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The Theory of Insurance

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The theory of insurance has been around as long as humans have. The point of insurance is to aid in reducing risks and spreads the risk from the individual to a larger community which diminishes the risk that every insurance policyholders will have losses at the same time. Insurance also offers a substantial foundation of long-term finance for both the public and private divisions. Insurance contracts in financial statements are to be characterized as short-duration or long-duration agreements. Long term policies comprise policies like whole-life insurance and annuities, where short term contracts would comprise property and liability insurance policies. All insurance policies have a rule to be in a legal form or text.

In American insurance policies are organized by the Financial Accounting Standards Board (FASB) by state law and each state may identify that they only need explicit forms for explicit types of insurance. Furthermore, to make sure these regulations are being obeyed these policies must be then accepted by the state insurance department. There are also insurance rules from the International Financial Reporting Standards (IFRS) that must be used by the world about how certain types of contacts should be stated in financial statements, like how to insurance companies report their statements.

There have been two major rules created by FASB and IFRS in the last year that are becoming issues for accountants due to the time and energy that has to be given to follow them. ASC 606 is being proposed by FASB to progress financial standard on recognition of revenue from contracts with customers. IFRS 17 is IFRS’s new insurance contract that will entail detailed disclosures for insurance company’s financial statements. The changes to the disclosures will offer investors more info on these insurance companies documented monies from insurance policies and the extent of risks ascending from their insurance policies. (Chan, 2016) Some feel that these rules will be costly and are not worth the time and energy, while others, like myself, feel that they are much needed and will completely help the insurance industry.

FASB and the International Accounting Standards Board (IASB) distributed joined direction on recognizing revenue from contracts with customers. The new guidance is a major achievement to improve this important area of financial reporting. In June 2014, the FASB and the IASB proclaimed the creation of the FASB-IASB Joint Transition Resource Group for Revenue Recognition (TRG). The objective of this group is to notify the Boards about possible application problems that might occur when businesses state using the newly created revenue standard. The group was also in place to help investors better comprehend explicit facets of the newly created standards. ASC 606, Revenue from Contracts with Customers, was issued mutually by the FASB and IASB on May 28, 2014.

For public entities, the original active date for yearly reporting periods begin after December 15th, 2016. The ASC 606 rule was then differed to the active date of for another year, so public business entities, not-for-profit entities, and employee benefit plans, the effective date would begin after December 15, 2017. All other entities the effective date would be after December 15th, 2018. (ASC 606 — Revenue from Contracts with Customer, n.d.) The new amendment will be effecting all businesses that have contracts to transfer goods and services to clients in exchange for money. The purpose of ASC 606 is to create guidelines on how to account for the nature, timing and risk of revenue from contracts with customers for the users of financial statements. The ones that made this standard want to remove discrepancies and flaws in the current revenue requirements, have a stronger outline for revenue issues, and improving the similarity of revenue recognition ways throughout all industries.

The new ASC 606 standard will not alter the demands that revenue be acknowledged for only quantities not anticipated to be returned. Though, because a right of return is in existence marks the price flexible and subject to the constraint which will end in a variation in timing of revenue recognition to the degree a company determines that the appraised sum varies from the estimation under current GAAP rules. Being consistent with GAAP rules, rights of return can be contractual or based on a business’s customary practice. (Impact of the New Revenue Recognition Standard, 2015)Also, the standard was created to deliver improved disclosure rules and to streamline how the statements are arranged by decreasing the quantity of requirements that the companies must obey by. All insurance policies are to be recorded under the same guidelines as before, ASC 944, however some insurance companies usually perform other services to their customers that are actually not thought of as insurance policies under ASC 944. In these cases, the need to conform and understand ASC 606 is significant and must not be ignored.

These types of other services that insurance companies do that are not under ASC 944 which include but are not limited to agency and advisory type arrangements, claims processing, property valuation, appraisal services, and info risk management services. These types of services could be done on an unrelated basis from the underlying insurance policies and the performance obligations might be different for those services in comparison to the performance obligations of the underlying contract. What this leads to is the need to separately recognize and calculate the suitable revenue recognition arrangement for each performance obligation acknowledged by the insurance company. This will create some challenges when the contract amount for insurance intermediaries includes services for claims handing, policy endorsements, risk management and must be independently be examined for allocation of the contract amount to these performance obligations. However, this will be drastically beneficial for the insurance company financial statement users to understand the risks and rewards of this company. (Jacobs, 2016)

The International Accounting Standards Board (IASB) created a team to work on what was originally called the “Insurance project” in 1997 but it actually took twenty years for it to be fully completed. Now the new insurance accounting standard IFRS 17 will be in effect for the annual reporting periods beginning on Jan. 1, 2021. The fact that there was no globally accepted insurance accounting standard made it very hard for investors and analysts to be able to compare insurance companies” which then generated the use “non-GAAP” measures to evaluate the performance of insurance companies. IFRS 17 finally produces a global accounting standard for insurance policies. Its purpose is to create a reliable framework for the acknowledgment, measurement, presentation and reporting of insurance policies.

Which is supposed to make financial reports more beneficial and clear because it will offer additional info about the worth of insurance obligations because these companies will measure insurance policies at present value; they show the time value of money in projected payments to settle sustained claims; and companies will measure their insurance policies based solely on the obligations shaped by these contracts. Info about success is explained more as businesses will have to deliver dependable data on the components of present and impending profits from insurance agreements. IFRS 17 will be valid also for reinsurance policies, reinsurance policies held; and investment agreements with discretionary contribution features, only if the company issues insurance policies too.

The General Model for Globalization gives a formula on how insurance contract assets should be evaluated. This formula relies on the approximations of future cash flows, the modification for the time value of money, risk modification for non-financial risks, and contractual service margin (CSM). CSM embodies the unearned profit for a collection of insurance policies that the business will recognize over time as it delivers the amenities. These approximations of impending cash flows are remeasured each reporting period that means that specific alterations in anticipated future cash flows are fixed contrary to the CSM and are then recognized in profit or loss over the residual contract period. Companies are also given a choice of accounting policy to either show the effects of alterations in discount rates by putting it in profit or loss or other comprehensive income. Insurance contract revenue must be then documented in the statement of comprehensive income as the entity’s consideration for giving the services under the contracts, and the service expenditures will be documented based on claims and expenditures sustained throughout the specific period. These revenue and expenditure quantities discount any non-distinct investment factor.

The insurance companies must then show their results independently of their finance revenue or expenditures. IFRS 17 demands widespread disclosures to offer info on the recognized amounts from insurance policies and the degree of risks that can happen because of these insurance policies. Examples of these disclosures are but are not limited to the reconciliations of the carrying quantities of insurance policies from the opening to the closing balance and with connections among the movements in the liability to the quantities recognized in the statement of comprehensive income. The new standard will also force companies to restate comparative info. To recognize the issues in providing consistent info, these businesses have two different choices for transition purposes. They can use the modified retrospective approach where generalizations are permitted or the fair value approach.

Using the new standard force companies to use substantial alterations in the info systems and procedures they use to create their financial reports, applicable controls, as well possibly changing the employee that are involved in the accounting processes. It would be sensible for insurance companies to formulate a comprehensive communications plan to give investors, market analysts, and stockholders more simplicity to the alterations to their financial statements and profit profiles. Insurance companies should start strategizing for how they plan to start implementing IFRS 17. Impact assessment studies will be able to help these businesses plan those steps, figure out the amount of energy needed to follow this standard, and describe the financial impressions that will be made. Insurance companies should not to observe the IFRS 17 being just like any other expensive governing requirement but look at the standard as a way to create improved cooperation and collaboration amongst the Finance and Risk/Actuary departments. The IFRS 17 will be an incentive for insurance business to fix and reconfigure the state of their forthcoming financial reporting ways.

Deloitte’s global IFRS insurance leader Francesco Nagari states that IFRS 17 will take much energy to put in effect for companies but a common international accounting language will permit customers, investors, and other involved parties to be able to better compare insurance products across diverse countries. Raj Juta from Deloitte states that insurance companies should start changing for this new standard quickly because waiting for them to begin can end in disorder within insurance corporations and they could realize too late that they are not well equipped to stay on top of the new rules.However, beside the problems that could occur, it will result in many paybacks. The IFRS 17 will aid in clients making better choices in their insurance purchases, particularly when the prices vary considerably throughout the world. Also, insurance analysts will not have to be bothered much regarding the varying standards among the different companies in different countries.

Lastly, venture capitalists and other investors can practice IFRS 17 to boost their portfolios and to choose investments better. Others also suggest that procurement of master’s degree in accounting can definitely help accounting specialists investigate into international accounting standards, especially in the insurance sector. (IFRS 17 Could Impact Multinational Insurance Companies, n.d.)There are many individuals that are opposing these new insurance rules because Life insurance and annuities are intricate to begin with, and a change in insurance accounting rules with brings hurdles such as the fact that companies will need more facts and figures. IFRS 17, for example, does not directly affect America but it will effect professionals that are a part of a business in America that do business with other countries. This means that these accounting professionals will have to now study and follow the IFRS 17 procedures. These procedures demand that they must follow all IASB rules. Other issues that will come from the IFRS 17 accounting rule for insurance will be that the necessities forced by the IASB that requests substantial amounts of work in terms of dividing portfolios. IFRS 17 will force individual insurance businesses to divide portfolios even more in-house to recompense for profit- and loss-making portfolios which will lead to insurance firms being faced by granular distinction amongst and within explicit portfolios.

Also insurers have to use a specific measurement model for ever reporting period. This model is to make sure your reports include discounted cash flows, probability-weighted cash flows, risk adjustment, and contractual service margins. Then separate their contracts into three categories such as contracts that are onerous, contracts that carry no risk of becoming onerous and contracts that don’t apply to either of the first two categories. (IFRS 17 Could Impact Multinational Insurance Companies, n.d.) These insurance companies will need additional data technology, internal controls where means many more people in a trade that has previously been confronted by cutbacks. ASC 606 forces companies to figure out the impact the standard would have on the previous fiscal year. For public businesses who have three years of data they must gauge the influence on two previous years.

Companies must also look over contracts that began numerous years before the effective state of the new standard and may even have to do dual tracking of revenues for the retrospective period which will definitely be a time-consuming and difficult chore. Companies that imagine having alterations amongst their present revenue accounting and the new method they must use under the new rule might opt for the full retrospective changeover technique. This is because revenue will be reflected steadily for every year existing in the financial statements. Obeying to ASC606 will certainly encompass a widespread renovation of methods, procedures and controls across all departments of insurance companies. (ASC 606: Benefits of Early Adoption of the New Revenue Recognition Standard, n.d.)

Companies are holding off on adapting to the new standard because they believe that their insurances policies are under ASC 944 but they do not realize that if they are out of that scope in the slightest they could still be subject to the rule because there are revenue streams that do fall under ASC 606. Research shows that IFRS 17 is going to affect 450 listed insurers who manage 13 trillion dollars in assets. Baker A study piloted by top 10 accounting firm Baker Tilly Virchow Krause, LLP showed that 60 percent of insurance corporations are hardly ready to state using the new auditing standard. Baker Tilly’s staff also say that execution of the new standard will disturb a variation of business functions so it is important that internal resource restrictions be in place when considering to evaluate and the updated standard. (Insurance Companies Not Prepared to Implement New Accounting Standards, 2017)

Willis Towers Watson said that these rules will affect the capability to pay dividends and management bonuses, and meet market-wide performance goals. Even the accounting firm Deloitte says that the effort of the accountants and companies will create operation expenses for the insurers.by an estimated three and four billion dollars for insurers as a whole. (Jones, 2017) This will also lead to companies needing to hire someone that already has been trained in these types of rules. Companies will look for future employees with greater education and experience with more insights into global accounting as well as skills for dealing with international insurance policies. As you can imagine, it would be easier to hire someone from out of the country because they will have greater understanding. Hiring others from overseas will in turn lead to less jobs for Americans.

To conclude, both ASC 606 and IFRS 17 have the objective of changing insurance financial reporting for investors and others so they can better understand them. The objective of ASC 606 is to create principle ways to report the useful info to these user in the financial statements regarding the nature and improbability of revenue from insurance policies with their customers. While the IFRS 17 is an international standard for reporting insurance policies to help the same people understand the insurers risk level, productivity, and financial wellbeing. As we can see these rules will lead to more updated and useful data for users of the financial statements. Obviously we know this will lead to exponentially more work for companies and accountants because they will have to make alterations to their operating metrics, data systems, evaluating specific revenue streams and weighing the need for further internal controls over financial reporting. (Jacobs, 2016)

However, it seems apparent that these changes will be made because it is worth it for the investors to feel comfortable enough to financial support these insurance companies. This is almost the same situation as America not wanting to give up their usage of Generally Accepted Accounting Principles (GAAP) for IFRS so we can all run on the same international standards. We know that these changes will have to be made eventually so adapting to them quickly instead of resisting will make the change of rules easier for the company in the long run. So many pieces of business will be affected by these rules and there is so much at stake, so the sooner a corporation can acclimatize to the new rules, the sooner it can yield its assets. This process will take time to gain a better understanding but preemptive businesses will start discussions with auditors and shareholders as soon as possible to figure out the exact influence there will be on revenue recognition for their organization.(ASC 606: Benefits of Early Adoption of the New Revenue Recognition Standard, n.d.) IASB Chairman.

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GradesFixer. "The Theory of Insurance." GradesFixer, 17 Dec. 2018, https://gradesfixer.com/free-essay-examples/the-theory-of-insurance/
GradesFixer, 2018. The Theory of Insurance. [online] Available at: <https://gradesfixer.com/free-essay-examples/the-theory-of-insurance/> [Accessed 19 September 2020].
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