Separating and Combining Contracts (Setting the Boundary)

For thousands of contracts to be grouped into buckets, we first need to answer the simple question, what actually constitutes one contract?

1. Unbundling (Separating the Contract):

   Insurance companies frequently include additional products in their policies to enhance their appeal. According to IFRS 17, when a contract contains distinct and non-insurance components, the accountant needs to “unbundle” it. The IFRS 17 rule retains the pure insurance part but the other components are transferred to another accounting standard.

   Here are the three main scenarios for unbundling:

   • The Distinct Investment Component: When a customer buys life insurance, 20% of their premium goes into a guaranteed savings account they get back no matter what. Where does this go? IFRS 9 (Financial Instruments).
   • The Embedded Derivative: This policy gives you an additional pay-out based on the performance of stock markets around the globe. Where does it go? IFRS 9 (Financial Instruments).
   • Distinct Goods and Non-Insurance Services: A commercial fire insurance policy provides an exclusive monthly fire safety training class for the client's employees. Where is the final destination? IFRS 15 (Revenue from Contracts with Customers).
   
   
2. Combining Contracts (Bundling):

   At times, the accountant must act differently. In accounting, there is a golden rule which says “Substance Over Form”. That is to say, it is the commercial reality of the deal that matters and not the paperwork.

   IFRS 17 requires you to combine two or more separate pieces of paper and treat them as one single contract if they meet all of these conditions:

   • They are entered into at the exact same time (or nearly the same time).
   • They are with the exact same customer.
   • They are designed to achieve an overall commercial effect.

   When a life insurance policy is issued by a company to a customer, and if on the same day, the same customer is issued a second policy, but this second policy cancels out the risk of the first, they should be combined to measure the true, net risk.

Unbundling removes non-insurance components, while combining merges linked contracts into one true deal. With a "single" contract perfectly defined, let's see how we can start grouping contracts together!