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HMRC internal manual

General Insurance Manual

HM Revenue & Customs
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Reinsurance and other forms of risk transfer: financial reinsurance and alternative risk transfer (ART): accounting treatment: FRS5

Before the introduction of Financial Reporting Standard 5 (FRS5), there was only limited guidance available on the accounting treatment of financial reinsurance, for example in the ABI SORP (Statement of Recommended Practice) of 1990.

In practice the majority of cash flows under financial insurance and reinsurance transactions were accounted for on the same basis as the premiums and claims in conventional insurance arrangements. In the US the Financial Accounting Standards Board (FASB) Statement No. 113 of 1992 began the process by which accounting standards were tightened up, by distinguishing between prospective and retrospective contracts and requiring the transfer of both underwriting and timing risk before a contract can be accounted for as conventional insurance. Henceforth accounting rules emphasised the economic substance of the transaction rather than its legal form. In the UK the starting point for the accounting treatment of financial insurance is now FRS5 - Reporting the Substance of Transactions. This became effective for accounting periods ending on or after 22 September 1994. In recent years, FASB has consulted on the possibility of bifurcating reinsurance contracts, namely splitting them between financial and insurance aspects, but this is a very difficult task.


The stated objective of FRS5 is to ensure that the substance of an entity’s transactions is reported in its financial statements. The standard requires that in determining the substance of a transaction, all its aspects and implications should be identified and greater weight given to those more likely to have a commercial effect in practice. In order to give practical effect to this aim FRS5 goes on to say that to determine the substance of a transaction it is necessary to identify whether the transaction has given rise to new assets or liabilities for the reporting entity, and whether it has changed the entity’s existing assets and liabilities.

Assets are defined as rights or other access to future economic benefits controlled by an entity as a result of past transactions or events; and liabilities as an entity’s obligations to transfer economic benefits as a result of past transactions or events.

The statement also requires disclosure of the substance of transactions by providing that disclosure of a transaction in the financial statements, whether or not it has resulted in assets or liabilities being recognised or ceasing to be recognised, should be sufficient to enable the user of the financial statements to understand its commercial effect.

For insurance transactions, FRS5 was supplemented in December 1994 by a technical release (FRAG35/94) from the Insurance Industry Sub-Committee of the Institute of Chartered Accountants in England and Wales, entitled “The Application of FRS5 to General Insurance Transactions”. FRAG35/94 was subsequently incorporated into the ABI SORP.

GIM2000 onwards gives more detail about insurance accounting generally. See, in particular, GIM2060 on IFRS4 for insurers.