Life Insurance (Prudential Rules) Determination

No. 6 of 2005
Prudential Rules No. 49 - Contract Classification for the
purpose of regulatory reporting to APRA

Life Insurance Act 1995

I, John Francis Laker, Chair of APRA, under subsection 252(1) of the Life Insurance Act 1995
(the Act):

• MAKE the Prudential Rules No. 49 set out in the Schedule for the purposes of subsection
82(5), paragraph 117(2)(d) and subsections 117(3), 244(1) and 244(2) of the Act.

This Determination shall take effect upon registration on the Federal Register of Legislative
Instruments.

Dated 16 December 2005

John Francis Laker

Chair

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Interpretation

In this Determination

APRA means the Australian Prudential Regulation Authority.

Schedule

Prudential Rules No. 49 comprise the 5 pages commencing on the following page.

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Prudential Rules No. 49
Contract Classification for the purpose of regulatory
reporting to APRA

Life Insurance Act 1995 (ss 82(5), 117(2)(d), 117(3),

244(1) and 244(2))

These prudential rules are made under subsection 252(1) of the Life Insurance Act
1995 (the Act) for the purposes of subsection 82(5), paragraph 117(2)(d) and
subsections 117(3), 244(1) and 244(2) of the Act and apply to life companies
registered under the Act (including friendly societies).

Interpretation

In these Prudential Rules:

AASB means the Australian Accounting Standards Board

Actuarial standard means an actuarial standard made by the LIASB under the Act

APRA means the Australian Prudential Regulation Authority

IFRS means International Financial Reporting Standards as adopted in standards

issued by the AASB with effect for accounting periods commencing on or after
1 January 2005

AASB 4 means Australian Accounting Standard AASB 4 Insurance Contracts

AASB 118 means Australian Accounting Standard AASB 118 Revenue

AASB 139 means Australian Accounting Standard AASB 139 Financial Instruments:
Recognition and Measurement

AASB 1023 means Australian Accounting Standard AASB 1023 General Insurance
Contracts

AASB 1038 means Australian Accounting Standard AASB 1038 Life Insurance
Contracts

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Deposit component means a contractual component that is not accounted for as a
derivative under AASB 139 Financial Instruments: Recognition and Measurement
and would be within the scope of AASB 139 if it were a separate instrument.

Discretionary investment benefit means a benefit containing a discretionary

participation feature

Discretionary participation feature means a contractual right to receive, as a

supplement to guaranteed benefits, additional benefits:

(a) that are likely to be a significant portion of the total contractual benefits;

(b) whose amount or timing is contractually at the discretion of the issuer; and

(c) that are contractually based on:

(i) the performance of a specified pool of contracts or a specified type

of contract;

(ii) realised and/or unrealised investment returns on a specified pool of

assets held by the issuer; or

(iii) the profit or loss of the company, fund or other entity that issues the
contract

General insurance contract means an insurance contract issued by a life company

that does not meet the definition of a life insurance contract, including a private health
insurance contract that is issued under the National Health Act 1953 by a friendly
society.

Insurance contract means a contract under which one party (‘the life company’)
accepts significant insurance risk from another party (‘the policyholder’) by agreeing
to compensate the policyholder if a specified future event (‘the insured event’)
adversely affects the policyholder. Insurance risk is significant if, and only if, an
insured event could cause a insurer to pay significant additional benefits in any
scenario, excluding scenarios that lack commercial substance. More detailed
guidance on the application of the definition of an insurance contract is contained in
an appendix to AASB 1038.

LIASB means Life Insurance Actuarial Standards Board.

Life insurance contract means:

(a) an Insurance Contract that is regulated under the Act, or similar contracts
issued by entities operating outside Australia; or

(b) a financial instrument with a discretionary participation feature, which is

regulated under the Act, or similar contracts issued by entities operating
outside Australia.

Life investment contract means any contract governed by the Act that does not meet
the definition of a Life Insurance Contract.

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Regulatory reporting means all forms of reporting to APRA under the Act in the
form stipulated by Prudential Rules.

Valuation standard means the actuarial standard made by the LIASB under which
contracts are to be valued as required by subsection 114(2) of the Act

Application

1. For life companies other than friendly societies these rules:

(a) take effect on 31 December 2005; and

(b) apply to regulatory reporting, and to valuations of policy liabilities made

for that purpose, in respect of periods ending on or after 31 December
2005.

2. For life companies that are friendly societies these rules:

(a) take effect on 31 May 2006; and

(b) apply to regulatory reporting, and to valuations of policy liabilities made

for that purpose, in respect of periods ending on or after 31 May 2006.

Contract classifications under accounting standards

3. Under IFRS, the accounting treatment for a contract issued by a life company is
determined on the basis of the benefits that the contract offers to the
policyholder. A life company that offers different products (e.g. risk products
and unit-linked investment products) is required to account for these products
under different accounting standards. This differentiation will extend to the
valuation of the liabilities of the products for regulatory reporting purposes
under the Act.

4. The key distinction is between:

(a) Life insurance contracts - which are treated in accordance with the
requirements of AASB 1038;

(b) General insurance contracts - which are treated under AASB 1023
General Insurance Contracts or AASB 4 Insurance Contracts; and

(c) Life investment contracts - which are treated under AASB 139 Financial
Instruments: Recognition and Measurement, to the extent that they give
rise to financial assets or financial liabilities, and AASB 118 Revenue to
the extent that they also involve the provision of management services.

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Contract classifications for regulatory reporting purposes

5. For regulatory reporting purposes, all contracts are to be valued in accordance

with the Valuation Standard. The Valuation Standard makes a distinction
between the measurement of life insurance contracts and life investment
contracts in the same way as AASB 1038. (General insurance contracts are not
covered by the Valuation Standard as they are not regulated under the Act.)

6. For the purpose of applying the Valuation Standard, the definitions of life
insurance contract, life investment contract, insurance contract and discretionary
participation feature are to be the same as the definitions applying under AASB
1038.

Discretionary participation features and participating benefits

7. The definition of discretionary participation feature under AASB 1038 is not

necessarily the same as the definition of a participating benefit under section 15
of the Act.

8. However, Prudential Rules No. 22 sets out criteria for defining certain benefits
as non-participating under the Act which may also be of assistance in assessing
whether the extent of discretion available under a contract is significant for the
purpose of establishing whether the contract contains a discretionary
participation feature.

9. For regulatory reporting purposes, a non-participating benefit that is otherwise

deemed for general purpose reporting to contain a discretionary participation
feature is to be treated under the Valuation Standard as a non-participating
benefit with allowance made within the policy liabilities for the value of future
discretionary additions, including any additions in respect of the current
reporting period.

10. For regulatory reporting purposes, a participating benefit is deemed to satisfy

the definition of a life insurance contract, even if it is classified as a life
investment contract for general purpose reporting. In such circumstances a life
company may, under subsection 15(4) of the Act, request that APRA declare the
benefit to be non-participating, to allow the regulatory reporting treatment and
the general purpose reporting treatment to be aligned.

Constraints applying to discretions in contract classification available

under the accounting standards

11. Some contracts contain elements of both insurance contracts and deposits (i.e.
investment contracts, with or without a discretionary participation feature).
Sections 2.3.2 and 2.3.3 of AASB1038 permit such contracts to be unbundled
into separate insurance contracts and deposit components if (and only if) the
deposit component can be measured separately. However, the life company is
not required to unbundle, and may therefore treat the entire contract as a life
insurance contract if it so wishes.

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12. For regulatory reporting purposes, the following contracts must not be
unbundled:

(a) reinsurance contracts; and

(b) participating contracts with insurance riders, where the profits on the
riders are deemed to be in respect of participating business and so
allocated between policyholders and shareholders.

13. If not in conflict with rule 12 then, for regulatory reporting purposes, a contract
must be unbundled if it can be split for the purpose of recognising premium
revenue and claims expense under section 5 of AASB 1038.

14. If not in conflict with rule 12 then, for regulatory reporting purposes, where a
contract contains both investment linked and discretionary investment benefit
options, they must be unbundled as separate deposit components, with the
associated service components apportioned between them.

15. If not in conflict with rule 12 then, for regulatory reporting purposes, an option
to make future investments into a discretionary investment benefit option should
be unbundled and, if necessary, separately valued.