AASB 2005-2 - Amendments to Australian Accounting Standard - June 2005

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Legislation au F2005L01699 Not in force Legislative Instrument

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Explanatory Statement

AASB 2005-2 Amendments to Australian Accounting Standard

June 2005

EXPLANATORY STATEMENT

Reasons for Issuing AASB 2005-2

AASB 2005-2 is an amending standard, which makes amendments to AASB 1023 General Insurance Contracts. AASB 1023 was issued in July 2004.

In January 2005 some AASB constituents raised concerns with the AASB about the liability adequacy test, namely:

 the test constitutes a significant change to existing practice, considering that Phase I of the Insurance Project[1] is intended to introduce minimal change;

 requiring the same or similar probability of adequacy in performing the liability adequacy test, to that used in determining the outstanding claims liability, could create deficiencies in the unearned premium liability that are not expected to eventuate in practice; and

 requiring the liability adequacy test to be performed at an Australian Prudential Regulatory Authority (“APRA”) class of business level, or at an equivalent level for entities not regulated by APRA, goes beyond the requirements of, and expectations for, Phase I and creates unnecessary complexity for entities consolidating entities regulated by APRA with entities not regulated by APRA.

In response to these concerns, the AASB issued an Invitation to Comment Liability Adequacy Test in AASB 1023 General Insurance Contracts in March 2005.

Main Features of this Standard

This Standard was made by the AASB on 3 June 2005 under section 334 of the Corporations Act 2001.

Application Date

This Standard is applicable to annual reporting periods beginning on or after 1 January 2005 with early adoption not permitted.

Main Changes from AASB 1023 (July 2004)

The main changes from AASB 1023 (issued July 2004) are identified below [showing the relevant paragraph numbers in the Standard in square brackets].

1. The liability adequacy test is to be performed at the level of a portfolio of contracts that are subject to broadly similar risks and are managed together as a single portfolio. In contrast, under AASB 1023, issued in July 2004, the liability adequacy test is performed at the reporting entity level by class of business. For general insurers registered with the Australian Prudential Regulation Authority (“APRA”), a class of business is determined using the Prescribed Classes of Business used by APRA. For general insurers not registered with APRA, the test is performed using the APRA Prescribed Classes of Business or at an equivalent level of aggregation. [Paragraph 9.1]

2. Insurers are not required to adopt the same or similar probability of adequacy in performing the liability adequacy test, to that used in determining the outstanding claims liability. However, the users of financial reports need to be presented with information explaining any differences in probabilities of adequacy adopted, and insurers are required to disclose the reasons for any differences in accordance with paragraph 17.8(e). In contrast, under AASB 1023, issued in July 2004, insurers were required to adopt the same or similar probabilities of adequacy. [Paragraph 9.1.2]

3. Insurers are required to provide additional disclosures in relation to the liability adequacy test. In addition to existing disclosures, insurers are required to disclose:

a) where a deficiency has been identified, the amounts underlying the calculation performed, that is:

(i) unearned premium liability;

(ii) related reinsurance asset;

(iii) deferred acquisition costs;

(iv) intangible assets;

(iv) present value of expected future cash flows for future claims, showing expected reinsurance recoveries separately; and

(v) deficiency;

(b) in relation to the present value of expected future cash flows for future claims:

(i) the central estimate of the present value of expected future cash flows;

(ii) the component of present value of expected future cash flows related to the risk margin;

(iii) the percentage risk margin adopted in determining the present value of expected future cash flows (determined from (i) and (ii) above);

(iv) the probability of adequacy intended to be achieved through adoption of the risk margin; and

(v) the process used to determine the risk margin, including the way in which diversification of risks has been allowed for;

(e) where the probability of adequacy adopted in determining the outstanding claims liability is not the same or similar to the probability of adequacy adopted in performing the liability adequacy test, the reasons for the difference; and

(f) where a surplus has been identified, the insurer should disclose that the liability adequacy test identified a surplus. [Paragraph 17.8]

Consultation prior to Issuing this Standard

Public consultation was part of the process undertaken by the AASB prior to its decision to issue this Standard, amending the existing version of AASB 1023 (issued July 2004).

An Invitation to Comment Liability Adequacy Test in AASB 1023 General Insurance Contracts was issued for public comment in March 2004, with a comment period ending on 4 April 2005.

Six submissions relating to the Invitation to Comment were received and the AASB considered these submissions in finalising the amendments to AASB 1023.

A Regulatory Impact Statement has not been prepared in connection with the revision of this Standard as the amendments it makes do not have a direct, or substantial indirect, effect on business or restrict competition, are of a minor or machinery nature and do not substantially alter existing arrangements.

[1] The International Accounting Standards Board (“IASB”) is engaged in an Insurance Project to develop an accounting standard for insurance contracts. The AASB is working closely with the IASB to develop this standard. Phase I of this project was completed in time for the 2005 adoption of international accounting standards by Australian and European entities. Phase I was intended to make limited improvements to accounting for insurance contracts. Phase I of the project is incorporated in IFRS 4 Insurance Contracts. In Australia, Phase I is incorporated in AASB 4 Insurance Contracts, updated AASB 1023 (July 2004) and updated AASB 1038 Life Insurance Contracts (July 2004). Phase II of the project is dealing with recognition and measurement issues and is not expected to be completed until at least 2007.

Overview

The AASB 2005-2 Amendments to Australian Accounting Standard was enacted in June 2005 by the Australian Accounting Standards Board (AASB) under the authority of the Corporations Act 2001. This amendment was introduced to address concerns raised by AASB constituents regarding the liability adequacy test in AASB 1023 General Insurance Contracts. The concerns included the significant change to existing practice, potential deficiencies in the unearned premium liability, and unnecessary complexity for entities consolidating entities regulated by APRA with entities not regulated by APRA. The policy objective of this amendment is to provide a more practical and simplified approach to the liability adequacy test for general insurance contracts, while maintaining the integrity of financial reporting. This amendment was made following public consultation and consideration of submissions received in response to an Invitation to Comment issued by the AASB in March 2005.

Scope and Application

AASB 2005-2, which amends Australian Accounting Standard AASB 1023 General Insurance Contracts, applies to entities that issue general insurance contracts and are subject to the Corporations Act 2001. The amendments respond to concerns raised by AASB constituents about the liability adequacy test, which has been revised to be performed at the level of a portfolio of contracts that are subject to broadly similar risks and managed together, rather than at the reporting entity level by class of business. The changes also allow for different probabilities of adequacy in the liability adequacy test compared to the outstanding claims liability, with additional disclosures required to explain any differences. These amendments are applicable to annual reporting periods beginning on or after 1 January 2005, with early adoption not permitted. The AASB made this standard under section 334 of the Corporations Act 2001, ensuring that it applies to all entities regulated under this Act that issue general insurance contracts. The standard does not specify any exclusions, exemptions, or thresholds, and its application is not extended or restricted by subordinate instruments.

Key Provisions

The AASB 2005-2 Amendments to Australian Accounting Standard, issued on 3 June 2005 under section 334 of the Corporations Act 2001, introduces modifications to AASB 1023 General Insurance Contracts ((1)). These changes primarily address concerns raised by AASB constituents about the liability adequacy test, aiming to align the standard with the minimal change intent of Phase I of the Insurance Project ((2)). The key amendments include adjusting the level at which the liability adequacy test is performed, modifying the probability of adequacy requirements, and enhancing disclosure obligations for insurers ((3)). Under the amended standard, the liability adequacy test must be performed at the level of a portfolio of contracts that are subject to broadly similar risks and managed together as a single portfolio ((4)). This contrasts with the previous requirement, which mandated the test to be conducted at the reporting entity level by class of business ((5)). Additionally, insurers are no longer required to adopt the same or similar probability of adequacy in the liability adequacy test as that used in determining the outstanding claims liability, although they must disclose any differences and the reasons for them ((6)). The enhanced disclosure requirements include details such as the amounts underlying the calculation of the unearned premium liability, related reinsurance assets, deferred acquisition costs, intangible assets, present value of expected future cash flows for future claims, and the deficiency identified ((7)). Entities governed by AASB 2005-2 must comply with the new provisions for the liability adequacy test, ensuring it is performed at the appropriate level and that any differences in the probability of adequacy are properly disclosed. Insurers must also provide comprehensive disclosures as specified, including detailed calculations and the rationale behind any variations in the probability of adequacy ((8)). Failure to comply with these requirements may result in non-compliance with Australian accounting standards, potentially impacting the accuracy and reliability of financial reports ((9)). There are no specific offences, penalties, or consequences outlined in the AASB 2005-2 amendments themselves ((10)). However, non-compliance with Australian accounting standards can lead to broader legal and financial repercussions, including potential investigations by regulatory bodies, financial penalties, or reputational damage to the entity ((11)). The primary focus of AASB 2005-2 is to ensure the adequacy and clarity of financial reporting in the insurance sector, rather than to impose direct penalties for non-compliance with the amendments.

Area of Law: Financial Regulation
Instrument: Regulation
Concepts: Definitions & Interpretation; Reporting & Disclosure Obligations; Regulatory Standards
Catchwords: Liability Adequacy Test

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