Law in Quebec

The new standard, intended to improve financial disclosure, recognition and measurement criteria for insurance contracts, introduces a universal definition of an insurance contract that came into effect as of January 1, 2011.

Thanks to this new definition, insurance contracts must under International Financial Reporting Standards (IFRS) 4 involve the transfer of significant insurance risk to be considered as an insurance contract, otherwise it could be deemed to be either investment contracts or service contracts.

IFRS 4 is part of a two-phase approach adopted by the independent, privately-funded accounting standard-setter based in London, England towards the issuance of accounting standards for insurance contracts. A more comprehensive standard is currently under development.

On July 2010, the IASB issued a contentious exposure draft for a revised comprehensive standard for insurance contracts, which according to Canada’s life industry, could significantly change insurance accounting and could potentially have a negative impact on the quarterly results of Canadian insurers and may affect their ability to sell certain long-term investments.

A final standard  is expected issued in mid-2011, and expected to be in effect in 2013 at the earliest. “There’s a lot of pressure to make sure that the IASB get it right rather than just rush to get a standard done within an artificial time period,” said a life insurance expert regarding the controversial exposure draft.

In the meantime, though, life insurers are adjusting to the consequences of the new definition of life insurance contracts.

“Where the first phase of IFRS 4 seems to have had the most important impact, at least for Canadian insurers, is in situations where arrangements previously considered as insurance contracts are now more or less carved out of that definition, and are essentially considered to be more in the nature of deposit liabilities,” explained Jason Swales, a lawyer and partner in the tax services practice of PricewaterhouseCoopers LLP in Toronto. “The industry was quite keen to have Canada’s Department of Finance put new rules in place so that they’re seen in an enacted form prior to the beginning of 2011 when IFRS was effective.”

Approximately 10 per cent of Canadian life insurance contracts will be affected by the new definition, and will now be considered as either investment or service contracts, according to the Canadian Life and Health Insurance Association Inc.

The new definition will have an impact. The reclassification of life insurance policies to investment or service contracts could have a significant impact on a life insurer’s actuarial liabilities, said Swales. Moreover, the actuarial liabilities could be affected by changes to the treatment of assets supporting insurance liabilities on the adoption of IFRS, added Swales.

In other words, the way that actuarial reserves are determined in accordance with methodologies used under the current Canadian system  is “somewhat dependent” on the value of assets that underlie or support those insurance reserves. With the adoption of IFRS those assets may now be required to value their assets at fair value as opposed to amortized cost.

“Think of a pool of assets that are supporting the insurance liabilities,” said Swales. “If all of a sudden we’re valuing those assets in a different way, at fair value, then that’ll have a corresponding impact on the insurance reserves as well. So there’s really two issues – the change in the definition of the insurance contract as well as this change to the assets that underlying the reserves – and both of these items have a consequential impact on tax, which were addressed by the legislation” recently introduced by Canada’s Department of Finance.

Yet if past history is anything to go by, even though the Department of Finance introduced legislation that will address certain adverse consequences on adoption of IFRS, it will still take some time before all the kinks are worked out.

When the Finance Department changed the tax rules that applied to financial institutions and insurers due to the introduction of the Handbook 3855 of the Canadian Generally Accepted Accounting Principles (GAAP), which changed the accounting for investments, it took the Finance Department several years to actually finalize the rules, leaving “companies in an unenviable position” of having to prepare their accounts based on the old and new legislation, all of which “created additional work and more uncertainty.”

While the details of the changes imposed by IFRS 4 are clearly in the domain of accountants, Swales advises commercial, corporate and tax lawyers to polish up or at least acquaint themselves with the new IFRS insurance contract standard.

“This is a particular area of tax law in which accounting plays a significant role, and that’s not always the case,” remarked Swales. “In many areas of tax, the rules stand on their own. IFRS 4 is complex so there’s always going to be a primary role for accountants to tell us what they think. But in terms of understanding the rules, the legislation and the policy aspect and assisting as well to the extent that there is a lobbying requirement – that’s a traditional role that a lawyer would be asked to play.”