Measurement 8. A group of insurance contracts is subsequently measured at a. the liability for remaining coverage. ¢. aor b. the liability for incurred claims. d. sum of aand b Derecognition 9. According to PFRS 17, an insurance contract is not derecognized when a. itis extinguished. b. ithas expired. c. its terms have been modified and the modification is substantive. d. its terms have been modified and the modification is not substantive. Presentation 10. According to PFRS 17, insurance service result is recognized in a. profit or loss. c. partly a and partly b b. other comprehensive income. d.aorb