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Insurance contract liability under NFRS 4

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Recognition and measurement of Insurance contract liability under NFRS 4, 
For investment insurance companies in Nepal


When we go by the definition
Insurance contract means – 
“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.

Now, The major judgement required in insurance contract arrangement is recognition and measurement of insurance contract liabilities based on NFRS 4.

Here are two basic area to be covered for recognition and measurement of the insurance contract liabilities while going forward for the adaptation of NFRS 4:

Liability Adequacy Test:
Para 15 of NFRS 4 says that:
An insurer shall assess at the end of each reporting period whether its 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, such as those discussed in paragraphs 31 and 32) is inadequate in the light of the estimated future cash flows, the entire deficiency shall be recognized in profit or loss.”

So, as said in above para, insurance companies are required to assess the liabilities recognized by making in-depth assessment of the assumptions and estimate of future cash flows used by actuarial.

Para 16 of NFRS 4 says that:
If an insurer applies a liability adequacy test that meets specified minimum requirements, this NFRS imposes no further requirements. The minimum requirements are the following:
a.     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.     B.   If the test shows that the liability is inadequate, the entire deficiency is recognized in profit or loss.

Hence after testing all of the above requirements, it should be closely considered that, is there any error or changes in factors used for estimation of future cash flows including cash flows resulting from embedded options and guarantees, the entire resulting figure due to such inadequacy shall be immediate recognized in statement of profit or loss.

Besides it, the standard itself states that, NFRS 4 do not imposes any mandatory provision and guidelines regarding test of adequacy of insurance contact liabilities to reflect the fairness.


Unbundling of Deposit Component:
Another big hurdle for the adaptation of NFRS 4 is the “Unbundling of deposit component”. Let’s have brief view;

Para 10 of NFRS 4 States that:
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:
A.      unbundling is required if both the following conditions are met:
I)                   the insurer can measure the deposit component (including any embedded surrender options) separately (I. e. without considering the insurance component).
II)                 the insurer's accounting policies do not otherwise require it to recognize all obligations and rights arising from the deposit component.
B.      unbundling is permitted, but not required, if the insurer can measure the deposit component separately as in (a)(i) 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.
C.      unbundling is prohibited if an insurer cannot measure the deposit component separately as in (a)(i).

 Hence, when an insurer assesses separate components (Viz Insurance liability and deposit liability component) in any insurance contracts, and unbundling is done, 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.

It’s not an easy task to unbundle the deposit component even though we have reliable basis for its measurement, it shall be deliberately supported by the IT system and data analytics.

Thereafter, once unbundling is done, an insurer shall apply NFRS 9 for classification, recognition and measurement of deposit component and NFRS 4 for insurance component separately.

The standard also has given privilege on unbundling stating that “Unbundling is permitted, not required” , Hence, it’s a judgment from the insurer’s side whether to unbundle the deposit component fulfilling 2 conditions as stated in para 10 by  assessing the reliability of assumptions, observable inputs and other estimations to be used for the measurement.


Article by: 
Rohit Dhital, rohit.dhital@gmail.com

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