losses arising from the assets backing these contracts (the DPF latent surplus), the Company establishes a liability equal to 90% of these net gains as if they were realised at year-end. Shareholders' interest in the DPF latent surplus (equal to 10%) is recognised in the statement of comprehensive income. Revenue consists of fees deducted for mortality, policy administration and surrender charges. Interest or changes in the unit prices credited to the account balances and excess benefit claims incurred in the period are charged as expenses in the statement of comprehensive income.
(iv) Investment contracts with DPF
The liability for these contracts is established in the same way as for the universal life insurance contracts with DPF (see above). Revenue is also recognised in the same way. Where the resulting liability is lower than the sum of the amortised cost of the guaranteed element of the contract and the intrinsic value of the surrender option embedded in the contract it is adjusted and any shortfall is recognised immediately in the statement of comprehensive income.
(b) Embedded derivatives
Certain derivatives embedded in insurance contracts are treated as separate derivatives when their economic characteristics and risks are not closely related to those of the host contract and the host contract is not carried at fair value through income. These embedded derivatives are measured at fair value with changes in fair value recognised in the statement of comprehensive income. The Company does not separately measure embedded derivatives that meet the definition of an insurance contract or embedded options to surrender insurance contracts for a fixed amount (or an amount based on a fixed amount and an interest rate). All other embedded derivatives are separated and carried at fair value if they are not closely related to the host insurance contract and meet the definition of a derivative.
2.12.1 Liability adequacy test
At each balance sheet date, liability adequacy tests are performed. Current best estimates of future contractual cash flows and claims handling and administration expenses, as well as investment income from the assets backing such liabilities, are used in performing these tests. Any deficiency is immediately charged to the statement of comprehensive income by establishing a provision for losses arising from liability adequacy tests (the unexpired risk provision).
2.12.2 Reinsurance contracts held
Contracts entered into by the Company with reinsurers under which the Company is compensated for losses on one or more contracts issued by the Company and that meet the classification requirements for insurance contracts in Note 2.11 are classified as reinsurance contracts held. Contracts that do not meet these classification requirements are classified as financial assets. Insurance contracts entered into by the Company under which the contract holder is another insurer (inwards reinsurance) are included with insurance contracts.