1) Goodwill

No amortisation resulting in lower expenses, subject to impairment charges

Goodwill supportable at 1 July 2004 and 30 June 2005

The IAG Group will not restate the accounting for business combinations transacted prior to 1 July 2004, as permitted under the transitional provisions for first time adoption of A-IFRS. There are also no additional intangible assets to be recognised separately from goodwill upon first time adoption. Goodwill will not be amortised under A-IFRS and so the carrying value of goodwill as at 1 July 2004 of $1,455 million will be carried forward under A-IFRS subject to impairment testing. Part of that goodwill balance is denominated in New Zealand dollars and so the balance will continue to change reflecting foreign currency movements.

The net goodwill as at 1 July 2004 has been systematically allocated to cash generating units for the purpose of the recoverability test, which is to be conducted at each reporting date. Any impairment is to be recognised in the statement of financial performance in the period in which it is identified.

Using A-IFRS impairment methodology the $1,455 million goodwill balance is supportable at 1 July 2004, 31 December 2004, and 30 June 2005. Additional goodwill amounts have arisen through small acquisitions made during the year to 30 June 2005 totalling $9 million. Those amounts are also supportable at 31 December 2004 and 30 June 2005 using A-IFRS impairment methodology.

The elimination of the requirement to amortise goodwill under A-IFRS will increase reported profits, subject to any impairment charge that may be required at a reporting date. The IAG Group had a goodwill amortisation expense for the year to 30 June 2005 of $92 million. That amount will be removed from the statement of financial performance under A-IFRS and the 1 July 2004 goodwill balance of $1,455 million will be reinstated, subject to impairment testing. That balance together with the goodwill amounts that arose from acquisitions made during the year will result in a goodwill balance as at 30 June 2005 of $1,464 million.

2) Employee benefits

The accounting for employee benefits will remain unchanged except for defined benefit superannuation arrangements and share based payments.

2a) Superannuation plans

Net position of defined benefit superannuation plans to be recognised

The IAG Group has elected to early adopt the version of AASB 119 Employee Benefits issued in December 2004 to be effective from 1 January 2005 in line with the adoption of A-IFRS.

Under A-IFRS the relevant net position of defined benefit plans will be recognised in the statement of financial position. The movement in the net position will be recognised in the statement of financial performance, except for actuarial gains and losses, which will be recognised directly in retained earnings, in line with the accounting option selected under AASB 119.

The IAG Group has five arrangements that qualify as defined benefit plans under A-IFRS. These consist of a defined benefit superannuation plan in Australia, two defined benefit superannuation plans in New Zealand, and two pension schemes, both of which are unfunded. The net position of the three defined benefit superannuation plans is currently not recognised in the IAG Group’s statement of financial position although some information is disclosed in the notes to the annual financial report. The present value of each of the two unfunded pension liabilities is currently recognised in the IAG Group’s statement of financial position.

It is important to note that the net position of the defined benefit superannuation plans calculated under A-IFRS is different to that calculated for purposes of note disclosure in accordance with Australian GAAP because of the use of different measurement requirements in the actuarial calculations of obligations to employee members. The principal difference is the discount rate applied to determine the present value of those obligations.

The adjustments required to recognise the defined benefit plans under A-IFRS involve a credit to retained earnings as at 1 July 2004 of $57 million. Recognising the movement in the net positions of the plans for the year to 30 June 2005 involves recognition of an additional expense through the A-IFRS statement of financial performance for the year to 30 June 2005 of $79 million and the recognition of a $10 million debit directly to retained earnings as at 30 June 2005. The net result of these changes is a $32 million debit adjustment to retained earnings as at 30 June 2005.

The net financial positions of the defined benefit plans as at 30 June 2005 have been calculated by independent actuaries, however the audit of all of the calculations had not been finalised as at the date of this report.

2b) Share based payments

Initial reduction in the expense recognised

The only transactions within the IAG Group that qualify as share based payments are share based remuneration payments. The IAG Group provides share based remuneration through four different plans each of which has different purposes and different rules. The change in accounting treatments has not led to a change in the structure of the share based remuneration because the current arrangements are considered to be most appropriate given the Group’s history, environment, culture and objectives.

The IAG Group will not retrospectively apply the A-IFRS expense treatment to the Performance Share Rights Plan or the Employee Share Plan, as permitted under the transitional provisions for first time adoption of A-IFRS, because the last rights provided under those plans were granted prior to 7 November 2002. The A-IFRS transition changes will therefore impact on only the Performance Award Rights Plan (“PARs Plan”), and Non-Executive Director Share Plan (“NED Plan”), both of which are equity settled share based payments.

The IAG Group’s current practice is to acquire IAG shares on-market and hold them in trust to satisfy a future obligation for share based remuneration. The shares are purchased on or near grant date at the then market price. The cost of acquiring the shares is initially recorded as a prepayment and is then expensed in full, generally over the period during which the employees provide related services.

Under A-IFRS the fair value at grant date of share based remuneration is required to be recognised as an expense over the period from grant date until the equity instruments vest fully to the employee. For equity settled share based payments, an equity reserve is created as the expense is recognised. At each reporting date the total accumulated expense will be adjusted through the statement of financial performance based on the latest estimate of the number of equity instruments that will vest, considering only employee turnover, and taking into account the expired portion of the vesting period.

The vesting conditions for the two plans are different with only the PARs Plan incorporating a market based vesting condition. If equity instruments in either of the plans do not vest because the participant ceases to be employed by the IAG Group then the expense charged in relation to that participant will be reversed. If equity instruments in the PARs Plan do not vest only because the market condition is not met, then the expense will not be reversed.

The A-IFRS requirement to expense the fair value of the equity instruments granted may be different to the fair value (on-market purchase price) of acquiring the relevant number of shares to support the arrangements. For the PARs Plan, the fair value of the rights granted is lower than the market value of the shares purchased on or near grant date because of the variables and uncertainty that influence whether the participant will ever receive the share and what the value of the share will be at that time. For the NED Plan, the on-market share price at grant date is used as the fair value of the equity instrument granted because the shares vest on a pro-rata daily basis with limited forfeiture conditions and the participant is entitled to dividends and other shareholder rights during the vesting period.

The requirement to determine the fair value of the share based remuneration and recognise this expense over the period from grant date to vesting date will result in an initial reduction in the expense recognised for the IAG Group, to that currently recorded in relation to share based payments.

A transitional adjustment for the IAG Group will be made to retained profits as at 1 July 2004 of $2 million representing the accumulated reduction in the expense up to that date. An additional adjustment for the IAG Group will be made to retained profits as at 1 July 2005 of $5 million representing the accumulated reduction in the expense up to that date. The expense will be matched by a credit to an equity reserve. It is noted that certain matters in relation to share based payments are still subject to changing interpretation, which may impact on the determination of these adjustments.

Equity remuneration trusts to be consolidated

Under A-IFRS the equity remuneration trusts used to manage the share based arrangements will be consolidated by the IAG Group. Two trusts will be consolidated directly by the parent entity while one trust will be consolidated directly by a subsidiary. The parent and the IAG Group will recognise the IAG shares, the major asset of the trusts, as negative equity (referred to as treasury shares). The treasury shares will be measured at cost (total amount paid to acquire the shares), and will be shown as a deduction from equity. The shares held by the trusts as at 30 June 2004 that are to be consolidated, were acquired on different dates at a total cost of $20 million for the parent and $21 million for the IAG Group. The shares held by the trusts as at 30 June 2005 that are to be consolidated, were acquired on different dates at a total cost of $33 million for the parent and $34 million for the IAG Group. When the relevant rights are exercised, the Group will effectively reissue the shares, which will be recognised as equity measured at the net expense incurred in providing the shares.

3) Non-goodwill intangibles

All current non-goodwill intangible assets qualify for recognition

Introduction of
new software development asset

Existing non-goodwill intangible assets on the IAG Group’s statement of financial position at 1 July 2004 and 30 June 2005 meet the recognition and measurement requirements of A-IFRS and so the accounting treatment, including amortisation, will remain unchanged. They will be subject to impairment testing. There are no impairment charges for these assets at 1 July 2004, 31 December 2004, or 30 June 2005.

In certain circumstances under A-IFRS, development phase expenditure will be capitalised and so recognised as an internally generated intangible asset. Software development is the only development expenditure for the IAG Group. The IAG Group is not currently carrying any capitalised software development costs in the statement of financial position but will recognise such an asset under the more prescriptive A-IFRS requirements. Only software development projects with total budgeted expenditure of more than $2 million will be capitalised. All other software related costs are treated as maintenance expenditure, being an overall part of maintaining an efficient operating environment, and are expensed as incurred.

Only software development expenditure incurred after 1 July 2004, the Group’s A-IFRS transition date, is considered eligible for capitalisation under A-IFRS. For this reason, the first adjustment relating to software development expenditure will be for the year to 30 June 2005 amounting to $24 million. That amount will be included in the statement of financial position for the year to 30 June 2005 under A-IFRS. This amount is supportable using A-IFRS impairment methodology.

4) Property, plant and equipment

All property classified as owner occupied and depreciated over useful life

Under Australian GAAP, all property (land and buildings), regardless of the purpose for which it is used, must be designated as an investment integral to general insurance activities and so is measured at fair value. This designation will not continue under A-IFRS and property will be classified according to the purpose for which it is held. All of the property within the IAG Group will be classified as owner occupied property under A-IFR

The IAG Group has elected to apply the cost approach under which the buildings will be depreciated over the useful life and also be subject to impairment testing. The land will be subject to impairment testing. The IAG Group has elected to apply the optional exemption permitted under the transitional provisions for first time adoption of A-IFRS to use the fair value of the property held as at 30 June 2004 (shown in this report as $66 million) as the deemed cost of that property moving forward. This requires reversal of the movement in the market value of the property recognised in the reported profit for the year to 30 June 2005 of $8 million.

Based on the portfolio of properties held at 30 June 2005 this will introduce a depreciation expense of $1 million to the A-IFRS statement of financial performance for the year ended 30 June 2005. There are no impairment charges for property at 1 July 2004, 31 December 2004 or 30 June 2005.

Plant and equipment to continue to be measured at cost and depreciated over useful life

For plant and equipment, the IAG Group has elected to apply the cost approach under which each item will be depreciated over its useful life and also be subject to impairment testing. The IAG Group has elected to not apply the optional exemption permitted under the transitional provisions for first time adoption of A-IFRS to use the fair value of the plant and equipment as at 30 June 2004 as the deemed cost, and so will continue to depreciate the original cost. There are no impairment charges for plant and equipment at 1 July 2004, 31 December 2004 or 30 June 2005.

5) Taxation

More deferred tax assets and liabilities may be recognised

Income tax will be calculated based on the ‘balance sheet approach’ replacing the ‘income statement approach’ currently used. The A-IFRS treatment focuses on the closing balances rather than the movements for the period. This method recognises deferred tax balances when there is a difference between the carrying value of an asset or liability, and its tax base (being the amount attributed to an asset or liability for tax purposes) rather than for differences between accounting and taxable profit. Deferred tax assets under A-IFRS will be recognised based on a ‘probable’ criterion rather than the ‘beyond reasonable doubt’ criterion, or ‘virtually certain’ criterion for unused tax losses, under Australian GAAP. This may result in more deferred tax assets and liabilities and, as tax effects follow the underlying transaction, some tax effects will be recognised in equity. Deferred tax balances will continue to be undiscounted under A-IFRS.

The transition to A-IFRS involves two types of tax adjustments. There are adjustments arising from the different methodology used for the determination of tax adjustments as discussed above. There are also consequential tax impacts arising from the different recognition treatments of certain assets and liabilities under A-IFRS.

The adjustments arising from the transition to the balance sheet approach for the calculation of taxation had not yet been reliably determined as at the date of finalisation of this report.

6) Insurance contracts

All of the insurance products meet the accounting definition of an ‘insurance contract’

The only change to the accounting treatments for insurance contracts is the expanded liability adequacy test

In respect of the IAG Group’s core insurance business, the changes to accounting treatments on conversion to A-IFRS are minimal. A-IFRS allows the IAG Group to basically continue with current accounting treatments for those general insurance products and reinsurance products that meet the A-IFRS definition of an ‘insurance contract’. The only change is the introduction of an expanded liability adequacy test.

All of the IAG Group’s general insurance products and reinsurance products on offer, or utilised, meet the definition of an insurance contract and none of the contracts contain embedded derivatives or are required to be unbundled. This means that the IAG Group’s accounting for premium revenue, reinsurance expense, claims expense, acquisition costs, and reinsurance and other recoveries, together with related balances in the statement of financial position, will continue without change, subject to an expanded liability adequacy test.

The liability adequacy test is an assessment of whether the carrying amount of an insurance liability is adequate based on a review of future cash flows. It is to be conducted with the inclusion of an explicit risk margin (Australian GAAP version of the test does not refer to a risk margin) and is to be performed at the level of a portfolio of contracts that are subject to broadly similar risks and that are managed together as a single portfolio (Australian GAAP version of test conducted at reporting entity level). Any deficiency arising from the test will be recognised first through the write down of any related intangible assets and then the related deferred acquisition costs, with any remaining balance being recognised in the statement of financial position as an unexpired risk liability.

Liability adequacy test passed as at 1 July 2005

The liability adequacy test was passed as at 1 July 2005 demonstrating that the unearned premium liability is adequate.

7) Contributed equity

The reset preference shares to be reclassified as debt

Distributions on the reset preference shares to be treated as interest, not dividends

The measurement and treatment of the issued and fully paid ordinary shares will remain unchanged.

The IAG Group’s reset preference shares (“RPS”) are currently presented as equity under Australian GAAP as they are not considered a mandatory convertible instrument, are perpetual, and there is no obligation to pay distributions.

The RPS will be reclassified as debt under A-IFRS and will be measured at amortised cost. Distributions on the instruments (refer note 7(b)) made after 1 July 2005 will be treated as interest rather than dividends and so have a negative impact on reported profit. As the RPS will continue to be treated as equity for tax purposes, there will be no change in the ability to frank the distributions.

The transaction costs incurred from the issuance of the two tranches of RPS, totalling $11 million, have been recognised directly in equity under Australian GAAP as a reduction in the proceeds of the instruments. When the RPS are reclassified as debt under A-IFRS those transaction costs will be treated as having been capitalised (included into the value of the liability) and recognised on an effective yield basis (amortised over the period to the first reset date). This requires an adjustment to increase retained earnings as at 1 July 2005 by $11 million to recognise the capitalisation of the costs, offset by a reduction in retained earnings of $6 million representing the portion of the transaction costs that would have been effectively amortised up to that date.

With the distributions treated as interest under A-IFRS, the distributions will be recognised on an accruals basis, which is different to the current policy of recognising a provision for the distributions only when the distributions are declared. The adjustment to recognise the interest payable as at 1 July 2005 is a decrease in retained earnings of $1 million.

Reset preference shares will continue to qualify as Tier 1 capital, at least in the near term

This change has a direct impact on the contributed capital of the IAG Group, which is central to the capital adequacy requirements set by APRA. APRA has stated it will continue the current regulatory capital treatment for existing instruments that are adversely affected by the accounting standard change until further notice. If APRA’s approach changes, it has indicated it may ‘grandfather’ the treatment of affected issued securities. This would be considered a likely outcome, as the risk to the policyholders has not changed as a result of the change in accounting standards.

8) Investments

More choices around accounting policies for investments

Initial accounting policy selection means no immediate change

Under Australian GAAP, the IAG Group is required to measure at net market value (fair value less disposal costs) all investments integral to general insurance activities with movements in the net market value recorded in the statement of financial performance. Under A-IFRS, the IAG Group will be required to measure at fair value those financial assets held to back insurance liabilities. Those financial assets that are not held to back insurance liabilities will move to a system of purpose led accounting. A-IFRS requires classification of the investments based on the purpose for which they are held. The different classifications have different accounting treatments, being fair value through profit or loss, fair value through equity, and amortised cost. There is also an option to measure any financial asset at fair value through profit or loss, regardless of the purpose for which it is held, where certain conditions are met (the application of the conditions arises from the IAG Group’s election to early adopt amending standard AASB 2005-4 restricting the application of the fair value option).

The IAG Group has elected to apply the fair value through profit or loss option under its current investment strategy for shareholders’ funds and so all investments held will be measured on the same basis. This is basically a continuation of current practice with small adjustments for disposal costs (A-IFRS uses gross market value, not net market value) and a change in market price determination (move from last sale price to bid price). The net adjustment for the change is a $1 million increase in investments with a corresponding adjustment to retained earnings as at 1 July 2005.

The IAG Group reserves the right to deem further asset acquisitions as held for another purpose and thus be valued on one of the other available bases.

9) Derivatives

All recorded in statement of financial position at fair value

The IAG Group uses a variety of derivatives to manage risk exposures of the IAG Group.

Investment operations
All of the derivatives used in relation to the investment operations are currently recognised on the statement of financial position (disclosed together with the underlying instrument) at fair value, with movements in fair value being recorded through profit or loss. The A-IFRS treatment is basically a continuation of current practice with small adjustments for market valuation differences. The net adjustment for the change is included within the adjustment noted above for investments.

Treasury operations
There are various derivatives used by the IAG Group to hedge exposure to foreign currency and interest rate movements in relation to treasury transactions, which include borrowings. While the Group has a number of economic hedges in place, only a small number of these transactions have been selected for hedge accounting.

Hedge accounting to be applied to only a small number of transactions

Those derivatives, for which hedge accounting will not be used under A-IFRS, will be recognised on the statement of financial position at fair value, with movements in fair value being recorded through profit or loss. This is basically a continuation of current practice and requires no adjustment as at 1 July 2005.

A-IFRS specifies that hedge accounting can only be applied for fair value hedges, cash flow hedges, and hedges of investments in foreign operations, and only where stringent rules are met. While all derivatives will be measured at fair value, hedge accounting basically provides for the movement in fair value of the derivative to follow the accounting for the underlying instrument. Each of the derivative contracts selected for hedge accounting qualifies as a cash flow hedge.

The adjustment required to recognise the application of cash flow hedge accounting under A-IFRS for these transactions involves an increase in the measurement of the derivative recognised on the statement of financial position of $7 million with a corresponding credit to an equity reserve.

Embedded derivatives to be measured and recognised in certain circumstances

Under A-IFRS, derivatives embedded in other financial instruments or other non-financial host contracts are to be treated separately when their risks and characteristics are not closely related to those of the host contract and the host contract is not carried at fair value with movements recorded through profit or loss. Where an embedded derivative is required to be separated, they are to be measured at fair value. A review conducted of all contracts to which IAG Group entities are a party determined that, while embedded derivatives were identified, they are either not required to be separated from the host contract and /or currently have no material value.

10) Consolidation

Potential reclassification of outside equity interests in investment trusts controlled for accounting purposes

Other than the equity remuneration trusts (refer 2b above), there are no other entities in the IAG Group that are currently not consolidated that would require consolidation under A-IFRS.

The consolidated Group includes IAG Asset Management Wholesale Trusts in which the Group has a controlling interest for accounting purposes. Currently, when consolidating the trusts, an amount is recognised in equity as the outside equity interests in the trust, being the value attributable to unitholders outside the IAG Group. It is possible, at least for one of the trusts, that under A-IFRS, the residual interest in the trust will qualify as a liability in the statement of financial position of the trust and so will not be recognised as equity. Therefore, upon consolidation of the trust under A-IFRS, the value attributable to unitholders outside the IAG Group would be recognised as a liability in the statement of financial position of the IAG Group and not in equity as an outside equity interest

There are accounting and taxation issues outstanding that need to be resolved before the final treatment can be determined. These issues are expected to be resolved prior to preparation of the first financial report prepared in accordance with A-IFRS. The change will have no impact on the equity attributable to shareholders of Insurance Australia Group Limited.

11) First time adoption – optional exemptions

Upon transition to A-IFRS the general principle is that the financial reports must be prepared as if the new standards had always been applied. There are however optional exemptions that may be applied upon first time adoption. The IAG Group may elect to apply some, all or none of the options. Only seven of the twelve options are relevant to the IAG Group and these are listed below together with the elected treatment.

Business combinations – The IAG Group will not restate the accounting for business combinations transacted prior to 1 July 2004.

Share based payments – The IAG Group will not retrospectively apply the A-IFRS expense treatment to share based payments granted prior to 7 November 2002 and/or that vested prior to 1 January 2005.

Property, plant and equipment – The IAG Group will use the fair value of the property as at 30 June 2004 as the deemed cost of that property moving forward but will continue with original cost for plant and equipment.

Foreign currency translation reserve – The IAG Group will not reset the foreign currency translation reserve to zero.

Insurance contracts – The IAG Group will not apply certain disclosure requirements to prior periods.

Financial instruments options – The IAG Group will use this option to designate financial instruments to the various classifications available under A-IFRS upon transition.

Fair value measurement of financial instruments – The IAG Group will not apply the first time adoption option allowing relief from the retrospective application of ‘Day One’ recognition requirements as the IAG Group’s current practice complies with the requirements.