Insurance contracts for non-insurers?

Published on 11 October 2013 0 comments

By John Hitchins

My title might seem like a contradiction in terms to many of you, but that’s the problem. Only insurers have been engaged in the sixteen year old IASB project on insurance accounting yet the proposals could have an impact outside the insurance industry, especially for service contracts.

Unsurprisingly, non-insurance entities have not closely followed the development of the insurance contracts standard, except for a few banks with products that contain an insurance element, such as equity release mortgages. The insurance project is just for insurers, right?

Well, you could be wrong. IFRS 4 for insurance contracts already applies to a number of contracts outside the insurance industry. However, entities have been allowed to continue with their previous accounting practice as IFRS 4 does not contain detailed measurement guidance. That will all change when the new requirements come into play. While some service arrangements are scoped out, non-insurers might not be aware that the proposals could apply to their products. The IASB solved a number of issues when developing the exposure draft (ED), for example, around roadside assistance programmes and maintenance and repair contracts. Most of these arrangements won’t be in scope if their primary purpose is the provision of service and the contract is not individually priced.

Service contracts

The ED requires arrangements meeting the definition of an insurance contract (that is, the arrangement transfers significant insurance risk) to be accounted for under the insurance contract guidance, regardless of the type of entity issuing the arrangement. Some service contracts are specifically scoped out but not all.

For example, let’s look at an entity that manufactures big ticket items such as aircraft engines. The entity enters into a contract to service these for the next few years. In setting the contract price, management include an assessment of the risk associated with the individual customer, for example, the temperature in the engine and the distance flown. As this contract includes an assessment of individual customer risk, it is in the insurance contracts standard’s scope. This could equally apply to other big ticket items such as lifts and computer hardware. And it applies not only if the entity services items that it manufactures but also if the entity services items manufactured by other entities.

Warranties

Another common misconception is that warranties are scoped out of the insurance proposals. Most are, but if your business is not a manufacturer, dealer or retailer, warranties provided to customers could still be in scope. For example, if an entity that organises internet auctions also issues warranties for certain products sold, these could be in scope.

What is your view?

So do you think these contracts should be accounted for as insurance contracts? Some say these types of service contracts should be accounted for as insurance contracts, but others violently disagree. If the contracts are for a year or less then the accounting may not be that different, but for longer term service contracts the insurance proposals will require current discounted cash flows. My key point is that non-insurers should engage in the debate and be aware of what might be ahead of them.

Even though the final standard may be a few years away from implementation, this could be the last chance to influence the debate. The comment period ends on 25 October.

John Hitchins:
Read profile | Contact by email | Tel: 020 7804 2497


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