Separation of Insurance Contract
It is common practice for each financial reporting standard to delineate the scope of insurance contracts, defining what falls within and outside its purview. In TFRS 17, the standard specifies its own boundaries, detailing which components are subject to consideration under TFRS 17. For instance, it addresses the insurance component, the Non-Distinct Investment Component (NDIC), etc.
This chapter aims to categorize and analyze various types of insurance contracts, identifying elements that may not align with TFRS 17. Such additional components often arise from life insurance policies incorporating investment features or other bundled services alongside life coverage.
Thus, the focus here is on extracting and distinguishing the pure insurance component. This aspect is less problematic for non-life insurance businesses since it aligns more directly with their core offerings (in contrast, it was initially written to encompass life insurance to a greater extent).
Separation of Insurance Contract divides its content into four parts:
Insurance Component
The Insurance Component refers to elements of the insurance contract that focus on providing coverage. In simpler terms, it involves the sum insured designated to pay out when specified events occur as outlined in the policy document.
Embedded Derivatives
The Embedded Derivative component is less relevant to traditional non-life insurance as it involves derivative instruments created within insurance contracts that include investment elements. Examples include:
Callable Bond (where the debtor can repay the principal at any time and cease interest payments immediately.)
Interest Rate Swap (financial instruments requiring financial engineering knowledge, exchanging floating interest rates for fixed rates or vice versa.)
Currency Swap (financial instruments exchanging one currency's interest rate for another.)
When applying the concept of Embedded Derivatives to insurance business, there are certain types of insurance products that may potentially involve them, such as:
Guaranteed Minimum Benefits (GMXB) in life insurance, including various guarantees associated with investment-linked products like Unit Linked or Universal Life policies.
Insurance policies where premiums collected are invested in one currency while the sum insured are denominated in a different currency. This scenario involves assets and liabilities in different currencies, akin to guaranteeing liabilities in a foreign currency different from the asset side.
These examples illustrate how Embedded Derivatives can be relevant within certain types of insurance contracts, particularly those with integrated investment components and currency exposure.
In this first topic, Embedded Derivatives are not significantly relevant to the context of non-life insurance but are more relevant to life insurance business. They are rarely seen in life insurance policies in Thailand as well. Therefore, if readers find Embedded Derivatives confusing or unclear, they can safely skip this section without affecting their understanding of non-life insurance business directly.
Investment Component
One area that many people tend to find confusing is the distinction of the Investment Component. This part is relevant to insurance business because insurers typically invest premiums to generate returns to meet future claim obligations, which is prominently observed in life insurance operations.
The Investment Component can be classified into two types:
Distinct Investment Component: This refers to investments that are clearly separated and visible, such as in Unit Linked insurance products where there is a Unit Account or Account Value that shows the investment's current worth and can be used to assess withdrawals. This aspect is typically not relevant to non-life insurance, except in cases where non-life insurance products are structured as Unit Linked policies (though this is rare).
Non-distinct Investment Component: This involves investments embedded within insurance contracts that is non-distinct (unable to measure one component without considering the other). These often include types where funds are returned to customers, such as Return of Premium (ROP) policies or Experience Refunds, which are considered part of the Non-distinct Investment Component (NDIC). This component resembles deposits where funds are held and later returned.
The key point is that the Distinct Investment Component will not fall under TFRS 17 but will be treated as financial instruments under TFRS 9 for financial reporting purposes. On the other hand, the Non-distinct Investment Component remains subject to TFRS 17.
In interpreting this for the ease of insurance business operations, we can equate No Claim Bonus (NCB) to a straightforward insurance premium discount. These adjustments can simplify complexities without needing to categorize them as Non-distinct Investment Components.
Regarding life insurance (potentially also applicable to non-life insurance in the future), it involves types like Equity Index Linked or Gold Index Linked policies where the policy specifies payouts based on the performance of invested stocks or gold, respectively.
Promises to Transfer Goods or Non-Insurance Services
The final part of the first topic is Distinct Goods and Services (Promises to Transfer Goods or Non-Insurance Services), which falls under TFRS 15 and pertains to revenue recognition. This section typically involves supplementary services that accompany insurance premiums, such as additional medical services that are charged separately. However, such elements are rarely seen in the non-life insurance business, as additional charges for supplementary services are not commonly levied.
In summary, this first section outlines the standard's requirement to define the scope of the Insurance Contract. Apart from insurance components, there is a component that still relates to TFRS 17 which is Non-distinct Investment Components , however when presenting in financial position this item does not appear on the top line (Insurance Revenue and Service Expense).
Let’s consider an example of a Non-distinct Investment Component (NDIC) like Return of Premium (ROP) in life insurance. Suppose the insurance premium is 1,000 Baht paid upfront, and the contract duration is 10 years. At the end of the 10-year period, the Return of Premium is 100 Baht. In this example, the insurance company would recognize revenue annually, averaging 90 Baht per year (1,000 Baht minus 100 Baht return, divided by 10 years). Over the 10-year term, the total recognized revenue would amount to 900 Baht. This implies that the 100 Baht that is not recognized (Revenue recognized 900 Baht compared to the expected 1,000 Baht) will then be offset by the 100 Baht from return of premium.
Another important aspect of the Non-Distinct Investment Component (NDIC) to emphasize is that the 100 Baht from the Return of Premium (ROP), classified as NDIC, will not be recorded in the profit and loss statement. Instead, it will be fully reserved from the first day in the amount of 100 Baht. This reserve will remain until the ROP is actually paid to the beneficiary, at which point the reserve will be reduced to zero. It is important to note that from the start of reserving until the ROP is paid, this amount will not impact the profit and loss statement at all.
Written by Master Tommy (Pichet)
FSA, FIA, FRM, FSAT, MBA, MScFE (Hons), B.Eng (Hons)
All rights reserved for the content of this article. Do not use it for any commercial gain. In addition to receiving permission from ABS company only.
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