8.1 Obligations arising from life insurance contracts (life insurance liabilities) shall be recognised as liabilities and shall be measured at the end of each reporting period as:
(a) the net present value of future receipts from and payments to policyholders, including participating benefits, allowing for the possibility of discontinuance before the end of insurance contract periods, plus planned margins of revenues over expenses relating to services yet to be provided to policyholders, on the basis of assumptions that are best estimates and using a discount rate determined in accordance with paragraphs 8.7 or 8.8; or
(b) the accumulated benefits to policyholders after allowing for the portion of acquisition costs expected to be recouped where the result would not be materially different from the application of paragraph 8.1(a).
8.1.1 The participating benefits component of life insurance liabilities includes previously vested benefits and future supportable bonuses. In addition to life insurance liabilities, there may be other liabilities that relate to participating policyholders. Insurance contract benefits attributable to participating policyholders that are not yet vested with specific policyholders are recognised as liabilities. These are further discussed in section 9.
8.1.2 Premiums are generally received in advance of the provision of services to policyholders, including the payment of claims. In return for premiums, life insurers provide services sometimes over long periods. Entering into a life insurance contract is considered to be the event that gives rise to future benefits and present obligations under a policy.
8.1.3 Where there are a number of variables relating to future uncertainties, a net present value approach to measuring life insurance liabilities is likely to provide the most appropriate measurement basis. The obligations under these more complex contracts are generally measured as the present value of the expected inflows, such as premiums and fees, and outflows, such as claims and other expenses, based on assumptions relating to whole populations of policyholders, and taking into account applicable taxation.
8.1.4 An accumulation approach involves accruing the entitlements in policyholders’ records at the end of the reporting period. If the fees expected to be charged by the life insurer to the policyholder in each future reporting period are expected to equal or exceed any expenses incurred by the life insurer, the life insurance liability calculated under the accumulation approach would not be materially different from that obtained using the approach in paragraph 8.1(a).
8.1.5 The ultimate cost of meeting claims under many life insurance contracts depends on the frequency of occurrence of particular future events such as death and surrender and in some cases may depend upon other factors such as the future levels of investment returns. Assumptions need to be made about these future events. In order to ensure that life insurance liabilities are measured reliably, such assumptions need to be “best estimates”.
8.1.6 Best estimate assumptions used in determining the present value of life insurance liabilities, such as the best estimate of the bonus rate, are made on the basis of the assets available to the life insurer at the end of the reporting period and do not include any allowance for future contributions by owners and other funds which may be provided in the future to support the business.
Acquisition Costs
8.1.7 Life insurance contracts written in one reporting period often give rise to benefits to the life insurer in subsequent reporting periods, such as future management fees and surrender penalties. Therefore, there are future benefits associated with the costs of acquiring life insurance contracts, and such costs are often substantial.
8.1.8 In the life insurance industry, acquisition costs are usually recognised as expenses in the reporting period in which they are incurred. This is generally offset by identifying a portion of the planned margins included in life insurance liabilities as relating to the recovery of acquisition costs. The most useful and reliable information available about the acquisition costs that will give rise to future economic benefits is the amount of future charges for acquisition costs identified as part of the process of determining life insurance liabilities.
Recognition of Planned Margins as Revenues
8.2 Planned margins of revenues over expenses for life insurance contracts shall be recognised in the statement of comprehensive income over the reporting periods during which the services, to which those margins relate, are provided to policyholders, and the revenues, relating to those services, are received.
8.2.1 In setting premium rates, life insurers will include planned margins of revenues over expenses. As noted in paragraph 8.1.2, premiums are generally received in advance of the provision of services to policyholders.
8.2.2 In this Standard, planned margins are recognised in the statement of comprehensive income when, and only when, the life insurer has performed the services necessary to establish a valid claim to those margins and has received the revenues relating to those services. To ensure that planned margins are recognised during the reporting period in which the relevant services are provided, life insurance liabilities include a component relating to those margins. These margins are then “released” based on one or more factors or “profit carriers” which correspond to the performance of services and the earning of the margins. In relation to many products, the profit carrier might be premiums or claims.
Differences between Actual and Assumed Experience
8.3 Except in relation to investment earnings rate assumptions for participating business, the effect of changes in life insurance liabilities resulting from a difference between actual and assumed experience determined during the reporting period shall be recognised in the statement of comprehensive income as income or expenses in the reporting period in which the changes occur.
8.3.1 The assumed patterns and frequencies of events used in determining life insurance liabilities are compared with actual events in each reporting period to assess their accuracy. The effects of differences between actual and assumed experience represents decreases or increases in the expected payments to policyholders and are income or expenses of the reporting period in which the differences occur. For example, where the assumed costs of death claims under a renewable term life product line are greater than the actual costs for a reporting period, income equal to the difference is recognised in the statement of comprehensive income for the current reporting period.
8.3.2 The recognition of the net amount of changes in life insurance liabilities resulting from a difference between actual and assumed experience identified during the reporting period as income or an expense is consistent with the use of assumptions that are best estimates as at the end of each reporting period.
Changes to Underlying Assumptions
8.4 Assumptions used for measuring life insurance liabilities shall be reviewed for each reporting period. Where the review leads to changes in assumptions, with the exception of new business, the changes shall be deemed to occur at the end of the reporting period.
8.4.1 Assumptions used for measuring new business may be deemed to have occurred at the beginning of the reporting period, or at the date of commencement of the new business or at the end of the reporting period.
8.4.2 In preparing interim financial reports, the end of the reporting period is the end of the interim reporting period. Accordingly, changes in assumptions are deemed to occur at the end of the interim reporting period.
8.5 The financial effects of changes to the assumptions underlying the measurement of life insurance liabilities made during the reporting period shall be recognised in the statement of comprehensive income over the future reporting periods during which services are provided to policyholders, except that:
(a) any estimated excess of the present value of future expenses over the present value of future revenues for a group of related products arising during the reporting period shall be recognised as an expense of the reporting period;
(b) the reversal of an expense previously recognised in accordance with paragraph 8.5(a) shall be recognised as income of the reporting period in which the reversal of the loss is recognised;
(c) the effects of a change to adopted discount rates and related economic assumptions caused by changes in investment market and general economic conditions shall be recognised as income or expense of the reporting period in which the change occurs; and
(d) material calculation errors and similar errors shall be treated in accordance with AASB 108 Accounting Policies, Changes in Accounting Estimates and Errors.
8.5.1 The assumptions underlying the measurement of life insurance liabilities are reviewed at the end of each reporting period. Based on past experience and revised expectations about the future, it may become apparent that particular assumptions are not consistent with likely future experience and need to be changed. Such changes are effectively a reassessment of the likely patterns and frequencies of future events. The normal revision of assumptions is not considered to be an error.
8.5.2 Apart from the circumstances identified in paragraph 8.5, changes to underlying assumptions are effectively recognised over future reporting periods by adjusting the planned margins included in life insurance liabilities. If the effect of a changed assumption is a decrease in the present value of present obligations to policyholders, the planned margin is increased. If the effect is an increase in the present value of obligations to policyholders, the planned margin is reduced. The overall amount of life insurance liabilities is not affected by these changes to underlying assumptions, as long as the planned margin of revenues over expenses is not eliminated.
8.5.3 Material calculation errors and similar errors are treated in accordance with AASB 108. Under AASB 108, except to the extent that it is impracticable to determine either the period-specific effects or the cumulative effect of the error, an entity corrects material prior period errors retrospectively in the first financial statements authorised for issue after their discovery by:
(a) restating the comparative amounts for the prior period(s) presented in which the error occurred; or
(b) if the error occurred before the earliest prior period presented, restating the opening balances of assets, liabilities and equity for the earliest prior period presented.
Changes to Discount Rates and Related Economic Assumptions
8.5.4 As with other assumptions, the discount rates and related economic assumptions used in determining life insurance liabilities are reviewed at the end of each reporting period. The effects of a change to adopted discount rates and related economic assumptions caused by changes in investment market and economic conditions are recognised in the reporting period in which the change is made. For a life insurer with a typical spread of investments, if market yields fall, investment values generally rise and the resulting increases in investment values are recognised as income in the reporting period in which they occur. Where the discount rates are adjusted in line with such falls in market rates, life insurance liabilities for such contracts will increase and an expense will be recognised, having an offsetting (but not usually matching) effect on the increased investment values.
8.5.5 In relation to participating business (which is discussed in section 9), the effect of a change to the assumptions about discount rates, explained in paragraph 8.5.4, is a result of adjusting the best estimate of life insurance liabilities, including future participating benefits. For example, if market rates of return rise, investment values generally fall and the resulting decreases in investment values are recognised as an expense in the reporting period in which they occur. The fall in investment values will clearly impact on the ability of the life insurer to support future participating benefits. These are likely to be reduced, with an offsetting effect on the reduced investment values.
Liability Adequacy Test
8.6 Life insurers shall perform a liability adequacy test.
8.6.1 Situations may arise where the present value of the planned margin of revenues over expenses for a group of related products will be adjusted as a result of changing underlying assumptions to the extent that the planned margin is eliminated and becomes a planned loss. That is, a review of expected future cash flows indicates that the present value of estimated future expenses for a group of related products exceeds the present value of estimated future revenues. In such circumstances, the excess of the present value of expenses over revenues arising during the reporting period is recognised in the statement of comprehensive income in the reporting period in which the assessment is made. The loss reflects a higher present obligation due to adverse future experience, which is now expected in future years. Whilst the future cash flows giving rise to the loss are yet to occur, this treatment is justified on the basis that entering into life insurance contracts is an event that gives rise to a present obligation to meet the expected future claims.
8.6.2 A group of related products, for the purpose of the calculating the planned margin, performing the liability adequacy test and for disclosure, would be products that have substantially the same contractual terms and were priced on the basis of substantially the same assumptions.
8.6.3 In reviewing expected future cash flows, the insurer takes into account both future cash flows under insurance contracts it has issued and the related reinsurance contracts.
8.6.4 Where an intangible asset has arisen under paragraph 13.1.1(b), a loss arises when the present value of planned margins of revenues over expenses is less than the related intangible asset. This test is to be performed for groups of related products and the intangible asset is allocated, on a reasonable basis, across these groups. Any loss is recognised as an expense in the statement of comprehensive income. In recognising the loss in the statement of comprehensive income, the life insurer first writes down the related intangible asset and then reflects any additional liability in the life insurance liabilities.
Discount Rates
8.7 To the extent that the benefits under life insurance contracts are not contractually linked to the performance of the assets held, the life insurance liabilities shall be discounted for the time value of money using risk-free discount rates based on current observable, objective rates that relate to the nature, structure and term of the future obligations.
8.8 To the extent that the benefits under life insurance contracts are contractually linked to the performance of the assets held, the life insurance liabilities shall be discounted using discount rates based on the market returns on assets backing life insurance liabilities.
8.8.1 In applying paragraph 8.7, the discount rates adopted are not intended to reflect risks inherent in the liability cash flows, which might be allowed for by a reduction in the discount rate in a fair value measurement, nor are they intended to reflect the insurance and other non-financial risks and uncertainties reflected in the life insurance liabilities. The discount rates are not intended to include allowance for the cost of any options or guarantees that are separately measured as part of the life insurance liabilities.
8.8.2 In applying paragraph 8.7, typically, government bond rates may be appropriate discount rates for the purposes of this Standard, or they may be an appropriate starting point in determining such discount rates.
Financial Instruments with Discretionary Participation Features
8.9 Financial instruments with discretionary participation features are life insurance contracts for the purposes of this Standard and shall be treated in accordance with paragraphs 8.1 to 8.8 and section 9.