For IRDA, one-size-fits-all IFRS guidance a challenge

The roadmap issued by the ministry of corporate affairs ( MCA) requires all insurance companies to apply International Financial Reporting Standards (IFRS) starting from April 1, 2012. Interestingly, IFRS 4 insurance contracts and IAS 39 financial instruments: recognition and measurement are being revised by the International Accounting Standards Board (IASB). The replacement standards IFRS 4 — Phase 2 & IFRS 9 are not expected to be applicable until at least 2013. Because of the moving goal post, the question is should insurers be made to converge with IFRS in 2012, and thereafter in a short time be subjected to another round of significant changes or should we postpone implementation till the insurance and related standards are finalised by IASB, so that the convergence for insurers takes place only once.

This is a matter on which IRDA or MCA should provide immediate clarification. In a survey conducted by Ernst & Young on the IFRS perspectives in the insurance sector, disclosures were identified as the biggest pain area. IFRS-4 requires a number of disclosures , such as, risk management objectives and policies, information about insurance risks — including sensitivity to and concentration of insurance risks, actual claims compared with previous estimates etc. As insurance contract accounting varies among various jurisdictions, the current effective IFRS-4 was issued as an interim measure by IASB to make limited improvements to accounting for insurance contracts. The aim of the project was not to make fundamental changes to accounting of insurance contracts, but to set the path for IFRS-4 – Phase 2, which would be a more comprehensive standard.

A key requirement of insurers is to assess as to whether a product contract would meet the definition of an insurance contract or an investment contract. Under the current IFRS-4 , the company has an option to continue to account for insurance contracts as per its current accounting policies (subject to certain conditions ), whereas the accounting for investment contracts (products where significant insurance risk is not transferred) is governed by IAS39. Even though IFRS-4 allows firms to continue with existing accounting policies under their respective national GAAP, it may still entail significant amendments to current accounting for insurance contracts under Indian GAAP, especially where the product classification exercise results in the contracts being classified as investment contracts. As an illustrative example of the potential impact — let us assume a Ulip (for which the IFRS product classification exercise results in an investment contract classification) for which premium of 1,000 is received.

Under Indian GAAP, the entire amount is recognised as revenue. Under IFRS, as the product would meet the definition of an investment contract , accounting would fall within the purview of IAS39 and potentially the proceeds received would be recognised as a liability, and not as revenue. In addition, when IFRS-4 – Phase 2 kicks in, insurance contracts accounted under Indian GAAP will also entail significant amendments. Deferred acquisition costs are another area of difference between IFRS. Investments of an insurer are required to be segregated and measured as per IRDA regulations. Those rules differ from those under IAS 39. For example, under IFRS, an entity that applies HTM classification for its debt securities has to hold them to maturity. Sales or reclassification before maturity, taint such classification and would result in such securities being measured at fair value. There are no such tainting provisions under IRDA regulations for any classification of investments . It is worthwhile to note that IFRS 9, which replaces IAS 39, will have completely different requirements in this regard.

In the E&Y survey, 62% participant felt that lack of sufficient guidance and the emerging standards was the main hurdle. Most insurance entities prefer to continue getting comprehensive accounting guidance from the regulator to make things clearer and consistent across companies . It would be a challenging task for IRDA to issue a one-size-fits-all guidance under IFRS, since application of several IFRS principles; for example, the determination of business model for investment classification (IFRS9) will depend on facts and circumstances for each entity. Therefore IRDA will have to be careful that the guidelines issued by it do not violate global practice or the spirit of the overall IFRS framework.

(The author is partner and national IFRS leader, Ernst & Young. Views are personal)