a. Objectives of Defence Service Homes Insurance Scheme
The Defence Service Homes Insurance Scheme (the Scheme) forms part of the operations of the Health and Community Services Division of the Department of Veterans’ Affairs (the Department). The objective of the Scheme is to provide domestic building insurance in accordance with the Defence Service Homes Act 1918 and Regulations.
The Scheme operates under the control of the Secretary of the Department of Veterans’ Affairs.
The continued existence of the Scheme in its present form is dependent on Government policy.
b. Basis of Preparation of the Financial Statements
The financial statements are required by Section 49 of Schedule 1 of the Financial Management and Accountability Act 1997 and Section 50B of the Defence Service Homes Act 1918. The financial statements are a general purpose financial report.
The statements have been prepared in accordance with:
- Finance Minister’s Orders (FMO’s) for reporting periods ending on or after 1 July 2011 except to the extent that disclosures and formats required by the FMOs are inconsistent with the requirements of AASB 1023 Accounting for General Insurance Contracts (this exemption was approved in the FMO’s on or after 1 July 2011); and
- Australian Accounting Standards and Interpretations issued by the Australian Accounting Standards Board (AASB) that apply for the reporting period.
The financial statements have been prepared on an accrual basis and in accordance with the historical cost convention, except for certain assets at fair value. Except where stated, no allowance is made for the effect of changing prices on the results or the financial position.
The financial statements are presented in Australian dollars and values are rounded to the nearest thousand dollars unless otherwise specified.
Unless an alternative treatment is specifically required by an accounting standard or the FMOs, assets and liabilities are recognised in the balance sheet when and only when it is probable that future economic benefits will flow to the Scheme or a future sacrifice of economic benefits will be required and the amounts of the assets or liabilities can be reliably measured. However, assets and liabilities arising under agreements equally proportionately unperformed are not recognised unless required by an accounting standard. Liabilities and assets that are unrecognised are reported in the schedule of commitments.
Unless alternative treatment is specifically required by an accounting standard, revenues and expenses are recognised in the statement of comprehensive income, when and only when the flow, consumption or loss of economic benefits has occurred and can be reliably measured.
c. Significant Accounting Judgements and Estimates
In the process of applying the accounting policies listed in this note, the Scheme has made the following judgements that have the most significant impact on the amounts recorded in the financial statements:
- The value of outstanding claims and estimated future claims on unexpired premiums has been estimated by an independent actuary. The actuary has used the methods and assumptions detailed in note 1q.
No accounting assumptions or estimates have been identified that have a significant risk of causing a material adjustment to carrying amounts of assets and liabilities within the next accounting period.
d. Changes in Australian Accounting Standards
Adoption of New Australian Accounting Standard Requirements
No accounting standard has been adopted earlier than the application date as stated in the standard. The new standards, revised standards, interpretations, amendments to standards which were applicable to the current reporting period and issued prior to the signing of the financial statements have no material financial impact, nor are expected to have a future financial impact, on the Scheme.
Future Australian Accounting Standard requirements
The new standards, revised standards, interpretations and amendments to standards which are applicable to future reporting periods that were issued by the Australian Accounting Standards Board prior to the signing of the financial statements are not expected to have a material financial impact on the Scheme.
e. Ongoing Sustainability
The Scheme is continuing to address the issue of ongoing sustainability. The strategies the Scheme is using to return it to surplus include: continued appropriate premium rate increases; implementation of a prudent capital management plan; and the targeted marketing of potential new policyholders. The DSHIS Advisory Board, which provides governance for the Scheme, oversees the Scheme’s overall financial position, including the implementation of these strategies and the Scheme’s voluntary compliance with Australian Prudential Regulation Authority standards.
Direct premium revenue comprises amounts charged to policyholders, excluding amounts collected on behalf of third parties, principally GST in full. The earned portion of premiums received and receivable, including unclosed business, is recognised as revenue. Premium revenue is recognised as earned from the date of attachment of risk.
The pattern of recognition over the policy or indemnity periods is based on time, which is considered to closely approximate the pattern of risks underwritten.
Commissions Received Revenue
Commissions received revenue is recognised when it becomes due to the Scheme.
Revenue from Government
Amounts appropriated are recognised as revenue when the Scheme gains control of the appropriation. The Scheme receives appropriation revenue for interest equivalency payments only.
Resources Received Free of Charge
Resources received free of charge are recognised as gains when, and only when, a fair value can be reliably determined and the services would have been purchased if they had not been donated. Use of those resources is recognised as an expense.
Resources received free of charge are recorded as either revenue or gains depending on their nature.
Contributions of assets at no cost of acquisition or for nominal consideration are recognised as gains at their fair value when the asset qualifies for recognition, unless received from another Government agency or authority as a consequence of a restructuring of administrative arrangements.
h. Employee Benefits Equivalent
Salary, Wages and Superannuation
The Scheme’s salaries, wages, superannuation, long service leave and annual leave are paid by the Department, and the Scheme repays the Department as a supplier on 30 day terms. Any salaries, wages, superannuation, long service leave and annual leave unpaid as at 30 June 2013 are recorded as unpaid supplier expenses.
All long service and annual leave liabilities are recorded by the Department of Veterans’ Affairs.
Staff are members of the Commonwealth Superannuation Scheme (CSS), the Public Sector Superannuation Scheme (PSS) or the PSS accumulation plan (PSSap).
The CSS and PSS are defined benefit schemes for the Australian Government. The PSSap is a defined contribution scheme.
The liability for defined benefits is recognised in the financial statements of the Australian Government and is settled by the Australian Government in due course. The liability is reported by the Department of Finance and Deregulation as an administered item.
The Department makes employer contributions to the Australian Government at rates determined by an actuary to be sufficient to meet the cost to the Government of the superannuation entitlements of the Scheme’s employees.
i. Fire Brigade and Emergency Services Contributions
In New South Wales, fire brigade and emergency services contributions and in Victoria, fire service contributions received or receivable from policy holders are included in premiums. A liability for fire brigade, emergency services and other charges is recognised on business written to the reporting date, regardless of whether assessments have been issued by the appropriate authority. Levies and charges payable by the Scheme are expensed on the same basis as the recognition of premium revenue, with the portion relating to unearned premium being recorded as unearned revenue.
j. Deferred Acquisition Costs
A portion of acquisition costs relating to unearned premium revenue can be deferred in recognition that it represents future benefits to the Scheme. Deferred acquisition assets must have a probability of future economic benefit and be able to be reliably measured. The Scheme does not have the data or reporting to reliably measure the value of this asset, therefore it does not take up a deferred acquisition asset.
The Scheme has no deferred acquisition costs or assets.
A distinction is made between finance leases and operating leases. Finance leases effectively transfer from the lessor to the lessee substantially all the risks and benefits incidental to the ownership of leased assets. An operating lease is a lease that is not a finance lease. In operating leases, the lessor effectively retains substantially all such risks and benefits.
Operating lease payments are expensed on a straight line basis which is representative of the pattern of benefits derived from the leased assets.
The Scheme has no finance leases.
Cash and cash equivalents includes notes and coins held and any deposits held at call with an original maturity of three months or less that are readily convertible to known amounts of cash and subject to insignificant risk of changes in value. Cash is recognised at its nominal amount.
m. Reinsurance Receivables
Reinsurance receivables are recorded at discounted estimated value on paid claims and incurred claims not yet paid and recognised as a reduction in the claims expense.
n. Financial Assets
The Scheme classifies its financial assets in the following categories:
- Financial assets at fair value through profit or loss; and
- Loans and receivables.
The classification depends on the nature and purpose of the financial assets and is determined at the time of initial recognition. Financial assets are recognised and de-recognised upon trade date.
Effective Interest Method
The effective interest method is a method of calculating the amortised cost of a financial asset and of allocating interest income over the relevant period. The effective interest rate is the rate that exactly discounts estimated future cash receipts through the expected life of the financial asset, or, where appropriate, a shorter period.
Income is recognised on an effective interest rate basis except for financial assets that are recognised at fair value through profit or loss.
Financial Assets at Fair Value Through Profit or Loss
Financial assets are classified as financial assets at fair value through profit or loss where the financial assets:
- have been acquired principally for the purpose of selling in the near future;
- are a part of an identified portfolio of financial instruments that the Scheme manages together and has a recent actual pattern of short-term profit-taking; or
- are derivatives that are not designated and effective as a hedging instrument.
Financial assets at fair value through profit or loss are stated at fair value, with any resultant gain or loss recognised in profit or loss. The net gain or loss recognised in profit or loss incorporates any interest earned on the financial asset.
Loans and Receivables
Trade receivables, loans and other receivables that have fixed or determinable payments that are not quoted in an active market are classified as ‘loans and receivables’. Loans and receivables are measured at amortised cost using the effective interest method less impairment. Interest is recognised by applying the effective interest rate.
Impairment of Financial Assets
Financial assets are assessed for impairment at each balance date.
Financial assets held at amortised cost – if there is objective evidence that an impairment loss has been incurred for loans and receivables held at amortised cost, the amount of the loss is measured as the difference between the asset’s carrying amount and the present value of estimated future cash flows discounted at the asset’s original effective interest rate. The carrying amount is reduced by way of an allowance account. The loss is recognised in the Statement of Comprehensive Income.
o. Financial Liabilities
Financial liabilities are classified as either financial liabilities ‘at fair value through profit or loss’ or other financial liabilities.
Financial Liabilities at Fair Value Through Profit or Loss
Financial liabilities at fair value through profit or loss are initially measured at fair value. Subsequent fair value adjustments are recognised in profit or loss. The net gain or loss recognised in profit or loss incorporates any interest paid on the financial liability.
Financial liabilities are recognised and derecognised upon ‘trade date’.
Other Financial Liabilities
Supplier and other payables are recognised at amortised cost. Liabilities are recognised to the extent that the goods or services have been received (and irrespective of having been invoiced). For outstanding claims, refer to Note 1q.
The Scheme’s intangibles comprise internally developed software for internal use. These assets are carried at cost less accumulated amortisation and accumulated impairment losses except for purchases costing less than $2,000, which are expensed in the year of acquisition (other than where they form part of a group of similar items which are significant in total).
Software is amortised on a straight-line basis over its anticipated useful life. The useful life of the Scheme’s software is 10 years (2011–12: 10 years).
All intangible assets were assessed for impairment at 30 June 2013. Where indications of impairment exist, the asset’s recoverable amount is estimated and an impairment adjustment made if the asset’s recoverable amount is less than its carrying amount.
The recoverable amount of an asset is the higher of its fair value less costs to sell and its value in use. Value in use is the present value of the future cash flows expected to be derived from the asset. Where the future economic benefit of an asset is not primarily dependent on the asset’s ability to generate future cash flows, and the asset would be replaced if the Scheme were deprived of the asset, its value in use is taken to be its depreciated replacement cost.
No indicators of impairment were found for intangible assets at fair value or intangibles at cost.
q. Underwriting Provisions
The provision for unearned premiums represents the estimated proportion of premiums written in the current year relating to cover provided in the subsequent year. The Scheme’s system allows for the unearned proportion to be calculated for each individual policy in accordance with AASB 1023 General Insurance Contracts.
Revenue in Advance
Revenue in advance is recognised where the revenue has been received prior to the period in which the revenue relates. The Scheme recognises revenue in advance at nominal value.
Liability Adequacy Test and Unexpired Risk Liability
AASB 1023 General Insurance Contracts requires the application of a liability adequacy test upon unearned premiums. Where this test indicates that the Scheme’s unearned premiums less related acquisition costs are insufficient to cover the expected future cash flows relating to future claims under the risk associated with those premiums, the difference is recognised in the Statement of Comprehensive Income. As a result of this test, the Scheme has recognised no movement (2012: $1,816,000) and an unexpired risk liability of nil (2012: nil) – indicating that the Scheme’s unearned premiums are sufficient to cover expected future cash flows relating to future claims. In performing the liability adequacy test the Scheme’s actuary has applied a risk margin of 14% (2012: 14%), which has increased the expected future cash flows relating to future claims by $1,750,000 (2012: $1,600,000). The probability of adequacy applied in the test is different to the probability of adequacy adopted in determining the outstanding claims liability. No specific guidance exists for the risk margin to be used in determining the adequacy of premium liabilities. The 75% basis is considered appropriate having regard to the purpose and nature of the test, the use of the 75% basis as a regulatory benchmark in Australia, and consistency with developing market practice.
The Scheme has not taken into account the income from invested retained surpluses or agency commissions which are used to subsidise costs associated with the building policy.
The Scheme’s unadjusted unearned premium liability as at 30 June 2013 was $18,443,000 (2012: $15,557,000) and future cash flows relating to future claims under the risk associated with those premiums as advised by the Scheme’s independent actuaries was $14,300,000 (2012: $13,400,000).
The provision for outstanding claims has been determined on a case by case approach in respect of all claims reported. The liability for outstanding claims includes claims incurred but not yet paid, incurred but not reported (IBNRs), and incurred but not enough reported (IBNERs). The provision includes the expected administration costs of settling those claims. A report on the adequacy of the provision was prepared by independent actuaries as at 30 June 2013. The methods used to assess the outstanding liability were Projected Case Estimates (PCE) and Payment Per Claims Incurred (PPCI). This methodology meets Actuarial Standard PS 300 Valuation of General Insurance Claims.
The methodology for the estimation of the net outstanding claims provision as at 30 June 2013 consists of:
- Predicting future claim payment cash flows in respect of claims incurred prior to 30 June 2013. Separate predictions by claim type (Liability, Catastrophe and Other) are made in respect of each combination of accident quarter and financial quarter of payment. The future cash flow predictions are derived from several actuarial models of the various claim processes. That is, actuarial models are constructed for numbers of claims reported, average payments per claim incurred, development of case estimates and payments as a proportion of case estimates. The results of the models are blended based on their individual characteristics to produce a single estimate of the outstanding claims.
- Initially all estimates are made in 30 June 2013 dollars, but subsequently are increased to allow for inflation from that date to the date of payment.
- Liability for outstanding claims is estimated by:
- - discounting these inflated claim payments to allow for investment return at risk free rates;
- - adjusting for the effect of GST; and
- - adding an allowance to provide for associated claims administration expenses.
- Gross and net liabilities are derived by making adjustments for both third party recoveries and reinsurance recoveries.
- The estimate of liability is increased by a prudential margin.
The following assumptions have been made in determining the net outstanding claims provision as at 30 June 2013:
- Inflation rates: 4.03% for 2013–14;
- Discount rates: 2.5% for 2013–14;
- Claims administration expenses: 5% of claim payments;
- Superimposed inflation: approximately 7.2% p.a. in the actuarial model with explicit superimposed inflation assumption;
- Prudential margin: 9% of central estimate of liability for 75% probability of sufficiency;
- Number of claims for the 2012–13 accident year: approximately 8,987; and
- Average claim size (in actual values) for the 2012–13 accident year: approximately $2,896.
The following assumptions were made in determining the net outstanding claims provision as at 30 June 2012:
- Inflation rates: 4.28% for 2012–13;
- Discount rates: 2.8% for 2012–13;
- Claims administration expenses: 5% of claim payments;
- Superimposed inflation: approximately 7.2% p.a. in the actuarial model with an explicit superimposed inflation assumption;
- Prudential margin: 9% of central estimated liability for 75% probability of sufficiency;
- Number of claims for the 2011–12 accident year: approximately 9,833; and
- Average claim size (in 30/6/12 values) for the 2011–12 accident year: approximately $2,767.
Process for Determining Assumptions
The process for determining each of the assumptions is as follows:
- Inflation rates: are taken as an average of CPI (housing) and AWE inflation expectations which are based on internal and external forecasts of future rates;
- Discount rates: derived from a yield curve fitted to the actual yields on Commonwealth Government bonds as at 30 June 2013;
- Claims administration expenses: assumed based on industry experience;
- Superimposed inflation: derived from actuarial models based on the long term average of past experience for all non-catastrophe claims;
- Prudential margin: selected based on analysis of estimated historical variability within the portfolio;
- Number of claims in 2012/13 accident year: derived from actuarial models of past claim reporting patterns;
- Average claim size (in actual values) for 2012/13 accident year: derived as an outcome of all the actuarial models blended to form adopted estimates of outstanding claims and hence total ultimate claim costs and average claim sizes.
Insurance Risk Management
Insurance risk management policies and practices are disclosed at Note 14 – Risk management.
Process for Determining Risk Margin
The risk margin required for a 75% level of sufficiency has been estimated using various statistical modelling techniques applied to the claim data. An actuarial model (the “chain ladder”) has been fitted to 10,000 simulated claim data sets to determine 10,000 estimates of the outstanding claims and hence an approximate distribution of those amounts. The analysis is on the basis prescribed by Australian Prudential Regulation Authority (APRA) in that it ignores asset risk but takes into account liability risk, including inflation risk.
r. Reinsurance Arrangements
The Scheme purchases reinsurance each year for dwelling per risk, catastrophe risk and legal liability risk. Premium ceded to reinsurers is recognised as an expense and is measured at nominal value in accordance with the pattern of reinsurance service received.
The Defence Service Homes Insurance Scheme is exempt from all forms of taxation except fringe benefits tax and the goods and services tax (GST).
Revenues, expenses, liabilities and assets are recognised net of GST:
- except where the amount of GST incurred is not recoverable from the Australian Taxation Office; and
- except for receivables and payables.