[Analysis] Ind AS 117 [Insurance Contracts] – New Accounting Standard for Indian Insurance Companies

Ind AS 117, Insurance Contracts, is a new accounting standard in India that aligns with the global IFRS 17 standard. Effective April 1, 2024, Ind AS 117 aims to improve the transparency and comparability of financial reports for insurance companies by providing a consistent framework for recognizing, measuring, presenting, and disclosing insurance contracts. It applies to entities that issue or hold insurance contracts, including reinsurance and investment contracts with discretionary participation features. The standard mandates that insurance contracts be grouped into portfolios based on similar risks and managed collectively, with specific guidelines on their recognition, measurement, and derecognition. Ind AS 117 represents a significant shift in accounting practices for the insurance sector, requiring companies to enhance their financial reporting systems and align with international norms.

Table of Contents

1. Introduction
2. Applicability of Ind AS 117
3. Contracts Excluded from Ind AS 117
4. Level of Aggregation of Insurance Contracts
5. Recognition of Insurance Contracts
6. Measurement of Insurance Contracts
7. Derecognition of Insurance Contracts
8. Presentation and Disclosure under Ind AS 117
9. Transitioning to Ind AS 117
10. Key Features of Ind AS 117
11. Challenges and Opportunities

1. Introduction

Ind AS 117, Insurance Contracts, signifies a pivotal change in India’s accounting standards, aligning with the internationally recognized IFRS 17, Insurance Contracts. Starting April 1, 2024, this new standard aims to improve transparency and comparability in the financial reports of Indian insurance companies.

The initiative to adopt Ind AS 117 in India started with releasing an exposure draft by the Institute of Chartered Accountants of India (ICAI) in 2018. Following a review, the National Financial Reporting Authority (NFRA) offered recommendations to the Ministry of Corporate Affairs (MCA) in July 2023. Subsequently, the Insurance Regulatory and Development Authority of India (IRDAI) took crucial steps, including instructing selected insurance firms to align their reports with IFRS 17 as of August 2023. By February 2024, the IRDAI had formed an Expert Committee to guide the implementation of Ind AS 117, establishing phase-wise timelines and providing comprehensive instructions for proforma financial statements and necessary disclosures.

Although insurance companies are defining their transition plans under the guidance of IRDAI, entities that are required to prepare Ind AS-compliant consolidated financial statements due to a non-insurance parent or investor must implement Ind AS 117 by April 1, 2024. Furthermore, firms previously utilizing Ind AS 104 for guarantee and other insurance contracts must transition to Ind AS 117.

1.1 History

Over the past decade, India’s financial reporting standards have evolved considerably, with corporate and non-banking financial companies (NBFCs) moving to Indian Accounting Standards (Ind AS). Meanwhile, insurance companies have adhered to Indian GAAP and IRDAI regulations. The implementation of Ind AS 117, following its official notification by the Ministry of Corporate Affairs (MCA) on August 12, 2024, represents a significant advancement in aligning the insurance sector with global accounting norms.

1.2 Global Impact of IFRS 17 and India’s Path to Alignment

With this update, India joins over 140 countries that have embraced IFRS 17, establishing a new standard in insurance reporting on risk exposure, profitability, and financial positioning. Given the Indian insurance sector’s management of assets totalling $13 trillion, the transition to Ind AS 117 is vital for maintaining strong and transparent accounting practices within the industry.

2. Applicability of Ind AS 117

Ind AS 117 applies to all entities that issue, hold, or manage insurance contracts, including reinsurance contracts and investment contracts with discretionary participation features, as well as insurance contracts acquired through business combinations or transfers, excluding reinsurance contracts held. This standard affects a diverse range of sectors, such as life, general, and reinsurance, along with other financial services that offer products akin to insurance.

This standard extends beyond insurance companies alone, as it applies to any entity dealing with contracts that meet the criteria outlined by Ind AS 117. Entities must thoroughly review their contracts to ascertain whether they fall under this standard’s definition of insurance contracts.

2.1 Meaning of Insurance Contracts

An insurance contract is a pact wherein one party (the insurer) undertakes to compensate another (the policyholder) upon a specified uncertain event adversely affecting the policyholder. To qualify as an insurance contract, a contract must facilitate a substantial transfer of insurance risk from the policyholder to the insurer. Such a risk is considered substantial if the insured event’s occurrence might compel the insurer to pay significant amounts in any plausible scenario, despite the unlikelihood of such events or the small expected payouts relative to the contract’s total value.

Compensation under an insurance contract may be monetary or provided through services like replacing stolen items or offering medical aid, with the contract’s classification as insurance remains intact regardless of the form of compensation. Some fixed-fee service agreements may qualify as insurance contracts if they meet certain criteria; however, entities may opt to account for these under Ind AS 117 or Ind AS 115, Revenue from Contracts with Customers, as per paragraph 8.

The core feature of an insurance contract is the uncertainty regarding the likelihood, timing, or amount related to the insured event at the contract’s commencement.

A. Combination of Insurance Contracts

When multiple insurance contracts are issued to the same or related counterparty, they may be structured to achieve a collective commercial objective. To accurately capture their economic essence, it might be necessary to treat them as a single combined contract, especially if one contract effectively neutralizes the effects of another when issued concurrently.

B. Separating components from an insurance contract

Insurance contracts may encompass elements like investment components or non-insurance services governed by different standards. Entities must identify and segregate these elements using Ind AS 109 for embedded derivatives and investment components and Ind AS 115 for non-insurance services. Once separated, the residual parts of the contract are managed under Ind AS 117.

2.2 Meaning of Reinsurance Contract

Under Ind AS 117, a “Reinsurance Contract” is described as an insurance contract initiated by one entity (the reinsurer) to indemnify another entity (the ceding company) against claims stemming from one or more insurance contracts issued by the latter.

Reinsurance is a protective mechanism for insurance companies, allowing them to transfer the risk of significant losses to another insurance company (the reinsurer). Essentially, the reinsurer commits to cover claims the ceding company’s policyholders might initiate.

For instance, consider Company A, which offers home insurance. Company A could face numerous simultaneous claims from its clients if a severe natural disaster like an earthquake occurs. To mitigate the financial risk of these claims, Company A might enter into a reinsurance agreement with Company B, whereby Company B agrees to absorb some of the financial burden from these claims.

2.3 Definition of Investment Contracts with Discretionary Participation Features

Ind AS 117 defines “investment contracts with discretionary participation features” as financial instruments granting an investor the contractual right to receive, in addition to a guaranteed amount, supplementary amounts that:

• represent a significant portion of the total contractual benefits,
• are determined in amount and timing at the issuer’s discretion and
• Are based on:

1. 1. returns from a specific pool or type of contract,
   2. realized or unrealized investment returns on certain assets managed by the issuer or
   3. the profit or loss of the entity or fund issuing the contract.

In simpler terms, these are investment contracts where an investor receives a guaranteed base return and may also receive additional significant benefits, the nature and timing of which are decided by the issuer based on the performance of specific assets or contracts. For example, if an individual invests in a savings plan offered by an insurance company, the plan might guarantee a 4% annual return. Depending on the performance of the company’s investment portfolio, the investor might also earn an annual bonus. The specifics of this bonus—its amount and the timing of its payment—are at the insurance company’s discretion, and these discretionary benefits define the unique feature of the investment contract.

While these investment contracts do not fulfil the criteria to be classified as insurance contracts, they fall under the purview of Ind AS 117 if issued by entities that also issue insurance contracts, ensuring comprehensive coverage within the financial reporting framework.

3. Contracts Excluded from Ind AS 117

Ind AS 117 does not cover several specific types of contracts governed by other applicable Indian Accounting Standards (Ind AS). These exclusions ensure that each contract type is accounted for under the most appropriate framework. Here’s an overview of these exclusions:

• Product Warranties – These include warranties provided by manufacturers, dealers, or retailers with the sale of goods or services and are covered under Ind AS 115, Revenue from Contracts with Customers, and Ind AS 37, Provisions, Contingent Liabilities, and Contingent Assets.
• Employee Benefits – This category encompasses contracts related to employee benefit plans, such as retirement benefits, addressed by Ind AS 102, Share-based Payment, and Ind AS 19, Employee Benefits.
• Non-Financial Items – Contracts involving rights or obligations linked to the future use of non-financial items, like license fees or lease agreements, are managed under Ind AS 115, Revenue from Contracts with Customers, Ind AS 38, Intangible Assets, and Ind AS 116, Leases.
• Residual Value Guarantees – These guarantees, often provided by manufacturers or dealers or embedded in leases, are treated under Ind AS 115, Revenue from Contracts with Customers, and Ind AS 116, Leases.
• Financial Guarantees – These are contracts where financial guarantees are given unless the issuer classifies them as insurance contracts. Issuers can apply Ind AS 117 or select from Ind AS 32, Financial Instruments: Presentation, Ind AS 107, Financial Instruments: Disclosures, and Ind AS 109, Financial Instruments. The choice made is irrevocable per contract.
• Business Combinations – Contingent consideration payable or receivable in a business combination is regulated under Ind AS 103, Business Combinations.
• Policyholder Insurance Contracts – Contracts where the entity is the policyholder are generally excluded unless they are reinsurance contracts.
• Credit Card Contracts – Contracts related to credit cards or similar arrangements that include credit terms and qualify as insurance contracts, unless the insurance risk influences individual pricing, fall under Ind AS 109, Financial Instruments.

For all these exclusions, entities must apply the relevant Ind AS standard that best fits the nature of the contract rather than Ind AS 117.

3.1 Applicability of Ind AS 117 to Fixed Fee Service Contract

Fixed Fee Service Contracts that align with the definition of an insurance contract allow entities a choice between applying Ind AS 115, Revenue from Contracts with Customers, or Ind AS 117, Insurance Contracts. This decision must be made individually for each contract, and once chosen, it becomes irrevocable. The criteria for choosing to apply Ind AS 117 over Ind AS 115 are:

• The contract’s pricing does not vary based on the customer’s individual risk.
• Compensation under the contract is provided through services rather than monetary payments.
• The primary insurance risk arises from the customer’s utilization of the services rather than the uncertainty of costs.

4. Level of Aggregation of Insurance Contracts

For the management and reporting of insurance contracts, entities must organize these contracts into portfolios that share similar risks and are managed together. Each portfolio is further segmented into at least three groups:

• Onerous Contracts – Contracts that are onerous at the time of initial recognition.
• Contracts with Low Risk of Becoming Onerous – Contracts that, at inception, have no significant risk of becoming onerous.
• Other Contracts – All remaining contracts that do not fall into the previous categories.

Further subdivision of these groups is permissible if the entity has detailed internal data supporting such granularity. Moreover, contracts issued more than one year apart must not be grouped.

According to Ind AS 117, entities must adhere to the recognition and measurement guidelines specific to these groups. Based on the criteria outlined, groups must be established at the initial recognition of the contracts. Entities can add new contracts to existing groups as they are recognized, as specified in paragraph 28 of Ind AS 117. Once established, the composition of these groups should remain consistent without reassessment or alteration.

5. Recognition of Insurance Contracts

An entity is required to recognize a group of insurance contracts upon the earliest occurrence of the following events:

• The beginning of the insurance coverage period.
• The due date of the first payment from the policyholder.
• Identification of the group as likely to produce a loss (i.e., the contracts are onerous).

The contracts must meet one of the above criteria for recognition during any reporting period. The entity must determine the appropriate discount rates and the extent of coverage provided. If the first payment does not have a specified due date, it is recognized when received.

5.1 Onerous Contract Assessment

Before formally recognizing a group of contracts, the entity needs to evaluate whether any contracts within the group are onerous. This check is particularly crucial before the coverage commences or before the first payment is due, especially if there are indications that some contracts could be onerous.

5.2 Adding Contracts After Reporting Period

Contracts can be added to an existing group after the reporting period has ended, but only if they fulfil the established recognition criteria. When new contracts are added, the entity might need to revisit and adjust the discount rates initially used from the start of the reporting period to accommodate these new additions.

6. Measurement of Insurance Contracts

Under Ind AS 117, the measurement of insurance contracts is designed to provide a true representation of the expected cash flows, the time value of money, and both financial and non-financial risks associated with these contracts.

6.1 Initial Measurement under Ind AS 117

At the initial recognition, a group of insurance contracts is measured as the sum of:

• Fulfilment Cash Flows – This component includes projections of all future cash flows within the contract boundaries, adjusted for the time value of money and financial risks, and a risk adjustment for non-financial risks.
• Contractual Service Margin (CSM) – This is a crucial element, ensuring no immediate gains are recognized upon issuing the insurance contracts. It represents the profit that will be earned as the entity provides services under the contracts over the period of coverage.

Ind AS 117 defines the CSM as part of the asset or liability for a group of insurance contracts, signifying the unearned profit the entity will recognize as it delivers services under these contracts.

6.2 Subsequent Measurement under Ind AS 117

A. At each reporting period’s end, the total carrying amount for a group of insurance contracts comprises:

• Liability for Remaining Coverage, which includes:

1. 1. Fulfillment Cash Flows – Projections of future cash flows linked to the remaining period of insurance coverage, calculated according to established guidelines.
   2. Contractual Service Margin – This reflects the unearned profit that will be recognized as the insurance services rendered.

• Liability for Incurred Claims, encompassing:

1. 1. Fulfillment Cash Flows – Estimates of future cash flows for claims that have already occurred.

B. Recognition of income and expenses due to changes in the liability for remaining coverage involves:

• Insurance Revenue – Recognized due to decreased liability resulting from service provision during the period.
• Insurance Service Expenses – Includes costs from onerous contracts and any reversals of such losses.
• Insurance Finance Income or Expenses – Reflect changes related to the time value of money and financial risks.

C. Within the Liability for Incurred Claims:

• Insurance Service Expenses are recognized for increases due to claims and related costs.
• Changes in the fulfilment cash flows linked to these incurred claims and the time value of money and financial risks are reflected in the Insurance Finance Income or Expenses.

Entities must adhere to these guidelines when measuring all groups of insurance contracts under Ind AS 117. However, exceptions exist:

• For some insurance contracts, entities may opt for the simpler “premium allocation approach” detailed in paragraphs 55–59 of Ind AS 117.
• Different rules apply to reinsurance contracts held, and certain guidelines concerning profit-sharing and loss-bearing features are not applicable.
• For investment contracts with discretionary participation features, entities must follow the specialized rules outlined in paragraph 71, which modify the standard measurement principles to suit these contracts.

7. Derecognition of Insurance Contracts

An insurance contract is derecognized from the entity’s books when the contract is terminated, cancelled, or fulfilled or under circumstances such as the sale of the contract to another company or its replacement with a new contract. The process for removing an insurance contract from the books involves several key steps:

• Cash Flow Adjustments – The entity must revise its estimated future cash flows to exclude any payments and associated risks that pertain to the derecognized contract.
• Contractual Service Margin (CSM) Update – Adjust the unearned profit (CSM) to reflect the removal of the contract. This involves recalculating the CSM to account for the change in expected future profits due to the derecognition.
• Coverage Units Adjustment – Modify the coverage units to reflect the termination or cancellation of the contract. This adjustment ensures that the recognition of profit is appropriately aligned with the coverage provided up to the point of derecognition.
• Accounting for Transferred or Replaced Contracts – If the contract is transferred to another party or replaced by a new contract, the entity must account for any premium differences as though the new premium were received at the time of the contractual change. This adjustment ensures that the financial statements reflect the true nature of the entity’s obligations and entitlements following the transfer or replacement.

By following these steps, the entity ensures that its financial statements accurately represent its contractual rights and obligations following the derecognition of an insurance contract.

8. Presentation and Disclosure under Ind AS 117

The requirements for presenting and disclosing Insurance Contracts under Ind AS 117 ensure transparency and enable stakeholders to assess the impact of these contracts on the financial position, performance, and cash flows of an entity. Here are the specific guidelines:

8.1 Presentation of Insurance Contracts under Ind AS 117

An entity is required to present separately in the balance sheet the carrying amounts of:

• Insurance contracts issued that are assets;
• Insurance contracts issued that are liabilities;
• Reinsurance contracts held that are assets; and
• Reinsurance contracts held that are liabilities.

In the profit and loss statement, entities must separately present the following key components:

• Insurance Service Result, which includes –

1. 1. Insurance Revenue: Reflecting services provided through insurance contracts, measured according to specific guidelines.
   2. Insurance Service Expenses: Covering incurred claims and other related service expenses, excluding any investment components.

• Insurance Finance Income or Expenses – This category captures the financial effects related to the time value of money and changes in risks associated with insurance contracts. Entities have options regarding how these effects are reported in profit or loss.
• Reinsurance – Income and expenses from reinsurance contracts are to be distinctly reported from those of issued insurance contracts, with clear guidelines for the presentation of reinsurance recoveries and premiums.
• Accounting Policy Choices – Entities have discretion in how to recognize insurance finance income or expenses, with options to report them directly in profit or loss or to allocate them systematically over time with differences recognized in other comprehensive income.

8.2 Disclosure of Insurance Contracts under Ind AS 117

To aid users in evaluating the effects of these contracts, entities must disclose qualitative and quantitative information concerning recognized amounts, significant judgments, and associated risks. Key disclosure requirements include:

• Reconciliations – showing changes in the net carrying amounts of contracts due to cash flows, income, and expenses.
• Separate Disclosures – for insurance contracts issued and reinsurance contracts held.
• Methods, Assumptions, and Estimation Techniques – Clear disclosure of the methodologies and assumptions used in measuring contracts.
• Changes in Methods and Processes – Disclose reasons for any methodological changes, the processes involved, and their impact on the contracts.
• Risk Information – Provide detailed information on insurance and financial risks such as credit, liquidity, and market risks, including how these risks are managed.
• Risk Concentration and Sensitivity Analyses – Disclose information on risk concentrations, perform sensitivity analyses, and provide claims development information to give a comprehensive view of the risk landscape.

These detailed presentation and disclosure requirements under Ind AS 117 ensure that all stakeholders have a clear understanding of the nature, extent, and management of insurance and reinsurance contracts within the reporting entity.

9. Transitioning to Ind AS 117

Transitioning to Ind AS 117 involves significant adjustments for insurance companies across various areas, including financial reporting, actuarial practices, product design, pricing strategies, underwriting processes, reinsurance arrangements, treasury operations, IT systems, and data management. To facilitate a smoother transition and ensure alignment with the new standards, the following steps are recommended:

• Diagnostic Phase
  Evaluate existing processes, systems, and compliance with current standards. Determine what needs to change to meet Ind AS 117 requirements.
• Design Phase
  Create a detailed plan outlining the changes needed and how they will be implemented. Set up a governance framework to oversee the transition.
• Implementation Phase

1. 1. Implement necessary changes in financial systems and actuarial models.
   2. Adjust insurance products and pricing strategies as per the new standards.
   3. Ensure all relevant staff are trained on the new standards

• Testing and Validation
  Test new systems and processes to ensure they work as expected and ensure that that all changes comply with Ind AS 117.
  
• Engage with Regulators

1. 1. Work with regulators to resolve any issues related to compliance and reporting.
   2. Ensure that investor reporting and statutory deadlines are met.

• Final Review
  Conduct a final review of the transition process and make necessary adjustments based on the results.

When transitioning to Ind AS 109, insurers can choose from three distinct approaches:

• The Full Retrospective Approach, which involves restating comparative information as if Ind AS 109 had always been applied, without using hindsight.
• The Full Retrospective Approach with Certain Exemptions allows for adjustments in opening retained earnings to reflect exemptions.
• The Classification Overlay Approach permits the classification and measurement of financial assets based on their expected treatment under Ind AS 109, using information available at the transition date.

The Insurance Regulatory and Development Authority of India (IRDAI) will issue notifications to insurers regarding the applicability of Ind AS 117 for statutory reporting purposes.

Non-insurers, on the other hand, should evaluate the relevance of Ind AS 117 to their existing contracts, including those financial guarantee contracts previously governed under Ind AS 104. This assessment is crucial to ensure compliance with the new standards.

10. Key Features of Ind AS 117

• Risk Adjustment: Future Cash Flow Uncertainity
• Enhanced Disclosures
• Contractual Service Margin: Unearned Profit Recognition
• Revenue Shift: Premium to Service Revenue
• Premium Allocation Approach: Alternate Contract Method
• Time Value of Money
• Profit Recognition: Over Service Period

11. Challenges and Opportunities

Ind AS 117 mandates a substantial shift in accounting for insurance contracts, promoting greater transparency and consistency in financial reporting. This change challenges entities to enhance their understanding of insurance liabilities and improve financial reporting systems, ultimately benefiting users with clearer and more comparable information. The adoption of Ind AS 117, driven by NFRA recommendations, now heavily depends on IRDAI’s implementation roadmap. This transition presents challenges like new measurement models, overhauling recognition and measurement principles, and enhancing disclosure requirements. Insurers must strategically consider their implementation approaches, particularly in areas like transition options, compliance with Ind AS 109, and managing dual reporting complexities. Additionally, the industry requires updated regulations, clear tax guidance, and adjustments to solvency norms, marking a pivotal transformation in India’s insurance accounting practices.