Credit life insurance sold with financing: agent or principal

Consumer and auto finance contracts are often sold with credit life, disability, unemployment or motor insurance placed with an insurer, and the premium is frequently added to the amount financed. The finance company may earn a commission from the insurer, may itself be the policyholder and beneficiary under a group policy, or may carry the risk itself through a debt-waiver feature. Each structure leads to a different answer: commission revenue under IFRS 15, a cost or recovery that forms part of the loan's cash flows, or an insurance feature that falls under IFRS 17 or IFRS 9. Getting it wrong grosses up revenue with premiums that belong to the insurer, or front-loads commissions that are refundable when loans are settled early.

Who is the insurer and who bears the insurance risk: a third-party insurer, the finance company through a debt waiver, or an affiliated insurer? Who is the policyholder and beneficiary: the borrower, or the finance company under a group policy? Is the insurance a condition of the financing or optional? Does the finance company set the premium, carry any risk if claims exceed premiums, or simply arrange the policy and remit premiums? Is the commission paid upfront, and is it clawed back pro rata when the loan is settled early or the policy cancelled? Is the premium financed and does the borrower pay interest on it?

1. Identify who bears the insurance risk. If the finance company itself waives the debt on death or disability, assess whether the contract is an insurance contract; IFRS 17 allows entities to apply IFRS 9 to such loan contracts where the only compensation is settlement of the borrower's obligation, as an election by portfolio.
2. Where a third-party insurer bears the risk, apply the principal versus agent guidance: the finance company is normally an agent because it does not control the insurance cover before it is transferred to the borrower.
3. As agent, recognise only the commission as revenue under IFRS 15 when the performance obligation, usually placing the policy, is satisfied; recognise later if ongoing services such as premium collection or claims handling are distinct and paid for by part of the commission.
4. Treat expected commission clawbacks on early settlement or cancellation as variable consideration, and recognise a refund liability for amounts expected to be returned.
5. Where the premium is financed, the premium paid to the insurer on the borrower's behalf is part of the loan principal; it is neither revenue nor an expense of the finance company.
6. Where the finance company is the policyholder under a group credit policy that protects it against borrower default or death, assess whether the cover is integral to the loans; if so, premiums charged to borrowers and the cover affect the loans' cash flows and ECL rather than IFRS 15 revenue.
7. Assess whether a commission is so closely linked to the loan that it should be treated as part of the effective interest rate; this is a judgment and the policy should be applied consistently.

Measure commission revenue at the amount the finance company expects to retain, using the expected value of clawbacks based on historic early-settlement and cancellation rates, constrained so that a significant reversal is highly probable not to occur. The refund liability is remeasured at each reporting date. The financed premium is included in the gross carrying amount of the loan and in the cash flows used for the effective interest rate. Where the insurance cover is integral to the loan, expected claim recoveries are included in the cash flows used to measure ECL.

Disclose: (1) the nature of insurance arrangements sold with financing and whether the company acts as agent; (2) insurance commission income separately from interest income, as IFRS 15 revenue; (3) the policy for commission clawbacks and the refund liability; (4) whether insurance cover is treated as integral to loans in measuring ECL; (5) any election to apply IFRS 9 to loan contracts with debt-waiver features; (6) arrangements with an affiliated insurer as related party transactions.

• Recognising the full premium as revenue and the amount remitted to the insurer as cost
• recognising upfront commission in full with no allowance for clawbacks on early settlement, which are frequent in consumer finance
• treating a financed premium as fee income of the finance company
• ignoring the insurance cover when measuring ECL even though the finance company is the beneficiary and the cover is integral
• presenting insurance commission within interest income without a documented policy
• overlooking that a debt-waiver feature carried by the finance company may be an insurance contract