Insurance - Accounting and Tax Aspects
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This article takes the viewer through the Accounting Aspects related to Insurance under IFRS and the Income Tax requirements in India. It also touches upon the Direct Tax Code and its impact on Insurance based deductions.
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Insurance - Accounting and Tax Aspects
- 3. S. 10(10D) of the ITA contains provisions relating to exemption of any amount received under life insurance policy. Prior to 2003 the provision was as under:- Any sum received under a life insurance policy, including the sum allocatedby way of bonus on such policy other than any sum received under subsection(3) of section 80DDA or under a Keyman insurance policy. CA Sandesh Mundra, Chartered Accountants
- 23. CA Sandesh Mundra, Chartered Accountants Policy taken during the period Type of Policy – Amount of Premium with reference to capital sum assured upon completion of the original period of contract upon the death of the insured Pre-mature withdrawal Prior • less than 5.00 % Exempt Exempt Taxable To • More than 5.00 % but less than 20.00% Taxable Exempt Taxable 1-4-2003 • More than 20.00% Taxable Exempt Taxable 1-4-2003 • less than 5.00 % Exempt Exempt Taxable To • More than 5.00 % but less than 20.00% Taxable Exempt Taxable 31-03-2011 • More than 20.00% Taxable Exempt Taxable 1-4-2011 • less than 5.00 % Exempt Exempt Taxable onwards • More than 5.00 % but less than 20.00% Taxable Exempt Taxable • More than 20.00% Taxable Exempt Taxable
- 35. What's the difference between an insurance company actuary and a mafia actuary? Answer: An insurance company actuary can tell you how many people will die this year, a mafia actuary can name them. CA Sandesh Mundra, Chartered Accountants
- 41. END OF PART - I Thanks for a patient hearing, We shall now move onto Part 2 CA Sandesh Mundra, Chartered Accountants
- 42. CA Sandesh Mundra, Chartered Accountants
- 43. Accounting under IFRS Insurance Industry CA Sandesh Mundra, Chartered Accountants
- 47. Agenda Product classification Accounting for investments CA Sandesh Mundra, Chartered Accountants
- 48. Agenda Product classification Accounting for investments CA Sandesh Mundra, Chartered Accountants
- 58. Protection vs investment - the spectrum of life products Term assurance Protection products Savings / investment products Permanent health insurance Whole life cover Endowments Pensions and annuities Maximum investment Insurance contract (traditional IAS 39 CA Sandesh Mundra, Chartered Accountants
- 59. Accounting of Insurance contracts Contract components Significant insurance risk ? Insurance contract IFRS 4 Unbundling ? Financial risk ? Financial risk ? Investment contract ??? Yes Account as per IAS 39: Fair value or amortised cost No Yes CA Sandesh Mundra, Chartered Accountants
- 60. Unbundling of an insurance contract Can the insurer measure the deposit component separately without considering the insurance component ? The insurer’s accounting policies require it to recognize all obligations and rights arising from the deposit component Unbundling prohibited Unbundling permitted but not required Unbundling required No No Yes Yes CA Sandesh Mundra, Chartered Accountants
- 61. Indicative contract classification: Indian context CA Sandesh Mundra, Chartered Accountants Product portfolio Classification Unit Linked life Insurance contracts as IRDA mandates a minimum death cover of 5 times the premium Unit Linked pension Insurance or Investment contracts depending on sum assured opted Participating – non linked life & endowment products Insurance or Investment contracts depending on sum assured opted Participating – endowment pension Insurance or Investment contracts depending on sum assured opted Non participating: Term (retail & group), Mortgage & Credit term and Health products Insurance contracts Group Superannuation, Gratuity & Leave encashment Investment contracts
- 63. Agenda Product classification Accounting for Investments CA Sandesh Mundra, Chartered Accountants
- 64. Investment accounting – Indian context Investments Linked Non Linked & Shareholders Valued at fair value; unrealised gain/loss is taken to Revenue account Equity & Mutual Fund Investment Other Investments including debt instruments Valued at fair value; Unrealised gain/ loss taken to Balance Sheet Valued at amortised cost using simple interest rate method CA Sandesh Mundra, Chartered Accountants
- 67. Lets laugh a bit ……….. CA Sandesh Mundra, Chartered Accountants
- 68. IAS 39 /IFRS 4 can disrupt the balance between assets & liabilities Balance sheet insurance company Held-to-maturity = amortised cost Traditional insurance contracts = net-premium method at prudent discount rate ≌ amortised cost Loans and receivables = amortised cost Unit-linked insurance contracts = market value of linked investments Available-for-sale = fair value Fair value through P&L = fair value CA Sandesh Mundra, Chartered Accountants
- 69. Measurement of financial instruments CA Sandesh Mundra, Chartered Accountants Fair value through profit and loss Held-to-maturity assets (HTM) Loans and receivables Available for sale financial assets (AFS) I. Classification requirements: a. Held for trading (acquired for the purpose of short-term profit taking) a. Fixed or determinable payments and fixed maturity with intention to hold till maturity a. Financial assets with fixed or determinable payments Financial assets not classified in any of the other categories b. Upon initial recognition, designated as fair value through profit or loss b. If the portfolio has been tainted, then financial assets cannot be classified as HTM b. Not quoted in an active market II. Initial measurement (at the time of purchase): Fair value Fair value + acquisition cost
- 70. Measurement of financial instruments (Contd..) CA Sandesh Mundra, Chartered Accountants III. Subsequent measurement: Fair value At amortised cost using effective interest rate method Fair value IV. Recognition of gains / losses through change in fair value: Recognised in profit or loss account Not applicable To be recognised in the equity account (i.e. the reserves and not through profit or loss account) Fair value through profit and loss Held-to-maturity assets Loans and receivables Available for sale financial assets
- 71. Measurement of financial instruments (Contd..) CA Sandesh Mundra, Chartered Accountants V. Impairment loss: Not applicable as any gains/losses are already recognised in the profit or loss account Amount of loss: difference between the assets carrying amount and the present value of estimated future cash flows Amount of loss: the difference between the acquisition cost and the current fair value Recognition: loss shall be recognised in the profit or loss account and the carrying value of the financial asset shall be accordingly reduced Recognition: the cumulative loss previously recognised shall be reduced from the equity (reserves) account and shall be recognised in profit or loss account Fair value through profit and loss Held-to-maturity assets Loans and receivables Available for sale financial assets
- 76. CA Sandesh Mundra, Chartered Accountants
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- For assessing significance of insurance risk, the insured event should have a a sufficient probability of occurrence and a sufficient magnitude of effect. Probability of occurrence and magnitude of effect are measured independently to determine the significance of the insurance risk. Occurrence of an event is viewed as sufficiently probable if the occurrence has commercial substance. Any event, which policyholders see as a threat to their economic position and for which they are willing to pay for cover, has commercial substance. Therefore even if its occurrence is considered unlikely this is considered to be sufficient. Following the same logic, the magnitude of the effect of an event is considered sufficient if the effect on the policyholder is significant when compared to the minimum benefits payable in a scenario of commercial substance. Payments made which do not compensate the policyholder for the effect of the insured event, e.g. payments made for competitive reasons, are not taken into consideration in the assessment of insurance risk. The significance of insurance risk would have to be measured at contract level without considering the risk exposure of the entire portfolio. Therefore, the effect of risk equalisation in the portfolio would be ignored. IFRS 4 provides that where a portfolio of homogenous contracts are known to generally contain significant insurance risk, each contract can be treated as an insurance contract, without applying the requirement to each individual contract. IFRS 4 further requires that the insurable interest is embodied in the contract as a precondition for providing benefits. IFRS 4 also clarifies that survival risk, which reflects uncertainty about the required overall cost of living, qualifies as insurance risk.
- Example: a zero death benefit pension product with an option to increase the sum assured 1. Term life insurance: risk remains significant throughout the contract 2. Endowment policy – amount at risk in case of death reduces as value of investment component increases 3. Deferred annuity – no insurance risk during savings phase, insurance risk in annuity phase; overall is insurance contract since opting for annuity is an event of commercial substance E.g Assume you have a savings contract with the following features: The investor pays in a regular stream of money which the insurer then invests in bonds. At the end of the contract term, the investor receives the amount paid to the insurer over the term of the contract plus interest. There is an additional clause added into policy which states that if investor dies during the term of contract, 110% of balance at the time of death, is paid out. Although the contract is not entered into purely for insurance against death, the death clause creates an insurance risk for the insurer . Insurer will suffer a significant loss (i.e., payment of additional 10%) in the event of the insured event (death) taking place, even if that event is unlikely to occur.
- Uncertainty over the occurrence of the event Uncertainty over the occurrence of the event may take various forms. Under some insurance contracts the insured event occurs during the period of cover specified in the contract, even if the resulting loss is discovered after the end of this period of cover. For others the insured event is the discovery of a loss during the period of cover of the contract, even if the loss arises from an event that occurred before the inception of the contract. Uncertainty over the timing of the event In whole life insurance contracts the occurrence of the insured event, within the duration of the contract, is certain but the timing is uncertain. Uncertainty over the magnitude of the effect Some insurance contracts cover events that have already occurred, but whose financial effect is still uncertain.
- This means the separation of deposit elements, which would be dealt with under IAS 39, from insurance elements which are dealt with under IFRS 4. It is designed to ensure that any rights and obligations are recorded on the balance sheet as assets and liabilities rather than treated as expenses or revenue. It is intended to capture deposit components or features for separate valuation where these are not already recognised and can be separately measured. Unbundling is required only if the insurance and deposit elements are not closely interdependent. If the components are interdependent the whole contract should be measured using the insurance standard. This requires the insurer to apply judgement. If deposit components are already recognised, there is no need to value them separately. e.g. is fair value is already applied, no need to unbundle. For eg Unit linked product with the premium of Rs.1000 initial charges of Rs.200 Unbundling required/opted then the revenue would be Rs.200 (Rs. 1000- Rs.200) and Rs. 800 would not be recognised in P&L, but as deposit liabilities in the B/S
- Additional impact on bottom line through differential treatment of DAC and DIL – Deferred income liability (Single premium products or one time income that we receive from contract i.e. initial fees)
- For Non linked & Shareholders – Equity and Mutual Fund investment – A Fair Value change account is created for solvency perspective and hence unrealised gains and losses are not considered.. i.e. book value is considered..
- AS 30 & 31 issued on lines with IAS 39 & effective from April 1, 2011 Presently IRDA does not allow trading in derivatives / hedge securities except Fixed income derivatives; accounting of which is in line with IFRS – hence excluded from the presentation
- A consequence of IAS 39’s recognition requirement is that a contract to purchase or sell a financial instrument at a future date is itself a financial asset or financial liability that is required to be recognised in the balance sheet today. The contractual rights and obligations are recognised when the entity becomes a party to the contract. In a regular purchase or sale transaction the standard provides the flexibility to adopt either settlement date or transaction date for recognition / de-recognition of investments.
- Financial assets at fair value through profit or loss - This category includes financial assets that the entity either holds for trading purposes or otherwise has elected to classify into this category A financial asset is considered to be held for trading if the entity acquired or incurred it principally for the purpose of selling or repurchasing it in the near term or is part of a portfolio of financial assets subject to trading. Trading generally reflects active and frequent buying and selling with an objective to profit from short-term movements in price or dealer’s margin. Held-to-maturity (HTM) investments - Financial assets with fixed or determinable payments and fixed maturity that the entity has the positive intention and ability to hold to maturity can be classified as HTM. This category is intended for investments in bonds and other debt instruments that the entity will not sell before their maturity date irrespective of changes in market prices or the entity’s financial position or performance. Loans and receivables - This includes financial assets with fixed or determinable payments that are not quoted price in an active market. For example, an entity may classify items such as account receivables, note receivables, and loans to customers in this category. Financial assets with a quoted price in an active market and financial assets that are held for trading, including derivatives, cannot be classified as loans and receivables. Available for sale (AFS) financial assets - Any financial assets which does not fall under any of the above categories has to be recognised as AFS. Tainting provisions for HTM: If the entity has during the preceding two financial years , sold or reclassified more than an insignificant amount of held-to-maturity investments before maturity, then it shall not classify any financial assets as held-to-maturity
- Asset is impaired when carrying amount > recoverable amount Recoverable amount is the higher of (1) or (2) (1) fair value less costs to sell - Fair value less costs to sell is the amount obtainable from the sale of an asset or cash-generating unit in an arm’s length transaction between knowledgeable, willing parties, less the costs of disposal. (2) value in use - Value in use is the present value of the future cash flows expected to be derived from an asset There may be considerable discussion on the merits or otherwise of marking assets to market eg. Is the market value a useful measure of value given that it is a price of a marginal trade and may not reflect the value of a portfolio esp in thinly traded securities. The essential point is that the liability valuation mode has to be consistent given expected future earnings on assets.
- However, if the significant amount is reclassified under AFS from HTM; the remaining HTM investment has also to be reclassified into AFS. Measurement at the reclassification date All reclassifications must be made at the fair value of the financial asset at the date of reclassification. Any previously recognised gains or losses cannot be reversed. The fair value at the date of reclassification becomes the new cost or amortised cost of the financial asset, as applicable.
- Adopting AS 30 (IAS 39) could also bring about volatility in the revenue account and an asset liability mismatch in the balance sheet as follows: In case the company decides to classify any part if its portfolio as Fair Value through Profit and Loss, any market volatility would impact the revenue account In case the company decides to value any part if its portfolio as Fair Value, in absence of any authoritative statement on valuation of actuarial liabilities under IFRS the liabilities shall continue to be valued at cost, leading to mismatch between assets and liabilities The above would consequently impact the solvency requirements. IRDA will have to thus make necessary amendments in the regulations relating to solvency requirements to ensure that implementation of this standard does not lead to increase in solvency requirements merely due to mismatch in the way Investment assets and actuarial liabilities are valued.
- Insurance being a long term contract; most of the investments are categorized as HTM by the Insurance companies. However, due to the tainting provision, the insurer has to rethink on its strategy of classifying all long term investments under HTM and thus would have to classify them under either FVTPL or AFS. This will bring volatility in policy liability calculation An investment system should be able to classify and tag each security as per the classification mandated by IAS 39 System should be capable enough to measure investments based on classification System enhancement required for calculating effective interest rate for amortisation of HTM securities from the current logic of simple interest rate IFRS 7 & IAS 32 which deal with investment disclosures & presentation; mandate host of disclosure requirement for the investments held by any entity. Unless this requirement is automated, an entity has to put in massive efforts in collating data required for disclosure as mandated by IFRS 7