On December 22, 2009, the Ministry of Finance and CIRC jointly published Relevant Accounting Rules on Insurance Contract (“the Rule”). The long awaited rule finally lifted its veil at the end of this year.
Government officials from Ministry of Finance and CIRC commented on the rule. According to the officials, the rule is designed to eliminate the discrepancies existing in the accounting standards of A-share annual report and H-share annual report. All insurance companies are required to follow the rule in creating the 2009 financial report.
The rule mainly covers three components: split-up of mixed insurance contract, major risk evaluation and calculation of reserves of insurance contract.
1. The rule requires mixed insurance contract to be divided when certain conditions are satisfied. A mixed insurance policy is a type of contract which contains not only insurance risk but other risks as well. In practice, they are lumped together as insurance contract, regardless they can be individually distinguished and calculated or not. It is expressly provided in the rule that a mixed insurance contract should be divided, where it can, into insurance contract and other contracts. Where it is impossible to be divided, a mixed insurance must be subject to major risk evaluation test.
2. Insurance company is required to take major risk evaluation test. Currently, insurance company has no major risk evaluation test in place—when insurance risk is transferred, an insurance contract is deemed to have been formed and premium income is recognized. Under the rule, however, all insurance contracts subject to major risk evaluation must be given the test on the date of recognizing the contracts. The point is to test whether the contracted insurance accidents are likely to result in payment of major additional interest by the insurer. If yes, the contract should be recognized as insurance contract and the charged premium should be recognized as premium income. If not, the contract is not recognized as insurance contract and the charged premium shouldn’t be recognized as premium income.
3. The rule also provides that reasonably estimated expenses are to be taken as the basis for calculating reserve of insurance contract. Currently, insurers compute reserves in accordance with statutory actuarial rule, and combine accounting rules with supervising requirements. This treatment fails to constitute a fair reflection of insurers’ status in terms of liabilities and operation performance. It is expressly provided in the rule that an insurer take reasonably estimated expenses incurred in performing the contract to be the basis for calculation, with due considerations given to marginal factors and time value of money. At the time of contract recognition, insurers shouldn’t recognize first day income, but first day loss instead. In addition, information available at the balance sheet date should be taken as the basis for determining discount rate, insurance accident rate, surrender rate, expenses ratio and policy dividend.
Officials also said the new rule has small impact on the insurance companies’ financial status, operating results and solvency. Most of the companies will show increased net assets and net profits numbers in balance sheet.