Chapter 22

Accounting for general insurance contracts

22.1

AASB 1023 requires that premium revenue be brought to account from the attachment
date. Paragraph 4.2 states:
Premium revenue shall be recognised from the attachment date as soon as there is a
basis on which it can be reliably estimated.
The attachment date is defined in AASB 1023 as:
for a direct insurer, the date from which the insurer accepts risk from the insured
under an insurance contract or endorsement or, for a reinsurer, the date from which
the reinsurer accepts risk from the direct insurer or another reinsurer under a
reinsurance arrangement
There is also a requirement that the revenue should be recognised in proportion to the pattern
of recognition of the risk. Paragraph 4.3 states:
Premium revenue shall be recognised in the income statement from the attachment
date:
(a)
over the period of the general insurance contract for direct business; or
(b)
over the period of indemnity for reinsurance business, in accordance with the
pattern of the incidence of risk expected under the general insurance
contract.
If it is assumed that the risk relating to the insurance is spread evenly throughout the period
of the insurance contract, then the related revenue can also be recognised uniformly.

22.2

The majority of insurers bring revenue to account on a time basis, with an equal amount
being attributed to each period. This is considered appropriate treatment, to the extent that
the risks are uniform throughout the life of the policy. Paragraph 4.4.4 of AASB 1023 states:
For most direct general insurance contracts the specified period of the contract is one
year. For many direct insurance contracts the pattern of the incidence of risk will be
linear, that is, the risk of events occurring that will give rise to claims is evenly spread
throughout the contract period. For these contracts the premium revenue will be
earned evenly over the period of the contract. However, for some direct insurance
contracts the risk of events occurring that will give rise to claims is not evenly spread
throughout the contract. For example, with motor insurance contracts, the risk of
events occurring that will give rise to claims may be subject to seasonal factors.
Hence, if the risks are uniform through the period of the insurance contract then the revenue
can be recognised on a time basis. That is, if half the contract relates to one financial year,
then half the revenue can be recognised in that year.

22.3

In this question it is useful to differentiate between recognition and measurement. In relation

to liability recognition, paragraph 5.1 of AASB 1023 requires:
An outstanding claims liability shall be recognised in respect of direct business and
reinsurance business and shall be measured as the central estimate of the present value

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of the expected future payments for claims incurred with an additional risk margin to
allow for the inherent uncertainty in the central estimate.
In explaining the central estimate, paragraph 5.1.4 states:
In estimating the outstanding claims liability, a central estimate is adopted. If all the
possible values of the outstanding claims liability are expressed as a statistical
distribution, the central estimate is the mean of that distribution.
The above requirements refer to the present value of the expected future payments. In
determining what these future payments shall include, paragraph 5.2 of AASB 1023 states:
The expected future payments shall include:
(a) amounts in relation to unpaid reported claims;
(b) claims incurred but not reported (IBNR);
(c) claims incurred but not enough reported (IBNER); and
(d) costs, including claims handling costs, which the insurer expects to incur in
settling these incurred claims.
AASB 1023 also has a requirement for the inclusion of a risk margin when recognising the
liability for outstanding claims. Paragraph 5.1.6 states:
The outstanding claims liability includes, in addition to the central estimate of the
present value of the expected future payments, a risk margin that relates to the
inherent uncertainty in the central estimate of the present value of the expected
future payments.
In explaining risk margins, paragraph 5.1.7 and 5.1.8 state:
Risk margins are determined on a basis that reflects the insurers business. Regard is
had to the robustness of the valuation models, the reliability and volume of available
data, past experience of the insurer and the industry and the characteristics of the
classes of business written.
The risk margin is applied to the net outstanding claims for the entity as a whole.
The overall net uncertainty has regard to:
(a) the uncertainty in the gross outstanding claims liability;
(b) the effect of reinsurance on (a); and
(c) the uncertainty in reinsurance and other recoveries due.
The outstanding claims are to be measured at present value. In relation to determining
present values, there is a general exemption from discounting for claims to be settled within
one year from the reporting date. As paragraph 5.1.3 of AASB 1023 states:
For claims expected to be settled within one year of the reporting date, where the
amount of the expected future payments does not differ materially from the present
value of those payments, insurers would not need to discount the expected future
payments.
For claims to be settled beyond one year from reporting dates, paragraphs 6.1 and 6.1.2 state:
The outstanding claims liability shall be discounted for the time value of money
using risk-free discount rates that are based on current observable, objective rates
that relate to the nature, structure and term of the future obligations.
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Typically, government bond rates may be appropriate discount rates for the
purposes of this Standard, or they may be an appropriate starting point in
determining such discount rates.
22.4

Reasons for the development of an industry specific Accounting Standard may relate to the
perceptions that the general insurance industry has its own quite specific accounting issues.
Students should be encouraged to consider whether the industry has any unique accounting
issues which justify the development of the Accounting Standard. Another argument for the
development of an industry specific Accounting Standard is that various reporting entities
within the industry were adopting alternative accounting policies and this made inter-entity
comparisons difficult. Whatever the reasons for its development, there should be an
expectation that the benefits generated from developing and mandating the Accounting
Standard exceed the costs associated with mandating it.

22.5

As stated in Chapter 22 of the textbook, a general insurer may adopt a number of different
valuation rules for its different classes of assets that back general insurance activities. For
example, in relation to financial assets (which would include equity investments), such
assets shall be measured at fair value through the profit or loss. That is, financial assets are
to be valued at fair value with any changes in fair value being included within the profit or
loss of the period.
For property, plant and equipment there is a requirement to determine which properties are
investment properties. Investment properties that back general insurance activities are to be
valued using the fair value model explained in AASB 140 Investment Property. Any gain or
loss on the investment property is to be included in the periods profit or loss.
In relation to other property, plant and equipment that backs general insurance activities,
AASB 1023 requires that the revaluation model described in AASB 116 Property, Plant and
Equipment be applied. In this approach, any increase in value is taken to a revaluation
reserve, rather than to profits.
Deferred acquisition costs are to be recorded at cost and amortised over the periods expected
to benefit from the expenditure.

22.6

Arguments against valuing a general insurers investment properties at fair value include:

It introduces a degree of volatility into the accounts, as the unrecognised gains and
losses are to be included in the periods profit or loss. This may be particularly
detrimental to companies that potentially face violation of debenture contracts, or
other such arrangements.

Introducing fair values into the accounting process may introduce a degree of
subjectivity, particularly if the properties are unique in nature.

Arguments for would include:

General insurers will, in part, rely upon realising their investments to pay for claims.
Valuing the property investments at fair value will provide information which enables
a better assessment to be made of the ability of the entity to pay for the claims.

Related to the point above, using fair values provides information which is, dependent
upon its reliability, more relevant to assessing the financial position of the entity.

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22.7

The investment performance of the entity can best be assessed by considering how the
value of the entitys investments have changed across time.

For claims to be settled beyond one year from reporting dates, paragraphs 6.1 and 6.1.2 state:
The outstanding claims liability shall be discounted for the time value of money
using risk-free discount rates that are based on current observable, objective rates
that relate to the nature, structure and term of the future obligations.
Typically, government bond rates may be appropriate discount rates for the
purposes of this Standard, or they may be an appropriate starting point in
determining such discount rates.

22.8

According to the definitions section (paragraph 19) of AASB 1023, the liability adequacy test
is an assessment of whether the carrying amount of an insurance liability needs to be
increased (or the carrying amount of the related deferred acquisition costs or related
intangible assets decreased) based on a review of future cash flows.
In undertaking the liability adequacy test the entity must consider future claims which are
defined as claims in respect of insured events that are expected to occur in future reporting
periods under policies where the attachment date is prior to the reporting date.
The present value of the future claims (which again is based on actuarial assessments) must
then be compared with the unearned premiums (that is, the amounts that are received to
cover the future claims) to determine if the unearned premiums appear to be sufficient
enough to cover the expected future claims. If the present value of the future claims (as
calculated by the actuaries) exceeds the unearned premium liability then the perspective taken
within AASB 1023 is that the liability is deficient and a further liability (and a corresponding
expense) needs to be recognised. When recognising this expense, the expense shall first be
recognised by writing down any related intangible assets and related deferred acquisition
costs. As we would recall, the deferred acquisition costs relate to those costs incurred at the
commencement of an insurance contract and which are expected to lead to future economic
benefits to the insurer. If the expected future claims exceed the unearned income, however,
there are no real benefits from signing up the contracts (indeed, there are expected to be
losses) and as such it appears appropriate for the deferred acquisition costs to be expensed.
In applying the liability adequacy test, paragraph 9.1 of AASB 1023 requires:
The adequacy of the unearned premium liability shall be assessed by considering
current estimates of the present value of the expected future cash flows relating to
future claims arising from the rights and obligations under current general
insurance contracts. If the present value of the expected future cash flows relating
to future claims arising from the rights and obligations under current general
insurance contracts, plus an additional risk margin to reflect the inherent
uncertainty in the central estimate, exceed the unearned premium liability less
related intangible assets and related deferred acquisition costs, then the unearned
premium liability is deficient. The entire deficiency shall be recognised in the
income statement. In recognising the deficiency in the income statement the insurer
shall first write down any related intangible assets and then the related deferred
acquisition costs. If an additional liability is required this shall be recognised in the
balance sheet as an unexpired risk liability. The liability adequacy test for the
unearned premium liability shall be performed at the level of a portfolio of

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contracts that are subject to broadly similar risks and are managed together as a
single portfolio.
22.9

Having fewer periods over which to discount the future cash flow will increase its present
value. As an example if it is considered that the entity will pay $50 000 in 3 years and the
appropriate discount rate is 10 per cent, then its present value would be $50 000/(1.1) 3 =
$37 566. One year later, and still using 10 per cent, the present value would be $50 000/
(1.1)2 = $41 322.
According to AASB 1023, the change in the present value of the obligation due to the
passing of time ($3756 in the above illustration) should be included in the claims expense for
the current financial period. As paragraph 6.1.3 of AASB 1023 states:
The portion of the increase in the liability for outstanding claims from the previous
reporting date to the current reporting date which is due to discounted claims not
yet settled being one period closer to settlement, ought, conceptually, to be
recognised as interest expense of the current reporting period. However, it is
considered that the costs of distinguishing this component of the increase in the
outstanding claims liability exceed the benefits that may be gained from its
disclosure. Thus, such increase is included in claims expense for the current
reporting period.

22.10 Broadly speaking, the rationale for a general insurer to value property, plant and equipment
and investment properties (that are integral to the business of general insurance) is that
AASB 1023 requires the general insurer to do so. The reason for this is that such information
will provide a better indication of whether the entity will be able to meet outstanding claims.
However, if it got to the point that the assets actually had to be disposed to meet the needs of
claimants then such sales would not tend to be orderly and therefore the actual receipts may
occur on a liquidation basiswhich would be less than fair value.
22.11 Paragraph 4.2.6 of AASB 1023 provides the answer to this question. It states:
From the perspective of the reinsurer, reinsurance premiums accepted are akin to
premiums accepted by a direct insurer. The reinsurer recognises inwards reinsurance
premiums ceded to it as revenue in the same way as a direct insurer treats the
acceptance of direct premiums as revenue.
22.12 (a)

The stamp duty payable on an insurance contract would typically be charged to the
customer and collected from the customer up front. The collection of stamp duties
from customers is not treated as revenue by the insurer but, rather, as revenue held on
behalf of the government (that is, as a liability). As paragraph 4.2.3 of AASB 1023
states:
In most States, stamp duty is charged on individual general
insurance contracts and is separately identified by insurers on
policy documents. The insurer is normally required to collect and
pass on to the government an equivalent amount. Because such
stamp duty is a tax collected on behalf of a third party and there is
no choice on the part of the insurer but to collect the duty from
the insured, it is not income of the insurer. Similarly, Goods and
Services Tax (GST) is not income of the insurer.

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(b)

The workers compensation charge would be part of the employee costs of the general
insurer. These costs would be built into the premiums charged to customers. That is,
the premiums would typically be higher to compensate for such costs. Hence, to the
extent that the costs are incorporated into the premium, the premium inclusive of the
component designed to cover the workers compensation levy would be treated as
part of premium revenue. As paragraph 4.2.2 of AASB 1023 states:
For certain classes of general insurance business, government authorities
may require the payment of levies and charges. For example, workers
compensation insurance levies, annual licence fees and fire brigade
charges may apply. Such levies and charges are expenses of the insurer,
rather than government charges directly upon those insured. The insurer is
not acting simply as a collector of these levies and charges. Although not
compelled to collect these amounts from those insured, the insurer is
entitled to include in premiums an amount to cover the estimated amount
of the levies and charges. The insurer is usually responsible for paying the
levies and charges at a later date. The amount paid by the insurer does not
depend on the amounts collected from those insured in relation to the
levies and charges. Therefore, the amounts collected to meet levies and
charges are income of the insurer. The insurer accrues for all levies and
charges expected under the general insurance contracts written in the
period.
If expenditure for certain levies and charges is incurred by the insurer upon the
acceptance of an insurance contract and the expenditure relates to income to be earned
in the future, the portion of the levies and charges that relates to unearned premium
revenue will need to be recognised as a prepayment in the accounts of the insurer.

22.13 It would be expected that adopting fair values would enable an account user to be better able
to assess the performance of the entity in terms of its decisions regarding investment choices.
It should also provide a better assessment of the ability of the entity to meet its claims when
they fall due. On the down-side, however, it may be argued that taking the changes in the fair
value of the investment properties to the profit or loss will introduce an unacceptable level of
volatility into the accounts. Further, it is possible that the value of the investment properties
at reporting date may not be reflective of the value either shortly before, or after, reporting
date.
Using net fair values may also be argued to introduce an element of subjectivity into the
accounts, particularly when the assets are relatively unique in nature.
22.14 The liability adequacy test is an assessment of whether the carrying amount of an insurance
liability needs to be increased (or the carrying amount of the related deferred acquisition
costs or related intangible assets decreased) based on a review of future cash flows.
In undertaking the liability adequacy test the entity must consider future claims, which are
defined as claims in respect of insured events that are expected to occur in future reporting
periods under policies where the attachment date is prior to the reporting date.
The present value of the future claims (which, again, is based on actuarial assessments)
must then be compared with the unearned premiums (that is, the amounts that are received to
cover the future claims) to determine if the unearned premiums appear to be sufficient to
cover the expected future claims. If the present value of the future claims (as calculated by
actuaries) exceeds the unearned premium liability, the perspective taken within AASB 1023 is
that the liability is deficient and a further liability (and a corresponding expense) needs to be
recognised. This expense is to be recognised first by writing down any related intangible
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assets and related deferred acquisition costs. As we know, deferred acquisition costs relate to
costs that are incurred at the commencement of an insurance contract and that are expected
to lead to future economic benefits for the insurer. If the expected future claims exceed the
unearned income, however, there are no real benefits to be derived from signing up the
contracts (indeed, losses would be expected) and as such it would appear appropriate for the
deferred acquisition costs to be expensed.
In applying the liability adequacy test, paragraph 9.1 of AASB 1023 requires the
following:
The adequacy of the unearned premium liability shall be assessed by considering
current estimates of the present value of the expected future cash flows relating to
future claims arising from the rights and obligations under current general
insurance contracts. If the present value of the expected future cash flows relating
to future claims arising from the rights and obligations under current general
insurance contracts, plus an additional risk margin to reflect the inherent
uncertainty in the central estimate, exceed the unearned premium liability less
related intangible assets and related deferred acquisition costs, then the unearned
premium liability is deficient. The entire deficiency shall be recognised in the
income statement. In recognising the deficiency in the income statement the insurer
shall first write down any related intangible assets and then the related deferred
acquisition costs. If an additional liability is required this shall be recognised in the
balance sheet as an unexpired risk liability. The liability adequacy test for the
unearned premium liability shall be performed at the level of a portfolio of
contracts that are subject to broadly similar risks and are managed together as a
single portfolio.

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