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Short term Insurance
Tuesday, February 1, 2005
Balancing act

Various types of Self-Insurance Programmes have existed for many years. These benefited clients by looking at Multi-Year Insurance Programmes which enabled them to see through the cyclical nature of the insurance industry, explains Danny Buitendag, National Executive Director, Corporate Risk Services at Glenrand MIB.
From time-to-time, auditors questioned the substance over the form of such transactions but largely they were left untouched and seen as good and proper risk management. But along came the major accounting scandals in the US and Europe and accountants have become very nervous about any structure that could be seen to be a so-called ‘off balance sheet asset or liability’.
These events resulted in a somewhat confrontational period between clients, insurers and the accounting profession. Notes Ian Bain, Divisional Executive Director, Risk Financing Services at Glenmib, “There were various and differing opinions tabled by the large accounting practices with almost no consistency between their interpretations from client-to-client. In parallel with these events, the accounting profession has set up the International Accounting Standards Board (IASB), which wants to rationalise the situation and introduced new disclosure requirements on a regular basis.
“All this has created an atmosphere of uncertainty as to how clients and insurers should treat such policies. This has resulted in the cancellation of certain of these policies because clients did not wish to involve themselves in confrontational positions with the auditors, audit committees or boards,” he says.
“During the course of last year, directive ED5 was issued by the IASB which dealt, amongst other issues, with the accounting treatment of so-called Contingency Policies. This has culminated in the issue of directive IFRS4 from the Board which will be integrated into the SA Institute of Chartered Accountants’ Generally Accepted Accounting Practices (GAAP) with local companies with year ends, after 1st January 2005.
“Whilst IFRS4 will not suit everyone and indeed will be introduced in stages because of its complexity and the implications, it does create a degree of certainty and hopefully consistency in interpretation.”
Mr Bain says the most important aspect of IFRS4 is the definition of insurance contracts which are now defined as “a contract under which one party (the insurer) accepts significant insurance risk from another party (the Policy holder) by agreeing to compensate the policy holder if the specified uncertain future event (the Insured event) adversely affects the policy holder.
The statement goes further to describe significant insurance risk as only if an insured event caused an Insurer to pay a significant additional benefit in any scenario, but excluding those scenarios that lack commercial substance.
IFRS4 creates a clearer definition for those contracts which may not contain significant insurance risk. “Those contracts that are deemed to be investment contracts will be dealt with under the IASB’s directive IAS39 and those that are simply service contracts will be accounted for under IAS18.
What all this means is that there is now agreement on the definition of the Insurance Contract, and which will be subject to the test of significant risk and that will ultimately determine how it will be accounted for in both the financial statements of the insurer and the insured.
This therefore has important implications for the so-called Contingency/ Primary Policies, as it is unlikely that many of them will meet the definition of significant risk and therefore may have to be treated as either an investment contract or a service contract which affects both the tax deductibility and the accounting treatment.
“This does not mean the death of the Contingency/Primary Policies which in our opinion is a legitimate part of the insured’s risk management and insurance programme,” says Mr Bain. “The Industry is now looking to provide so called blended insurance cover. This simply means that one policy is issued which deals both with elements of self-insurance and the transfer of major risk. As it will be looked at as one insurance policy, it will meet the test of risk transfer.
“Whilst in the past, contingency policies have been used to build up reserves over a number of years the blended cover policy, unless it is a multi-year contract, will not enable this to happen. For many clients however, this will not be important and they will be able to continue with their self-insurance program structured slightly differently.
“As for cell captives, we believe that the changed accounting environment could lead to many clients moving out of contingency policies and into cell captives whereby the client will put his capital at risk in the cell structure thereby automatically creating the risk transfers.
“From a client’s point of view, they will therefore account for their premium into the cell captive as they would have in the past and receive tax deductibility. The cell captive will operate as a cell of the insurance Company accepting premium, paying claims, creating reserves, etc. The client will be required to account for their investment in the cell in terms of IAS39 and any increase or decrease in reserves will be reflected in their financial statements.”

Copyright © Insurance Times and Investments® Vol:18.1 1st February, 2005
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