The AASB 17 Insurance Contracts standard, which applies to annual reporting periods on or after 1 January, 2023,may be deceptively complex. On the surface, it’s a change to the way insurance contracts are recognised, measured and disclosed, something the insurance industry has already spent much time preparing for. The complexity arises because the new standard will also impact many companies that don’t consider themselves insurance companies or part of the insurance industry.
The new standard focuses on the contract rather than the type of entity that issues it, with the following stated definition of an insurance contract.
A contract under which one party (the issuer) accepts significant insurance risk from another party (the policyholder) by agreeing to compensate the policyholder if a specified uncertain future event (the insured event) adversely affects the policyholder.
Accordingly, any reporting entity could be caught in the AASB 17 net if it has a contract that includes an insurance element that’s not within the scope of another standard.
Examples of AASB 17 applying to non-insurance companies
Contracts must be analysed to establish whether an insurance contract exists, and if it meets the criteria for exclusion. Some examples of non-insurance company contracts where AASB 17 would apply include:
- a landholder issues a contract to a farmer containing clauses regarding reduced crop yields from below-average rain in monsoon months
- a third party (not the manufacturer, retailer or dealer) provides extended warranty cover on goods
- fixed-price service contracts (e.g. motor vehicle servicing) where the price reflects an assessment of risk with an individual customer
- a management services provider has a contract with a hotel that obligates it to make payments to cover the shortfall if the actual EBITDA is below 85% of the projected earnings before interest, taxes, depreciation and amortisation (EBITDA)
- a reverse mortgage with a ‘no negative equity’ guarantee a loan with a death waiver (or where AASB 9 can be applied).
“Any reporting entity could be caught in the AASB 17 net if it has a contract that includes an insurance element that’s not within the scope of another standard.”
Does an insurance contract exist?
To establish if there’s an insurance contract (written, oral or implied), it’s important to consider the three most important criteria.
1. Any uncertain event has to adversely affect the policyholder. This might include compensation to a building owner for damage.
2. The risks transferred aren’t just financial in nature. If a company issues a reverse mortgage with a guarantee of no negative equity, the potential exists for additional risks.
3. The insurance risk is significant. In this instance, even if the odds of an event such as a natural disaster occurring are slim, the payouts would be substantial.
What else is new?
The accounting treatments for revenue recognition and liability valuation have been clarified, with provision for three measurement approaches.
- General measurement model.
- Premium allocation approach.
- Variable fee approach.
It introduces a raft of new disclosures, including:
- a new format for statements of profit or loss
- insurance finance income and expenses differentiated from those associated with investments
- analysis of insurance revenue
- reconciliations of the net carrying value of contracts
- inputs, assumptions and estimation techniques used.
Transitioning to AASB 17
When adopting AASB 17, there’s an impact to opening balances (or comparatives) on the transition date, resulting in two possible approaches.
1. Modified retrospective approach
Adjustments to the numbers are applied to the current period only, with any impact on the opening balances of equity disclosed in the statement of changes in equity. The effective entries are between the current period opening retained earnings adjustments and the statement of financial position items (e.g. insurance contracts issued that are assets and insurance contracts issued that are liabilities), using a fair-trade approach if reasonable and supportable information can’t be obtained.
2. Full retrospective approach
Adjustments to the numbers are applied to the comparatives (e.g. insurance contracts issued that are assets or liabilities, income/revenue, expenses and comparative period opening retained earnings), and flow through to the opening balances of the current period. The details of the adjustments are disclosed in the restatement of comparatives note, and there is not necessarily a need for a third statement of financial position (a third column is increasingly becoming the exception rather than the norm).
Even if the definition of an ‘insurance contract’ is met, it doesn’t automatically follow that a particular contract is covered by the new guideline. The following are excluded from AASB 17 as they’re covered by other standards.
1. Warranties by manufacturers, retailers and dealers on goods and services (AASB 15).
2. Employee benefit plan assets and liabilities (AASB 2 and AASB 119).
3. Retirement benefit obligations (AASB 119).
4. Contractual rights or obligations on the future use of a non-financial item (ASSB 15, AASB 16 and AASB 138).
5. Financial guarantee contracts (AASB 7).
6. Contingent consideration, payable or receivable, on a business combination (AASB 3).
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