FRED 82 – What insurance intermediaries need to know

Financial Reporting Exposure Draft (FRED) 82 amendments represent an important milestone in introducing:

• a new revenue recognition model which is similar to the International Financial Reporting Standard 15 (IFRS 15), five-step model; and
• a new, on-balance sheet, model for leases based on IFRS 16.

Both include appropriate simplifications and options for IFRS groups to streamline accounting policies.

This blog focuses on the new revenue recognition model under Financial Reporting Standard 102 (FRS 102). It provides practical advice for organisations wishing to get a head start considering the interaction among current reporting, FRED 82 and IFRS 15, and previous industry lessons learned.

Insurance intermediaries that already apply IFRS 15 in their group accounts are likely to be more familiar with the principles for reporting under FRED 82 in their solo accounts, compared to other peers that report under FRS 102 in both their group and solo accounts.

The Financial Reporting Council (FRC) expects to publish the final amendments to FRS 102 in the first half of 2024 with an effective date not before 1 January 2026. Early adoption is expected to be permitted.

Current reporting

Under FRS 102, insurance intermediaries recognise revenue from transactions based on the stage of completion when the amount can be reliably estimated, and it is probable that the economic benefit will flow to the entity.

Five-step model

FRED 82 establishes a five-step revenue recognition that better depicts the transfer of promised services to the customers in exchange for the consideration to which the insurance intermediary expects to be entitled.

The new guidance could accelerate revenue recognition for example, when an intermediary is entitled to contingent or renewal commissions, and there are no further implied or contractual services to be performed in the renewal periods.

The rest of this blog aims to highlight the following practical considerations when implementing FRED 82.

• Services, other than contract placement, expected to be provided (such as underwriting and claims handling) should be identified, documented and revenue should be allocated to those separate services. Under current reporting, revenue recognition criteria were applied to separately identifiable components of a single transaction to reflect the substance of the transaction. However, FRED 82 provides a more prescriptive guidance on how to identify the distinct promises.
• Under certain broking arrangements such as marine, reinsurance excess of loss and quote-share treaties, there will be a need for the best estimate of profit and volume-based commissions to be:
  • determined at a portfolio of similar policies level and
  • included in the transaction price to the extent that a significant revenue reversal is not highly probable.

Under current reporting, it was sometimes interpreted that profit and volume-based commissions could not be reliably estimated before they become due.

• For contracts with trail commission and multi-annual policies, it should be assessed whether the promise has been fully delivered at the contract inception or whether additional services are provided for subsequent renewals (i.e. they are separate promises). For trail commissions, the level of future commissions that can be considered highly probable not to reverse will typically need to be estimated on a portfolio basis and will likely be an area of significant judgement. Under current FRS 102, trail or renewal commissions that do not require the insurance intermediary to render any further services are recognised at the initial contract placement only if they can be reliably measured. They are often excluded because reliable measurement is not possible, and they are instead recognised when they arise.
• Identification of ‘incremental costs to obtain a contract’ is likely to be an area of judgement if an entity elects to capitalise those costs under FRS 102. An entity that reports under IFRS 15 for the group accounts and FRS 102 for the solo accounts may elect to capitalise such costs to avoid creating any new sources of dual accounting. Under current FRS 102 such costs are only capitalised if it is probable that they will be recovered.
• Identification of capitalised costs to ‘fulfil a contract’ is also likely to be an area of judgement, particularly in relation to anticipated contracts.

Detailed FRED 82 guide

For detailed guidance and a more comprehensive comparison between FRS 102, IFRS 15 and FRED 82, please refer to our publication.

Next steps

Given the significant changes resulting from the proposed FRED 82 requirements, companies should be thinking about:

• performing an impact assessment;
• engaging with the business partners to better understand:
  • the contractual terms and their impact on revenue recognition; and
  • data considerations to support the significant accounting judgments covered above.

Deloitte is well placed to support you on this journey. Read our detailed FRED 82 guide for further insights and please do get in touch with any questions, if you would like to discuss this further.