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UNIT III

INSURANCE, BANKS AND SIMILAR


FINANCIAL INSTITUTIONS

CHAPTER 6
THE BUSINESS OF INSURANCE

Fortades, Laniel Christel


Domingo, Marichu
Aranas, Angelica
Policarpio, Patricia Ella

Definition of Insurance

Insurance is defined as the equitable transfer of the risk of a loss, from one entity to
another, in exchange for a premium, and be thought of as a guaranteed small loss to prevent a
large, possibly devastating loss.

Nature
Insurer or Insurance Company (under Sec. 184 of the Philippine Insurance Code) shall
include all individuals, partnerships, associations, or corporations, including government-owned
or controlled corporations or entities, engaged as principals in the insurance business excepting
mutual benefit associations. This term shall also include professional reinsurers.

Insurance corporations are formed or organized to save any person or persons or other
corporations harmless from loss, damage, or liability arising from any unknown or future or
contingent event, or to indemnify or to compensate any person or persons or other corporations
for any such loss, damage, or liability, or to guarantee the performance of or compliance with
contractual obligations or the payment of debt of others.

Principles of Insurance:
Commercially insurable risks typically share seven (7) common characteristics.
1.
2.
3.
4.
5.
6.
7.

A large number of homogeneous exposure units.


Definite Loss.
Accidental Loss.
Large Loss.
Affordable Premium.
Calculable Loss.
Limited risk of catastrophically.

Types of Insurance Products:


A. Life insurance Products

1. Term Insurance is designed to provide pure life cover and so will provide benefit on
death during the term of a policy.
2. Whole Life Assurance (Policy) has no fixed term and there will always be a benefit
(contractual amount, adjusted for items such as policy loans and dividends, if any) at
the death of the insured.
3. Endowment Assurance Policy will pay the policyholder a sum after a fixed period
or on death before the period is completed.
4. Maximum Investment Contracts (Unit Linked Policies). Certain contracts are
designed to provide minimal life cover and the principally investment products.
5. Annuities. An annuity policy provides for payments to be made at regular intervals,
starting at a specified date, usually continuing until the death of the policyholder.
6. Pensions. Pension policies involve paying regular or single premiums to create a
stream of income (starting at retirement), usually also with the option of paying a
capital sum.
7. Permanent Health Insurance. A permanent health policy provides for income to be
paid in the event of the insured falling ill.
B. Non-life Insurance Products:
1. Marine covers insurance against loss or damage connected with navigation to which
a ship, cargo, freight, profits or even interest on movable properties which may be
exposed to perils of the sea during a voyage or for a period of time.
2. Aviation Insurance covers General Aviation risks available in the Aviation
Insurance Market. Risks of this nature pertain to aircrafts that have a seating capacity
of up to 50 seats. Common types of Aviation insurance are:
a. Aviation Hull Risk protects aircraft operators against physical loss/damage to
aircrafts that are being operated under their control at the time of loss.
b. Aviation Legal Liability Insurance protects aircraft owners/operators for legal
liability towards any temporary/permanent bodily injury suffered by the
passengers in the event of an aircraft accident causing bodily injury to passengers
on board the aircraft.
3. Engineering Insurance provides both the contractor and project owner protection
against accidents, damage or loss of materials and works-in-progress, and
construction equipment and machinery loss. A common type of coverage is:
Contractors All Risk Insurance (CAR) insures civil works or project during
the course of construction against sudden and unforeseen loss or damage
occurring within the period of cover.

4. Fire includes insurance against loss by fire and other allied perils.
5. Comprehensive General Liability (CGL) provides protection to the insureds
business against third party claims as a result of property damage and/or bodily injury
arising from the operations of the business.
6. Auto master Insurance covers protection from automobile damage or theft.
Common types of auto master insurance are:
a. Third Party Liability covers risk of accidentally hurting someone or
damaging another persons property.
b. Auto Personal Accident protection of oneself and ones passengers from
expenses arising from vehicular accidents.
c. Acts of God Protection protection from damages of automobile and/or
vehicles against the forces of nature.
d. Riots, Strikes & Civil Commotion protection of vehicles against the perils
of social unrest and lawless elements done intentionally or unintentionally by
third parties.
7. Casualty insurance covering loss or liability arising from accident or mishap.
8. Surety ship Is an agreement whereby a party called a surety guarantees the
performance by another party known as the principal or obligor of an obligation or
undertaking in favor or a third party called oblige.

Definition of Insurance Contract


Insurance Risk- is defined as transferred risk other than financial risk. The requirement
that insurance risk is always transferred risk means that only risks accepted by the
insurer, which were pre-existing for the policy holder at the inception of the contract,meet
the definition of insurance risk.
Insurance risk is significant, only if an insured event could cause an insurer to pay
significant additional benefits. The additional benefits refer to amount that exceed those
that would be payable if no insured event occurred.
Financial Risk- the risk of a possible future change in one or more of a specified interest
rate, financial instrument price, commodity price, foreign exchange rate, index of prices
or rates, credit rating or credit index or other variable, provided in the case of a
nonfinancial variable that the variable is not specified to a party to the contract.

Lapse/ Persistency Risk- (risk that the client will cancel the contract earlier or later) that
the insurer had expected in pricing the contract is not insurance risk as the payment of the
client is not contingent on an uncertain future event that adversely affects the client.
Uncertain Future Event- uncertainty or risk is the essence of insurance contrac t. at least
one of the following is uncertain at the start of a contract:
1) Whether an insured event will occur
2) When it will occur or;
3) How much the insurer will need to pay, if it occurs
Adverse effect on the policyholder- the definition of an insurance contract refers to an
adverse effect on the policyholder. The definition does not limit the payment, by the
issuer, to an amount equal to the financial impact of the adverse event.
Mutual Insurer
An insurer can accept significant insurance risk from the client only if the the insurer is
undertaking, separate from the client. In the case of a mutual insurer, the mutual accept
risk from each policyholder and pools that risk.
Although policyholders bear that pooled risk collectively (in their capacity as owners) the
mutual has still accepted the risk that is the essence of an insurance contract.
Examples of Insurance Contracts
1)

Insurance against theft (or damage) to property.

2) Insurance against product liability, professional liability, civil liability or legal expenses
3) Life insurance and prepaid funeral plans
4) Life contingent annuities and pension
5) Disability and medical cover
6) Surety bonds, fidelity bonds, performance bonds and bid bonds.
7) Credit insurance.
8) Product warranties.
9) Title insurance.
10) Travel assistance.
11) Catastrophe bonds.

12) Insurance swaps and other contracts.


Examples of Contracts that are not Insurance Contracts
1) Life insurance with no mortality risk- life insurance contracts that are written in which
the insurer bears no significant mortality risk are non-insurance financial instruments or
service contracts.
2) Legal form of insurance, but pass all significant insurance risk back to the policyholderthese includes some financial reinsurance contracts, or some group contracts(such contracts
are normally non-insurance financial instruments, or service contracts). Here the client6
keeps all the risk, as any claims paid will be reimbursed by the client through higher
premiums, in the future.
3) Self-insurance- a firm has an internal insurance department. It has a large number of
vehicles. The firm decides that to meet all claims internally, rather than insure with a third
party. The firm retains the risk. There is no insurance contract, as there is no agreement with
another party.
4) Gambling contracts- a client signs a contract with an insurer. The insurer will pay a
fixed amount for r every point gained by a stock exchange in the next year, excluding the
first 100 points. This enables the client to benefit from the gain, without buying shares (the
insurer can buy shares to cover the risk, if he wishes.) this is a gambling contract, not an
insurance contract.
5)

Derivatives that expose one party to financial risk- but not insurance risk, because
they are require that a party to make payment based solely on changes in a specified interest
rate, financial instrument price commodity price,foreign exchange rate, index of prices or
rates, credit rating or credit index or other variable, provided in the case of a non-fictional
variable that the variable is not specific to a party to the contract.
6) Credit-related guarantee contract (or a letter of credit, credit derivative default
product, or credit insurance contract) that requires payments even if the holder has not
incurred a loss on the failure of the debtor to make payments when due.
7) Weather derivatives- contracts that require payment based on a climatic, geological or
other physical variable that is not specific to a party to the contract.

8) Catastrophe bonds- that provide for reduced payments for principal, interest (or both),
based on a climatic, geological or other physical variable that is not specific to a party to the
contract.

CHANGES IN ACCOUNTING POLICIES


An insurer may change its accounting policies for insurance contracts only if the change
makes the financial statements more relevant for users. An insurer shall refer to the criteria in
IAS 8. To justify changing in its accounting policies for insurance contracts, an insurer shall
show that the change brings its financial statements closer to meeting the criteria in IAS 8, but
the change need not achieve full compliance with those criteria.

SHADOW ACCOUNTING (adjustments taken to equity)


Paragraph 30 of IFRS 4 permits, but does not require, the practice of shadow accounting.
Shadow accounting is not the same as fair value hedge accounting under IAS 39. A
non-derivative financial asset or non-derivative financial liability may be designated as a
hedging instrument only for a hedge of foreign currency risk.

Shadow accounting is not applicable for liabilities arising from investment contracts
within the scope of IAS 39 because the underlying measurement of those liabilities does not
depend on asset values or asset returns. However, shadow accounting may be applicable for
discretionary participation feature within an investment contract if the measurement of that
feature depends on asset values or assets returns.
Shadow accounting is not applicable if the measurement of an insurance liability is not
driven directly by realized gains and losses on assets held. Example: Assume that financial
assets are measured at fair value and insurance liabilities are measured using a discount
rate that reflects current market rates but does not depend directly on actual assets held.
The measurement of the assets and the liability does not depend directly in the carrying amount
of the assets held. Therefore, shadow accounting is not applicable and changes in the
carrying amount of the liability are recognized in profit or loss.

INSURANCE CONTRACTS ACQUIRED IN A BUSINESS COMBINATION OR


PORTFOLIO TRANSFER
To comply with IFRS 3, an insurer shall at the acquisition date, measure at fair value the
insurance liabilities assumed and insurance assets acquired in a business combination.
However, an insurer is permitted (but not required) to use a presentation which splits the
fair value of acquired contracts into two components:
1. A liability measured in accordance with the insurers policies for contracts that it issues
2. An intangible asset, representing the difference between (i) the fair value of the
contractual rights required and obligations assumed and (ii) the amount described in (i).
The subsequent measurement of this asset shall be consistent with the measurement of
the related insurance liability.
An insurer acquiring a portfolio of insurance contracts may use this presentation. The
intangible assets are excluded from the scope of IAS 36 impairment of assets and IAS 38
intangible assets.
However, IAS 36 and IAS 38 apply to customer lists (and customer relationships)
reflecting the expectation of future contracts that are not part of the contractual insurance rights
and contractual insurance obligations that existed at the date of a business combination (or
portfolio transfer).

DISCRETIONARY PARTICIPATION FEATURES

Some insurance contracts contain a discretionary participation feature (DPF) as well as a


guaranteed element. An example of a DPF might be a profit-sharing reinsurance contract, where
the cedant is guaranteed a minimum repayment of its premium and a share of the profits at the
reinsurers discretion. The issuer of such contract:
1. May (but need not) record the guaranteed element separately from the discretionary
participation feature. If the issuer does not record them separately, it shall classify the
whole contract as a liability. If the issuer classifies them separately, it shall classify the
guaranteed element as a liability.
2. Shall, if it records the discretionary participation feature separately from the guaranteed
element, classify that feature as either a liability or a separate component of equity.
DISCLOSURE
Explanation of recorded amounts
An insurer shall disclose information that identifies (and explains) the amounts in its financial
statements, arising from insurance contracts. An insurer shall disclose:
1. Its policies for insurance contracts and related assets, liabilities, income and expense.
2. The recorded assets, liabilities, income and expense (and if it presents its cash flow
statement using the direct method, cash flows) arising from insurance contracts.
Furthermore, if the insurer is a cedant, it shall disclose:
Gains (and losses) recorded in the income statement on buying reinsurance
If the cedant amortizes gain (and losses) arising on buying reinsurance, the amortization
for the period and the amounts remaining unamortized at the beginning and end of the
period.
3. The process used to determine the assumptions that have the greatest effect on the
measurement of the recorded amounts described in (2). Where practicable, an insurer
shall also give quantified disclosure of those assumptions.
4. The effect of changes in assumptions used to measure insurance assets and insurance
liabilities, showing separately the effect of each change that has a material effect on the
financial statements.
5. Reconciliations of changes in insurance liabilities, reinsurance assets and if any related
deferred acquisition costs.
Nature and extent of risks arising from insurance contracts
An insurer shall disclose information that helps users to understand the amount, timing
and uncertainty of cash flows from insurance contracts. An insurer shall disclose:
1. Its objectives in managing risks arising from insurance contracts and its policies for
mitigating those risks.

2. Information about insurance risk (both before and after risk mitigation by reinsurance)
including information about:
The sensitivity of the income statement and equity to changes in variables that
have a material effect on them
Concentrations of insurance risk including a description of how management
determines concentrations and a description of the shared characteristics that
identifies each concentration (e.g. type of insured event, geographical area or
currency)
3. Actual claims compared with previous estimates (i.e. claims development)
4. The information about liquidity risk, market risk and credit risk that IFRS 7 would
require, if the insurance contract were within the scope of IFRS 7.
5.

Information about exposure to interest rate risk (or market risk, under embedded
derivatives) contained in a host insurance contract, if the insurer is not required to (and
does not) measure the embedded derivatives at fair value.

Redesignation of Financial Assets


When an insurer changes its policies for insurance liabilities, it is permitted (but not
required) to reclassify some (or all) of its financial assets as at fair value through the income
statement.
This reclassification is permitted is an insurer changes policies when it first applies IFRS
4 and if it makes a subsequent policy change. The reclassification is a change in policy and IAS 8
applies.