Banks with insurance businesses are busy transitioning to the new insurance standard, IFRS 17 Insurance Contracts, which is effective from 1 January 2023.
However, the new standard applies to any insurance contract regardless of who issued it. Banks not caught by insurance accounting in the past may have contracts or arrangements containing insurance risk and could now be liable for adhering to the standard.
Examining the scope of IFRS 17
IFRS 17 defines an insurance contract as one under which one party (the issuer) accepts significant insurance risk from another party (a contract holder) by agreeing to compensate the holder, if a specified uncertain future event adversely affects the holder.
There are three qualifying stages for IFRS 17 that apply to the issuing bank’s contract. Firstly, the contract holder must require compensation for a specified uncertain future event, which could be in cash but might be in kind (for example, repairing or replacing a broken product). The future event must be uncertain at contract inception.
Secondly the specified uncertain future event needs to adversely affect the holder. For example, a contract which compensates the owner of a building for damage caused by an earthquake would meet the criterion because the owner would be adversely affected. Climate derivatives, however, are not insurance contracts (see section below on Derivatives).
Thirdly, significant insurance risk must be transferred from the holder. Insurance risk is any risk other than financial risk transferred from the holder to the issuer. Financial risk is the risk of a possible future change in a specified variable. In the case of non-financial variables, they must not be specific to a party to the contract to qualify as a financial risk.
If all three stages are met, IFRS17 may apply.
Other standards override IFRS 17 even if the insurance contract definition is otherwise met:
- Employer’s assets and liabilities (IFRS 2 / IAS 19)
- Contractual rights/obligations contingent on future use of a non-financial item (IFRS 16 / IFRS 15 / IAS 38)
- Residual value guarantees (for lessees) within a lease (IFRS 16)
- Contingent consideration arising from business combinations (IFRS 3)
- Insurance contracts held (but not reinsurance contracts), and
- Credit card contracts provided no assessment of the customer’s insurance risk is undertaken when setting the contract price.
Where no other scope exclusion applies, a bank can also choose to apply either IFRS 9 or IFRS 17 to contracts which limit the compensation to the amount otherwise required to settle the holder's obligation (see section below on Equity release mortgages).
Non-insurance contracts containing insurance features
The following is not exhaustive but outlines some of the contracts issued by banks that meet the definition of an insurance contract or which otherwise contain insurance risk and ought to be assessed.
Financial guarantees
Many banks issue financial guarantee contracts requiring them to make specified payments to reimburse the holder for a loss incurred because a specified debtor fails to make a payment when due. Although these contracts meet the definition of an insurance contract, they are outside the scope of IFRS 17 except where the issuer has previously asserted that it regards such contracts as insurance contracts and has accounted for them on that basis.
Credit card contracts
Some credit card contracts meet the definition of an insurance contract because they make payments to the cardholder where goods or services bought are faulty or are not delivered in some cases where the cardholder has been defrauded. Providing that contract pricing does not reflect an assessment of an individual customer’s insurance risk, IFRS 17 does not apply. In the UK credit card purchases over £100 are protected under consumer legislation and separate contractual obligations are not created.
Derivatives
Climatic or weather derivatives are not insurance contracts. Using the earthquake example, a derivative which involves a payment if there is an earthquake does not, as a precondition, require an adverse effect on the holder. The risk arises from a non-financial variable that is not specific to either party to the contract. These and other derivatives transfer financial rather than insurance risk and are accounted for under IFRS 9.
Equity release mortgages
Some banks issue equity release mortgages (aka ‘lifetime’ mortgages) with a ‘no negative equity’ guarantee. The contractual terms specify that principal and accrued interest becomes payable when the borrower dies or moves into long-term care. The proceeds from selling the property are used to repay the mortgage. The bank does not share any excess of the sales proceeds over the amount due but bears any shortfall. The contract transfers both financial and insurance risk to the bank arising from changes in market prices (financial variable) and property condition (non-financial variable). However, because the maximum shortfall is the mortgage balance (where the benefit to the borrower is limited to the amount otherwise required to settle their obligation), many banks typically elect to apply IFRS 9 rather than IFRS 17. Under IFRS 9, an equity release mortgage can be held at amortised cost provided the cash flow effect of the ‘no negative equity’ guarantee is negligible.
Enhanced current accounts
Banks may issue current accounts containing travel or mobile insurance or vehicle breakdown cover. The bank charges the customer a fee and negotiates with third parties to provide the insurance or breakdown cover. A portion of the fee representing the insurance or breakdown premium is passed to those third parties. These arrangements do not transfer insurance risk to the bank. Any insurance claims or breakdown services are between the customer and the third party. Fees and associated costs are not therefore accounted for under IFRS 17.
Action required
Banks, who are non-insurers, should not assume that IFRS 17 does not apply even if it might be clear that any insurance risk is insignificant. Banks should review contracts to identify whether any contain insurance risk and fall within the scope of IFRS 17. Banks should document their conclusions and take appropriate action including making any necessary elections.