ASA - South Africa's Leading Accountancy Journal

The Interaction Between IFRS 4 and IFRS 7

In the June 2007 issue of ASA you were introduced to IFRS 7 Financial Instruments: Disclosures, which is effective for years beginning on or after 1 January 2007.

Introduction

In the July 2007 issue this introduction was expanded to include a more detailed look at the specific disclosure implications IFRS 7 will have on banks. When IFRS 7 was issued, certain amendments were also made to IFRS 4 Insurance Contracts. These amendments will have certain disclosure implications for the issuers of insurance contracts 1, i.e. insurers. Similar to IFRS 7, the amendments to IFRS 4 are also effective for years beginning on or after 1 January 2007 and comparative disclosures also have to be restated accordingly.

What changes have been made to IFRS 4?

Previously IFRS 4 required an insurer to disclose information that will assist users in understanding the amount, timing and uncertainty of future cash flows from insurance contracts. The amended IFRS 4 requires disclosure of information that will enable users to evaluate the nature and extent of risks arising from insurance contracts (IFRS 4.38 amended). Consequently, more emphasis is placed on disclosing information about the risks related to insurance contracts than the actual cash flows.

The implementation guidance to IFRS 4 has also been amended to take into account this change in focus. The following summarises some of the major amendments to the implementation guidance to IFRS 4:

Table 1

Currently required

Previously required

IG 45

When determining the broad classes for which separate disclosure is required, an insurer might consider how best to indicate the level of uncertainty associated with the risks underwritten.

In this regard, it is also important to note the requirement in IFRS 7 whereby instruments outside the scope of IFRS 7 may not be grouped in the same class as those instruments within the scope of IFRS 7. Insurance contracts, as defined by IFRS 4, are specifically scoped out of IFRS 7. It therefore follows that insurance contract liabilities, e.g. outstanding claims, should not be grouped in the same class as financial liabilities, e.g. trade and other payables.

When determining the broad classes for which separate disclosure is required, an insurer might consider the need to indicate the level of uncertainty associated with the risks underwritten.

IG 48

The previous requirement has been expanded to include disclosure about the processes followed managing the risks from insurance contracts.

Amongst others, disclosure has to be provided about -

The structure and organisation of an insurer's risk management functions as well as information regarding the independence and accountability of these risk management functions;

The process for accepting, measuring, monitoring and controlling insurance risks; and

The process for managing, monitoring and controlling additional debt or capital commitments on the occurrence of specified events.

An insurer has to provide information about its objectives in managing the risks from its insurance contracts and what its policies are for mitigating those risks.

IG 49 and IG 50

Although the section dealing with disclosure of the terms and conditions of insurance contracts has been deleted, this type of disclosure may still be required as part of disclosure on the sensitivity of insurance risk.

Disclosure regarding the terms and conditions of insurance contracts.

IG 51A

Disclosure of insurance risk has been expanded to consider disclosure of the following:

Information about the nature of the risks covered, including a short summary describing the classes;

Information about policyholder participation features (i.e. discretionary participation features); and

Information about any obligation (contingent or otherwise) to contribute to government or other guarantee funds.

Disclosure regarding insurance risk.

IG 52 to
IG 54

Disclosure regarding the insurer's sensitivity to insurance risk. The standard allows two alternatives for this disclosure, namely:

Qualitative disclosure of how profit or loss and equity would be impacted with changes in risk variables that were reasonably possible at the reporting date; and

Qualitative disclosure of sensitive information and information about the terms and conditions of insurance contracts that have a material effect on the amount, timing and uncertainty of the insurer's future cash flows.

Disclosure regarding the sensitivity of profit or loss and equity for changes in variables that have a material effect on them.

IG 55

Disclosure regarding concentrations of insurance risk has been expanded to include a cross reference to the capital disclosure requirements of IAS 1 Presentation of Financial Statements (IAS 1).

Disclosure regarding concentrations of insurance risk.

IG 62 to
IG 65

Requires disclosure regarding credit risk, liquidity risk and market risk as if the insurance contracts are within the scope of IFRS 7. Similar to IFRS 4, these additional disclosures may either be provided in the financial statements or incorporated by cross-reference to another statement that is available to users of the financial statements on the same terms and at the same time as the financial statements.

Amongst others, these disclosures may include the following:

The risk that an insurer may incur a financial loss because a reinsurer fails to pay in accordance with the terms of a reinsurance contract, i.e. credit risk exposure from balances owed by reinsurers.

Credit risk exposure from balances owed by agents and brokers.

IFRS 7 requires disclosure of the remaining contractual maturities of financial liabilities. For insurance contracts the remaining contractual maturities refer to the estimated date when the contractually required cash flows will occur. Should an insurer already disclose an analysis, by estimated timing, of the amounts recognised in the balance sheet, the IFRS 7 maturity analysis is not required for insurance liabilities. An insurer may also consider disclosing how the maturity analysis could be influenced with changes in the exercise of lapse or surrender options.

A sensitivity analysis for each type of market risk should be disclosed at the reporting date. This requirement may be met by disclosing an embedded value sensitivity analysis for insurance contracts.

If no reasonable possible change in the relevant market risk variables will impact profit or loss and equity, a statement to that effect should be included in the financial statements.

Requires disclosure regarding interest rate risk and credit risk as if the insurance contracts were within the scope of IAS 32.

What are the implications of the changes to IFRS 4?

Both IFRS 4 and IFRS 7 state that disclosures have to be provided so that the users of the financial statements can assess the financial position, performance and cash flows of the insurer "through the eyes of management". However, both IFRS 4 and IFRS 7 contain certain minimum disclosure requirements, which may be more than what insurers are currently including in their internal reporting. Insurers therefore have to assess their current internal reporting to determine whether any additional information has to be collected for purposes of compliance with IFRS 4 and IFRS 7. Consequently insurers should implement the necessary processes to collect the additional information required by IFRS 4 and IFRS 7 for disclosure purposes.

Conclusion

At first glance, the amendments to IFRS 4 seem negligible. However, insurers should perform a careful analysis of the amendments, since they may result in significant additional disclosures. These additional disclosures may necessitate the implementation of further information-gathering processes and procedures.

Now is the time to take action, since the amendments to IFRS 4 are effective initially for insurers with a 31 December 2007 year-end.

(Footnotes)
1 The references in this column are to the paragraphs in the Implementation Guidance to IFRS 4.

Joanett Pienaar CA(SA), BAcc (Hons), is an Associate Director in the Department of Professional Practice at KPMG Services (Proprietary) Limited.

Comment(s)

No comments have been made.

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	Currently required	Previously required
IG 45	When determining the broad classes for which separate disclosure is required, an insurer might consider how best to indicate the level of uncertainty associated with the risks underwritten. In this regard, it is also important to note the requirement in IFRS 7 whereby instruments outside the scope of IFRS 7 may not be grouped in the same class as those instruments within the scope of IFRS 7. Insurance contracts, as defined by IFRS 4, are specifically scoped out of IFRS 7. It therefore follows that insurance contract liabilities, e.g. outstanding claims, should not be grouped in the same class as financial liabilities, e.g. trade and other payables.	When determining the broad classes for which separate disclosure is required, an insurer might consider the need to indicate the level of uncertainty associated with the risks underwritten.
IG 48	The previous requirement has been expanded to include disclosure about the processes followed managing the risks from insurance contracts. Amongst others, disclosure has to be provided about - The structure and organisation of an insurer's risk management functions as well as information regarding the independence and accountability of these risk management functions; The process for accepting, measuring, monitoring and controlling insurance risks; and The process for managing, monitoring and controlling additional debt or capital commitments on the occurrence of specified events.	An insurer has to provide information about its objectives in managing the risks from its insurance contracts and what its policies are for mitigating those risks.
IG 49 and IG 50	Although the section dealing with disclosure of the terms and conditions of insurance contracts has been deleted, this type of disclosure may still be required as part of disclosure on the sensitivity of insurance risk.	Disclosure regarding the terms and conditions of insurance contracts.
IG 51A	Disclosure of insurance risk has been expanded to consider disclosure of the following: Information about the nature of the risks covered, including a short summary describing the classes; Information about policyholder participation features (i.e. discretionary participation features); and Information about any obligation (contingent or otherwise) to contribute to government or other guarantee funds.	Disclosure regarding insurance risk.
IG 52 to IG 54	Disclosure regarding the insurer's sensitivity to insurance risk. The standard allows two alternatives for this disclosure, namely: Qualitative disclosure of how profit or loss and equity would be impacted with changes in risk variables that were reasonably possible at the reporting date; and Qualitative disclosure of sensitive information and information about the terms and conditions of insurance contracts that have a material effect on the amount, timing and uncertainty of the insurer's future cash flows.	Disclosure regarding the sensitivity of profit or loss and equity for changes in variables that have a material effect on them.
IG 55	Disclosure regarding concentrations of insurance risk has been expanded to include a cross reference to the capital disclosure requirements of IAS 1 Presentation of Financial Statements (IAS 1).	Disclosure regarding concentrations of insurance risk.
IG 62 to IG 65	Requires disclosure regarding credit risk, liquidity risk and market risk as if the insurance contracts are within the scope of IFRS 7. Similar to IFRS 4, these additional disclosures may either be provided in the financial statements or incorporated by cross-reference to another statement that is available to users of the financial statements on the same terms and at the same time as the financial statements. Amongst others, these disclosures may include the following: The risk that an insurer may incur a financial loss because a reinsurer fails to pay in accordance with the terms of a reinsurance contract, i.e. credit risk exposure from balances owed by reinsurers. Credit risk exposure from balances owed by agents and brokers. IFRS 7 requires disclosure of the remaining contractual maturities of financial liabilities. For insurance contracts the remaining contractual maturities refer to the estimated date when the contractually required cash flows will occur. Should an insurer already disclose an analysis, by estimated timing, of the amounts recognised in the balance sheet, the IFRS 7 maturity analysis is not required for insurance liabilities. An insurer may also consider disclosing how the maturity analysis could be influenced with changes in the exercise of lapse or surrender options. A sensitivity analysis for each type of market risk should be disclosed at the reporting date. This requirement may be met by disclosing an embedded value sensitivity analysis for insurance contracts. If no reasonable possible change in the relevant market risk variables will impact profit or loss and equity, a statement to that effect should be included in the financial statements.	Requires disclosure regarding interest rate risk and credit risk as if the insurance contracts were within the scope of IAS 32.