Ind AS 117 Insurance Contracts — A standard that affects more than just insurers

Ind AS 117 Insurance Contracts — A standard that affects more than just insurers

The Ministry of Corporate Affairs (MCA) had earlier notified Ind AS 117, Insurance Contracts, vide notification dated 12 August 2024. Ind AS 117 superseded interim insurance standard Ind AS 104 Insurance Contracts and was effective for annual reporting periods beginning on or after 1 April 2024. Whilst the MCA had notified Ind AS 117, the roadmap for applicability of Ind AS to insurance companies was not notified. This would have effectively required insurance companies to prepare their own financial statements as per legacy Indian GAAP; however, they would have also separately required to prepare another set of financial statements as per Ind AS for providing to their parent, investor, or venturer, if any, for preparation consolidated financial statements by the parent/ investor/ venturer.

Subsequently, the MCA notified the Companies (Indian Accounting Standards) Third Amendment Rules, 2024 (‘relief amendment’), to address challenges that were expected to be faced by the insurers/ insurance companies in complying with the complex reporting requirements. As per the notification, the insurers or insurance companies may provide their financial statements prepared in accordance with Ind AS 104 to their parent, investor, or venturer for preparation consolidated financial statements by the parent/ investor/ venturer, until the Insurance Regulatory and Development Authority notifies Ind AS 117. Additionally, Ind AS 104 has been reissued for use by the insurers or insurance companies.

This amendment enumerates the following principles:

• This relief is provided only to insurers or insurance companies for preparing the consolidation reporting package.
• The relief offers the option to prepare the consolidation package using Ind AS 104.
• Apparently, no relief has been provided to the non- insurance companies and they may need to apply Ind AS 117 to the extent relevant immediately.

Accordingly, non-insurance companies presenting quarterly financial information will need to adopt Ind AS 117 during the quarter ended 30 September 2024. Companies impacted by Ind AS 117 and presenting only annual financial statements will adopt Ind AS 117 while presenting financial statements for the year ended 31 March 2025.

In this Article, we look at key impacts of Ind AS 117 adoption that are likely to arise for non-insurance companies.

Relevance of Ind AS 117 for non-insurance entities

Ind AS 117 deals with accounting for insurance contracts and not just insurance companies. Hence, any entity which enters into contracts meeting definition of ‘insurance contract’ under the standard is likely to be impacted. These entities may no longer be permitted to apply previous accounting practices, such as Ind AS 115 Revenue from Contracts with Customers or Ind AS 109 Financial Instruments, unless a specific exemption from Ind AS 117 is available. Particularly, entities issuing contracts, such as extended warranties, product breakdown contracts and fixed fee service contracts, should carefully analyze the terms of their contracts to determine whether they are likely to be impacted by Ind AS 117. This is particularly for the reason that unlike its predecessor Ind AS 104, Ind AS 117 does not provide entities an option to their existing accounting policies for arrangements meeting the definition of the term ‘insurance contract.’

Ind AS 117 focuses on accounting for insurance contracts and not just insurance entities. Entities issuing contracts such as extended warranties, product breakdown contracts and fixed fee service contracts, should carefully analyze terms of their contracts to determine whether they are likely to be impacted. Unlike Ind AS 104, Ind AS 117 does not provide entities an option to their existing accounting policies for arrangements meeting definition of the term ‘insurance contract.’

Definition of insurance contract

Ind AS 117 defines the term ‘insurance contract’ as 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. Hence, the definition focuses on transfer of significant insurance risk arising due to uncertain future event from the policyholder to the issuer. The term ‘insurance risk’ is defined as the risk, other than financial risk, transferred from the holder of a contract to the issuer.

Uncertain future event (the insured event)

Uncertainty (or risk) is the essence of an insurance contract. Accordingly, Ind AS 117 requires at least one of the following to be uncertain at the inception of an insurance contract:

a) The probability of an insured event occurring

b) When the insured event will occur, or

c) How much the entity will need to pay if the insured event occurs.

An insured event will be one of the following:

• The discovery of a loss during the term of the contract, even if the loss arises from an event that occurred before the inception of the contract
• A loss that occurs during the term of the contract, even if the resulting loss is discovered after the end of the contract term, or
• The determination of the ultimate cost of a claim which has already occurred but whose financial effect is uncertain.

A policyholder is adversely affected when they suffer a loss due to an insured event. Contracts that pay out regardless of loss, such as gambling contracts, do not qualify as insurance contract.

An insurance contract must involve an uncertain event specific to the policyholder. Contracts like weather derivatives, which pay out based on general events not unique to the holder, do not qualify as insurance contract.

The compensation to the policyholder can be in cash or in kind. Payment in kind refers to compensation through goods or services rather than cash. For example, when the entity replaces a stolen good instead of reimbursing the policyholder in cash for its loss, constitutes a payment in kind.

Meaning of insurance risk

For a contract to qualify as insurance under Ind AS 117, it must transfer significant insurance risk. Insurance risk is significant if, and only if, an insured event could cause the issuer to pay additional amounts that are significant in any single scenario, excluding scenarios that have no commercial substance (i.e., no discernible effect on the economics of the transaction). If an insured event could mean significant additional amounts would be payable in any scenario that has commercial substance, the condition in the previous sentence can be met even if the insured event is extremely unlikely, or even if the expected (i.e., probability-weighted) present value of the contingent cash flows is a small proportion of the expected present value of the remaining cash flows from the insurance contract.

No quantitative guidance supports the determination of ‘significant’ in Ind AS 117. The lack of a quantitative definition of significant insurance risk means that insurers must apply their own judgement as to what constitutes significant insurance risk.

Ind AS 117 defines insurance risk as any risk, excluding financial risk, transferred from the policyholder to the issuer. It is important to make a distinction between non-financial risk and financial risk because this affects the measurement and presentation of insurance contracts. According to Ind AS 117, financial risk is the risk of a possible future change in one or more of a specified interest rate, financial instrument price, commodity price, currency exchange rate, index of prices or rates, credit rating or credit index or other variable, provided in the case of a non-financial variable that the variable is not specific to a party to the contract. For example, exposure to an index of regional earthquake losses is a financial risk, while the risk of an earthquake affecting a specific property is an insurance risk. Given below are some more examples of arrangements that are designed to address the impact of non-financial risks:

• Life and general insurance policies
• Warranty arrangements
• Residual value guarantee contracts
• Rent guarantees
• Financial guarantee contracts
• Performance bonds/ guarantees
• Contingent consideration agreed in a business combination
• Services performed at a fixed fee
• Indemnity issued by a vendor in a sale of its business
• Loans or mortgages issued with a waiver for death or job
• loss
• Guarantees of minimum profit
• Contracts that guarantee minimum output (e.g., electricity generation by a solar plant

Non-financial risk becomes insurance risk when one party accepts this risk from a counterparty. For example, when a manufacturer provides warranties for goods it sells to customers, it is effectively accepting the insurance risk that the product may be defective by promising to compensate or make good with the customer.

Scope of Ind AS 117

While Ind AS 117 has a very wide definition of the term ‘insurance contract,’ it does not apply to all contracts meeting such a definition. Rather, Ind AS 117 provides certain scope exclusions where entities are prohibited from applying Ind AS 117 and, in certain other cases, it allows entities an option to apply Ind AS 117 or other Ind AS. Insurance contracts can generally be categorized into the following three groups:

Insurance contracts eligible for accounting policy choice

Ind AS 117 permits entities to apply either Ind AS 117 or another Ind ASs to certain contracts that meet the definition of an insurance contract. Examples of such contracts are given below:

Fixed fee service contracts

A fixed-fee service contract is one in which the level of service depends on an uncertain event but the fee does not. Examples include roadside assistance programs and maintenance contracts in which the service provider agrees to repair specified equipment after a malfunction. Such contracts can meet the definition of an insurance contract because:

• It is uncertain whether, or when, assistance or a repair will be needed
• The owner is adversely affected by the occurrence, and
• The service provider compensates the owner if assistance or repair is needed

Although these contracts may meet the definition of insurance contracts, their primary purpose is to provide services for a fixed fee. Ind AS 117 permits entities a choice of applying Ind AS 115 instead of Ind As 117 to such contracts that it issues if, and only if, they meet specified conditions. The entity may make that choice contract by contract, but the choice for each contract is irrevocable. The conditions are:

• The entity does not reflect an assessment of the risk associated with an individual customer in setting the price of the contract with that customer
• The contract compensates the customer by providing services, rather than by making cash payments to the customer, and
• Insurance risk transferred by the contract arises primarily from the customer’s use of services, rather than from uncertainty over the cost of those services.

The accounting policy choice between applying Ind As 117 or Ind AS 115 applies only to fixed-fee service contracts. When an entity charges a fee which varies with the level of service provided (e.g., an elevator service contract that levies a fee per breakdown according to the work required), then the contract is unlikely to transfer significant insurance risk and it would be a service contract within the scope of Ind AS 115.

Examples of contracts likely to attract fixed fee service contracts of Ind AS 117

• Annual maintenance contract where a service provider agrees to repair specified equipment in the event of a malfunction.
• Car breakdown service contract where service provider offers roadside assistance or towing for a fixed annual fee, based on expected breakdowns across all cars at a portfolio level rather than the individual customer level.

The service provider can choose to account for such contracts as per Ind AS 115 or Ind AS 117.

Financial guarantee contracts (FG contracts)

A financial guarantee contract is defined as a contract that requires the issuer to make specified payments to reimburse the holder for a loss it incurs because a specified debtor fails to make payment when due in accordance with the original or modified terms of a debt instrument. These contracts transfer credit risk and may have various legal forms, such as a guarantee, some types of letters of credit, a credit default contract or an insurance contract.

Financial guarantee contracts are excluded from the scope of Ind AS 117 unless the issuer has previously asserted explicitly that it regards such contracts as insurance contracts and has used accounting applicable to insurance contracts. If so, the issuer may elect to apply either Ind AS 117 or Ind AS 32, Ind AS 107 and Ind AS 109 to the financial guarantee contracts. The issuer may make that choice contract by contract, but the choice for each contract is irrevocable.

Ind AS 117 does not elaborate on the phrase ‘previously asserted explicitly’. However, the application guidance to Ind As 109 suggests that assertions that an issuer regards contracts as insurance contracts are typically found throughout the issuer’s communications, contracts, and financial statements.

This accounting policy election is the same as that was available previously in Ind AS 104.

How we see it

In our view, on transition to Ind AS 117, an entity that has previously asserted explicitly that it regards financial guarantee contracts as insurance contracts and has used accounting applicable to insurance contracts may reconsider its previous election regarding accounting for financial guarantee contracts made under Ind AS 104 and decide whether it would prefer to account for those contracts under Ind AS 117 or Ind AS 109. This is because there are no specific transition provisions either within Ind AS 117 or Ind AS 109 as to whether previous elections made under a different standard, i.e., Ind AS 104, should be continued.

Hence, Ind AS 117 would not prevent an entity from making new elections on the application of Ind AS 117. However, an entity which had not previously asserted explicitly that it regards such contracts as insurance contracts or which had not previously used accounting applicable to insurance contracts (i.e., Ind AS 109 accounting was applied) may not reconsider its previous election (either implicitly or explicitly made).

Loan contracts that transfer significant insurance risk only on settlement of the policyholder’s obligation created by the contract

Some contracts meet the definition of an insurance contract but limit the compensation for insured events to the amount otherwise required to settle the policyholder’s obligation created by the contract (for example, loans with death waivers). An entity may choose to apply either Ind AS 117 or Ind AS 109 to such contracts that it issues unless such contracts are excluded from the scope of Ind AS 117 under any of other scope exclusions. The entity must make that choice for each portfolio of insurance contracts, and the choice for each portfolio is irrevocable.

Examples of such contracts are:

• Mortgages loan when the outstanding balance of the mortgage is waived if the borrower dies.
• Lifetime mortgages (sometimes called equity release mortgages) where the entity’s recourse is limited to the mortgaged property. If the property is sold for less than the mortgage balance (when the customer dies or moves into long-term care) then the loss is borne by the entity.
• Student loan contracts where repayments are income and/or life contingent and may not be made at all if the borrower’s income never exceeds the repayment threshold or the borrower dies.
• A loan provided to a customer to buy a non-financial asset, which is repaid via low installments over the period of the loan with a final, higher ‘balloon’ payment at maturity.
• At maturity the customer can choose to return the non- financial asset to the entity instead of making the ‘balloon’ payment and the supplier is exposed to a loss if the value of the non-financial asset received is less than the ‘balloon’ amount. If the contract compensates the customer only for changes in market prices and not for changes in the condition of the customer’s non-financial asset, then it would not provide insurance coverage and meet the definition of a derivative within the scope of Ind AS 109.

Credit card contracts (or similar contracts) that provide insurance coverage

Credit card contracts (or similar contracts that provide credit or payment arrangements) that provide services that meet the definition of an insurance contract are excluded from the scope of Ind AS 117 if, and only if, the entity does not reflect an assessment of the insurance risk associated with an individual customer in setting the price of the contract with that customer. If excluded from Ind AS 117, these contracts would be within the scope of Ind AS 109 and other applicable standards. However, if, and only if, the insurance component is a contractual term of such a financial instrument (rather than, say, required by local legislation), Ind AS 109 requires an entity to separate and apply Ind AS 117 to that insurance component.

This can be illustrated by the diagram below:

An example of a credit card contract (or similar contract) that provides insurance coverage is one in which the entity:

• Must refund the customer for some claims against a supplier in respect of a misrepresentation or breach of the purchase agreement (for example, if the goods are defective or if the supplier fails to deliver the goods) if the supplier does not rectify it
• Is entitled to be indemnified by the supplier for any loss suffered in satisfying its liability with its customer.

The requirements in Ind AS 117 for credit cards or similar arrangements that provide insurance coverage will result in a different accounting treatment depending on the terms and conditions of the arrangement:

• Fully accounted under Ind AS 117: When insurance risk is assessed for individual customers in pricing
• Fully accounted under other standards: When insurance risk is not assessed for individual customers and insurance coverage is not a contractual term
• Mixed approach: When insurance coverage is a contractual term but not priced based on individual risk, then the insurance component separated and accounted for under Ind AS 117

Accounting for contracts covered under Ind AS 117

Once an arrangement is considered an insurance contract within the scope of Ind AS 117, then such contracts are grouped together for measurement when they share similar risk characteristics. There are three ways to measure such groups of insurance contracts – the General Model, the Premium Allocation Approach (PAA), and the Variable Fee Approach (VFA).

The three models have similar objectives in that they provide a mechanism to release the premium received as insurance revenue over the coverage period that the insurance service is provided to the counterparty. This results in a liability representing the compensation for promising to fulfill future claims and service costs and earn a profit margin (contractual service margin).

In addition, all three models require entities to separately recognize and provide for claims when incurred. This is then remeasured subsequently for changes in expectations of future cash outflows (claims, service costs, etc.).

The general model is the default model for accounting for insurance contracts, whereby the liability is constantly reassessed to reflect the experiences and current expectations of future claims. For contracts with a coverage period of one year or less, the PAA may be elected to simplify the accounting to allocate the premium over the coverage period on the basis of either the passage of time or the expected release from risk. When the coverage period is more than one year, if it is reasonably expected that the liability recognized under the PAA would be materially the same as the general model, then this simplified approach can be applied.

The VFA is a tailored version of the general model, which is to be applied to contracts with direct participation features. Direct participation features exist where the payout under the insurance contract is substantially linked to the return of an identified pool of underlying items (usually investments).

Each of these models can be complex and has its own detailed measurement and disclosure requirements.

Conclusion: A new beginning for some non- insurance entities

Non-insurance entities who have not previously applied insurance accounting are not necessarily exempt from applying insurance accounting in the future. The elimination of the unbundling feature of Ind AS 104, along with the stricter measurement requirements set out in Ind AS 117, may have a significant impact on the accounting of contracts that meet the definition of an insurance contract. Due to the complexity and time-consuming nature of applying Ind AS 117, non-insurance entities (if they have not already done so), must carefully evaluate this Standard to determine its applicability.

Where non-insurance entities conclude they have issued contracts within the scope of Ind AS 117, they will need to assess the adequacy of their information systems, relevant processes, personnel and governance to satisfy considerably more complex recognition and measurement procedures as well as the demanding presentation and disclosure requirements set out in the Standard.

While the relief amendment is a significant boon for insurance companies, it is imperative that these entities closely monitor regulatory developments and prepare for the eventual implementation of Ind AS 117. A proactive approach will not only ensure compliance but also position companies for sustained growth and stability in a competitive market environment.