• Project carried over from IASC – click for History of That Project
• Interim standard on insurance contracts: IFRS 4 Insurance Contracts
• Discussed at July 2004 IASB meeting - Educational Session
• September 2004: Working Group on Insurance Appointed – Fresh Start on the Project
• Discussed at January 2005 IASB meeting - Educational Session
• Discussed at February 2005 IASB meeting - Educational Session
• Discussed at April 2005 IASB meeting - Educational Session
• Discussed at May 2005 IASB meeting - Non-Life Insurance Accounting
• Discussed at July 2005 IASB meeting - Educational Session
• Discussed at October 2005 IASB meeting - Educational Session
• Discussed at November 2005 IASB meeting - Educational Session
• Discussed at December 2005 IASB meeting - Educational Session and Board Meeting
• Discussed at February 2006 IASB meeting
• Discussed at March 2006 IASB meeting
• Discussed at April 2006 IASB meeting
• Discussed at May 2006 IASB meeting
• Discussed at June 2006 IASB meeting
• Discussed at July 2006 IASB meeting
• Discussed at September 2006 IASB meeting
• Discussed at October 2006 IASB meeting
• Discussed at January 2007 IASB meeting
• Discussed at February 2007 IASB meeting
• 3 May 2007 Discussion Paper published
  Press release (PDF 69k).
• May 2007 Deloitte Newsletter – Implications of the IASB Insurance Discussion Paper
• Discussed at November 2007 IASB Meeting
• Deloitte Letter of Comments on the Discussion Paper
• Discussed at January 2008 IASB meeting
• Discussed at February 2008 IASB meeting
• Discussed at September 2008 IASB Meeting
• Discussed at October 2008 IASB Meeting
• Discussed at February 2009 IASB Meeting
• Discussed at March 2009 IASB Meeting
• Discussed at April 2009 IASB Meeting
• Discussed at May 2009 IASB Meeting
• Discussed at June 2009 IASB Meeting
• Discussed at July 2009 IASB Meeting
• Discussed at September 2009 IASB Meeting
• Discussed at October 2009 IASB Meeting
• Discussed at October 2009 Joint IASB-FASB Meeting
• Discussed at November 2009 IASB Meeting
• Discussed at December 2009 IASB Meeting
• Discussed at 5 January 2010 Special IASB Meeting
• Discussed at January 2010 IASB Meeting
• Discussed at 10 February 2010 Special IASB-FASB Joint Meeting
• Discussed at Special 31 May-2 June 2011 IASB-FASB Meeting (jump to notes below)
• Discussed at February 2010 IASB-FASB Joint Meeting
• Discussed at March 2010 IASB-FASB Joint Meeting
• Discussed at April 2010 IASB-FASB Joint Meeting
• Discussed at May 2010 Joint IASB-FASB Meeting
• Discussed at 1 June 2010 Special Joint IASB-FASB Meeting
• Discussed at 10 June 2010 Special Joint IASB-FASB Meeting
• Discussed at June 2010 Joint IASB-FASB Meeting
• Discussed at July 2010 Joint IASB-FASB Meeting
• 30 July 2010 Exposure Draft ED/2010/8 Insurance Contracts
  IASB press release (PDF 36k)
• 30 July 2010 Deloitte press release on IASB ED/2010/8
• 30 November 2010 – Deadline for comments on ED/2010/8
• Discussed at December 2010 IASB Meeting (jump to notes below)
• Discussed at January 2011 IASB Meeting (jump to notes below)
• Discussed at 1-2 February 2011 Special Joint IASB-FASB Meeting (jump to notes below)
• Discussed at February 2011 IASB Meeting (jump to notes below)
• Discussed at 1-2 March 2011 Special Joint IASB-FASB Meeting (jump to notes below)
• Discussed at March 2011 IASB and IASB-FASB Meetings (jump to notes below)
• Discussed at Special 29 March 2011 IASB Meeting (jump to notes below)
• Discussed at April 2011 IASB Meeting (jump to notes below)
• Discussed at Special 27 April 2011 IASB Meeting (jump to notes below)
• Discussed at Special 4 May 2011 IASB-FASB Meeting (jump to notes below)
• Discussed at Special 11-12 May 2011 IASB-FASB Meeting (jump to notes below)
• Discussed at May 2011 IASB Meeting (jump to notes below)
• Discussed at Special 31 May-2 June 2011 IASB-FASB Meeting (jump to notes below)
• Discussed at June 2011 IASB Meeting (jump to notes below)
• Discussed at July 2011 IASB Meeting (jump to notes below)
• Discussed at September 2011 IASB Meeting (jump to notes below)
• Discussed at October 2011 IASB Meeting (jump to notes below)
• Discussed at November 2011 IASB Meeting (jump to notes below)
• Discussed at December 2011 IASB Meeting (jump to notes below)
• Discussed at January 2012 IASB Meeting (jump to notes below)

Timetable

• Click for IASB Project Timetable

IASB Project Insights

• A quick overview of this project is available on our IASB Project Insights page

21 September 2004: New IASB Insurance Working Group

In September 2004 the IASB announced the membership of its new working group on financial reporting by insurers. Although the IASB's predecessor produced an Issues Paper and a Draft Statement of Principles, and the IASB itself has discussed the project at many Board meetings, other priorities forced the IASB to suspend work following the January 2003 meeting. Therefore, the IASB will regard the past work as a useful resource, but will not feel bound by it. "The only restrictions on a fresh look are the IASB's Framework and the general principles established in the IASB's existing standards", the Board's announcement said.

Note: The members of the Insurance Working Group have changed since the initial formation of the group. The current membership of the group can be found on the IASB website.

Discussion at the July 2004 IASB Meeting

The Board discussed general education material on the nature of insurance contracts and current accounting models for insurance contracts. In essence, this meeting was the kick-off of the Phase II project starting with a clean slate. No decisions were made as this session was meant to be a 'refresher' for the Board.

The Board discussed general issues around which model(s) should be used for different types of insurance contracts--focussing on the 'asset/liability model' and the 'deferral and matching model'. The Board also discussed general issues on whether the model should:

• be constructed in a manner that prohibits or limits the recognition of net profit or loss on initial recognition,
• incorporate expectations about cash inflows and outflows that are a consequence of policyholder renewals or cancellations, and
• should require costs incurred to acquire new insurance contracts to be capitalised as assets and amortised.

In September, the Board will discuss issues related to measurement, such as discounting, asset/liability interaction, risk/service adjustments, unbundling, participating contracts, and credit standing. This discussion is also expected to be educational, and no decisions are expected.

Discussion at the January 2005 IASB Meeting

The IASB had an education session presented by the International Actuarial Association, focussing on non-life claims liabilities.

The Board also discussed the project apart from the educational session. During that discussion, the staff indicated that it is too early to develop a detailed plan at the moment. Much depends on the advice that emerges from discussions within the Insurance Working Group and on the interaction with other projects. The staff will update this plan as the project progresses and make it more detailed.

The Board discussed the interaction of this project with the other projects that are currently underway: conceptual framework, revenue recognition, accounting measurement, performance reporting, financial instruments, and the liability and equity project. The staff indicated that the level of interaction makes it difficult to develop a detailed timetable at this stage.

The remit of the Financial Instruments Working Group was discussed in the context of how its work affects this project. The Board agreed that there would be consultation on an ad hoc basis rather than formulating a policy framework.

The Board noted that the interaction of the insurance project with the revenue recognition project would be challenging.

On the issue of convergence, the staff indicated that the FASB is not expected to commit resources to the insurance contracts project at this time. The Board indicated its intention to continue with the project.

The Board was asked whether any 'initial output' document should be issued for comment – something along the lines of a brief discussion paper, dealing only with certain 'hot spots' and indicating the Board's preliminary views. The Board agreed with this approach and advised the staff not to dwell on matters of detail. The following topics would be the main areas of focus in that paper:

• Model. Should the Board create a single model for all contracts, or different models for different types of contracts? Should the accounting model be based on direct measurements of contract assets and liabilities (asset-and-liability model), on deferral and matching of contract revenues and expenses (deferral-and-matching model), or some combination of the two?
• Measurement. Should an asset-and-liability model use measurements based on fair value, entity-specific value, or some combination of measurement attributes? If the measurement attribute is fair value, should it be a business-to-customer measurement (customer consideration) or a business-to-business measurement (legal layoff). Should the measurement address options or guarantees embedded in a contract?
• Discounting. Should the measurement of some or all amounts recognised in the balance sheet be based on their present values?
• Asset/liability interaction. Should the measurement model incorporate expectations about asset performance in determining the carrying amount of the contract liability?
• Risk/service adjustment. How should the accounting model approach the question of risk (or service) adjustment?
• Gain or loss on initial measurement/liability recognition. Should the accounting model be constructed in a manner that prohibits or significantly limits the recognition of net profit or loss on initial recognition?
• Policyholder behaviour. Should the accounting model incorporate expectations about cash inflows and outflows that are a consequence of policyholder renewals or cancellations of an insurance contract?
• Acquisition costs. Should costs incurred to acquire new insurance contracts be capitalised as assets and amortised?
• Unbundling. Should the measurement model unbundle the individual elements of an insurance contract and measure them individually?
• Participating contracts. How should the insurer's liability to holders of participating contracts be recognised and measured?
• Credit standing. Should the measurement include the effects of the entity's credit standing?

Discussion at the February 2005 IASB Meeting

The Board received a presentation on aspects of discounting and risk margins for property and casualty insurance liabilities. The presenters present at the table were Ralph Blanchard (Casualty Actuarial Society), Robert Conger (Towers Perrin Tillinghast) and Sam Gutterman (PricewaterhouseCoopers). No decisions were made.

The Board held public education sessions on non-life insurance contracts, focussing on discounting and risk margins. The sessions were led by the General Insurance Association of Japan and the Group of North American Insurance Enterprises. No decisions were made.

Discussion at the April 2005 IASB Meeting [Educational Session]

The Board held an education session on non-life insurance contracts, focussing on discounting and risk margins. In particular, this session was with the Australian and Canadian members of the IASB's Insurance Working Group.

Accounting for (Non-Life) Insurance in Australia was presented by Tony Coleman and Andries Terblanche.

Phil Arthur and Jim Christie presented Non-Life Insurance Accounting: Canadian Perspective on Discounting and Use of Risk Margins.

No decisions were made.

Discussion at the May 2005 IASB Meeting Non-Life Insurance Accounting

The Board considered the following aspects of non-life insurance accounting:

• (a) whether the measurement of non-insurance claims liabilities should include discounting and risk margins.
• (b) four possible accounting approaches for non-life insurance contracts, which discussed in January 2005 with the Insurance Working Group.

There was a brief digression when Board members expressed extreme disappointment at receiving a letter from several insurance industry associations that challenged the activities of the Insurance Working Group. The Board expressed its absolute support for the Working Group and appreciation for the way it has engaged the Board and the staff in studying complex problems. However, it was apparent that the insurance associations had not understood the Working Group's terms of reference, which did not include making recommendations to the Board. It was agreed that the Board should clarify matters with the industry associations as soon as possible.

Introduction

The IASB staff reviewed recent developments on the Insurance project, noting that the FASB had expressed the desire that this become a 'modified joint project' at the appropriate time (i.e., after the IASB has published a discussion paper). The staff noted that the topics for discussion at the meeting reflected the following advice from participants in the Insurance Working Group.

• (a) it is important to consider not only individual measurement topics but also the whole package of decisions that make up entire accounting approaches.
• (b) there is concern about the possibility of accounting mismatches between insurance liabilities and the assets that back them.

The Board agreed that it should not discuss whether there should be a single model until the Working Group has had the opportunity to discuss several basic types of insurance contract (annual non-participating non-life, non-participating life, participating life, unit-linked (variable) life or annuity, universal life). In addition, there was a need to look again at the measurement attributes before committing to a particular course of action. One Board member noted that he would not support any solution that produced a different accounting model for each type of insurance contract depending on how it was described. There might be arguments for a different approach as between life and non-life, but other 'bells and whistles' could be accommodated through existing accounting standards on bifurcation, derivative accounting, etc.

Non-life business: over-view of possible accounting approaches

The Board discussed four possible approaches to accounting for non-life contracts, labelled A-D, as follows:

Approach A:

• (a) uses the main features of most countries' existing accounting requirements for insurance liabilities (that is, unearned premium liability [amortised as the premium is earned, and subject to a liability adequacy test], deferred acquisition costs [amortised and subject to an impairment test], undiscounted claims liabilities with no explicit risk margin).
• (b) applies IAS 39 Financial Instruments: Recognition and Measurement to financial assets.

Approach A is essentially the existing position for many insurers subject to IAS 39, local equivalents of IAS 39 or US GAAP.

Approach B:

• (a) uses the main features of most countries' existing accounting requirements for insurance liabilities (same as approach A).
• (b) modifies approach A's treatment of some financial assets held. Specifically, it permits amortised cost measurement for financial assets that provide fixed or determinable payments and are held to back insurance liabilities.

Approach C:

• (a) distinguishes the stand-ready obligation to pay valid claims for future insured events arising under existing contracts from the claims liability (that is, the liability to pay valid claims for insured events that have already occurred, including claims incurred but not reported [IBNR]). The stand-ready obligation is measured (as in approaches A and B) as the unearned portion of the premium, less deferred acquisition costs (a future meeting should discuss whether deferred acquisition costs should be recognised separately from unearned premium).
• (b) modifies approach A's treatment of the claims liability. Specifically, claims liabilities:
  • (i) are discounted. The Working Group has not yet discussed explicitly what discount rate should be used in an approach of this kind. To provide a specific proposal, this paper assumes a current risk-free discount rate. The use of a current discount rate seems consistent with Working Group participants' wish to minimise accounting mismatches.
  • (ii) include a risk margin (basis to be determined).
• (c) applies IAS 39 to financial assets (same as approach A).
• Approach C's treatment of claims liabilities would be consistent with the treatment of provisions in IAS 37 Provisions, Contingent Liabilities and Contingent Assets.

Approach D:

• (a) accounts for insurance liabilities (both claims liabilities and pre-claims liabilities) using the approach that the IASB and FASB are exploring in their joint project on revenue recognition. In some respects, this approach is also similar to the proposals in the Draft Statement of Principles developed by the former IASC Steering Committee. Specifically, 'unearned' premium and acquisition costs would not be deferred. Instead, the insurer's contractual rights and obligations would be measured at current exit value from inception.
• (b) applies IAS 39 Financial Instruments: Recognition and Measurement to financial assets (same as approach A).

It was noted that the 'exclusive' labels were not necessarily useful, and that there was some overlap, especially between Approaches C and D. It was noted that Approach C is similar to the approaches adopted in Australia, Canada and New Zealand. Approach C could also be described as 'no change for premium accounting; FAS 60 with discounting for claims.' Approach D is generally a new approach.

The Board discussed the alternatives proposed by the staff at some length. The decision on preference was deferred pending the discussion of discounting and risk and uncertainty.

Discounting

The Staff reviewed arguments in favour and opposed to discounting insurance liabilities (see Observer Notes, Agenda Paper 4A for these arguments). The Board had a wide-ranging discussion, but eventually agreed that discounting should be required for all non-life claims liabilities. There should there be no specific exemption on materiality grounds for liabilities that meet specified criteria. Normal materiality criteria should apply.

Risk and uncertainty

The Board discussed how risk and uncertainty should be reflected in the accounting model. The staff noted that this area had been particularly difficult for the Working Group to resolve. After a vigorous debate, the Board agreed that:

• the measurement of non-life insurance claims liabilities should include risk margins. This recommendation is compatible with approaches C and D, as described above.
• if approach D were to be adopted, risk margins would be included in both:
  • (a) the claims liability (i.e. the liability to pay valid claims for insured events that have already occurred, including claims incurred but not reported [IBNR]); and
  • (b) the stand-ready obligation to pay valid claims for future insured events arising under existing contracts, in other words obligations relating to the unexpired portion of risk coverage. (For discussion with the Insurance Working Group, the staff invented the term pre-claim liability to describe this.)
• Risk margins should be applied in carrying out a liability adequacy test.

The Board noted that 'risk margin' was a term of art and expressed some dissatisfaction with it.

Estimation techniques

The Board agreed that it should clarify the measurement objective (in due course) and give high level guidance, but should not give detailed operational guidance on techniques for estimating the number and amount of claims arising under insurance contracts.

Discussion at the July 2005 IASB Meeting [Educational Session]

There were two educational sessions at the July Board meeting.

The first session was led by the FASB staff and focussed on how to determine when significant insurance risk is transferred. This impacts the accounting for the contract, either as an insurance contract or as a financial contract (deposit or derivative).

At the second session, two life insurance industry experts gave a presentation on aspects of life insurance accounting, concentrating on product features. Their presentation (141 slides) is available on the IASB Website www.iasb.org. There were no decisions taken and very little discussion of the matters by Board members, other than items of clarification.

No decisions were made during these sessions.

Discussion at the October 2005 IASB Meeting [Educational Session]

The session was educational and no decisions were taken.

Insurance experts from two international public accounting firms made a presentation to the Board relating to the characteristics of renewals and their impact on accounting for insurance contracts. The Board considered a range of different types of contracts, and particularly considered the issue of whether the entity could control future premiums in certain situations.

The Board noted that such decisions would need to be made on a portfolio basis, based on the terms of the product, rather than in respect of each individual policy holder. The Board also noted that completing the insurance project would result in significant thought about certain elements of the financial statements, and the outcomes of that research and discussion would be very useful in considering the Framework for the Preparation and Presentation of Financial Statements.

Discussion at the November 2005 IASB Meeting

This was an educational session and no decisions were made.

Representatives from the insurance and reinsurance business held an educational session on reinsurance and insurance linked securities. This is the second of three educational sessions on insurance in conjunction with the development of the phase II project on insurance contracts.

Presenters gave an introduction on the aspects and nature of reinsurance. The session also covered the different types of reinsurance and the risk models reinsurance companies' use when assessing risks and premiums from insurers. The Board considered different accounting issues in conjunction with these types of contracts and specifically considered guidance on risk transfer to be one of the key issues.

At the end of this session Board members considered the accounting implications of the increasing market for insurance-linked securities (catastrophe bonds) used by insurance companies to deal with peak risks due to severe catastrophes.

Discussion at the December 2005 IASB Meeting

Cancellation and Renewal Options

As a part of phase II of the Insurance Contracts project, the Board discussed staff papers dealing with issues on Cancellation and Renewal options.

The first question raised was related to potential differences on short-term versus long-term contracts. The staff's perception was that there should be no inherent difference in contracts as long as the terminology in the contracts is the same. Some Board members disagreed with this statement. They pointed out that acquisition costs may be different for short-term than for long-term contracts. Other comments were that there could be different intentions behind a short-term contract with a renewal option and a straight long-term contract. The Board seemed to agree that institutional as well as contractual arrangements have to be considered when assessing the accounting treatment.

The staff also raised a question on whether only substantive features should raise different treatments of contracts. The Board had a short discussion on whether price would be the only substantial difference in a contract, and agreed that it probably would not be. They agreed to come back to this issue.

The next staff paper raised the issue on whether an asset could be recognised based on cash flows from policyholders. A Board member noted that the analysis made by the staff that an asset should not be recognised seemed reasonable, but not for the reason addressed, that the insurer does not control the cash flows. The Board member stated that the question should be whether the insurer has a present right to these cash flows.

The other issue dealt with was whether this conclusion would apply even if cash flows expected are specified in the contract. In conjunction with this issue, the Board discussed briefly, the meaning of the word specified. Some Board members commented that the policyholders have no obligation to pay the premium even if an amount is specified in the contracts and it would therefore not change the fact that this would not create an asset for the insurer.

The Board also discussed the rights and obligations in an insurance contract. The Board was asked whether rights have to be enforceable. Board members tended to agree that enforceability is crucial. An additional issue discussed was whether an insurer could acquire contractual rights from an insurance relationship. The staff pointed out that if the policyholder did not pay premiums, the insurer is able to let the contract go without any obligations. The question is how strong the remedy has to be before you can say it is enforceable and giving contractual rights to the insurer. The Board agreed that this would need further deliberation.

The Board did not discuss agenda papers 3E and 3F.

Insurance Contracts Phase II - Educational Session

No decisions were made during this session.

Representatives from the IAA held an educational session on Participation and Performance - Linked Features in Insurance and Related Contracts.

Presenters gave an introduction to the principal scope of the products they would cover during the session. This would be mainly life insurance, investments contracts and certain non-life contracts. The Board considered features on insurance contracts such as performance-linked contracts, which include contractual reference to one of the parties of the contract. Presenters introduced the issue of discretion in insurance contracts, and the Board had a discussion on different discretionary elements and constraints in contracts.

At the end of this session the representatives raised three main accounting issues arising from use of these features in insurance contracts. Some members of the Board had concern about the perception of discretion and the effect this could have, specifically if this could create reclassification of surplus from equity to liabilities.

Life Insurance Accounting Models

The purpose of this session was for the Board to get an overview of the various accounting approaches available to the Board without going into the detail of precise measurement attributes.

The Board discussed the potential difficulties involved in the measurement of the margin recognised as the insurer provides service and is released from risk under the contract. This is coupled by the fact that additional risks may arise during the period resulting in a requirement to reassess at each balance sheet date, the full extent of risk within existing contracts, in addition to the assessment of risk release from the date of inception or previous assessment.

After discussing other aspects of the staff's presentation, the Board decided that the staff should concentrate all further work on the project on the two current-value approaches.

Discussion at the February 2006 IASB Meeting

The discussions were based on agenda papers 10A - 10J.

Contractual cash flows that depend on policyholder behaviour (agenda papers 10A - C)

This discussion centred round an extremely simple example developed by staff of a two-year life insurance policy (see paragraphs 3-5 of the paper). The paper considered four possible presentations of the insurer's balance sheet. The Board agreed in principle with the second approach, whereby all future cash flows resulting from future cash flows from the contract were recognised. It was agreed that the right to benefit under the insurance contract represents an asset to the insurer, and that the asset meets the definition of an intangible asset in IAS 38. The intangible asset would be recognised subject to meeting various recognition criteria. It was generally agreed that the intangible asset was a customer relationship that arises out of a contract. This paper did not address how the asset and liability would be presented in the balance sheet (e.g. gross or net).

Summary of possible accounting approaches (agenda papers 10D - E)

Agenda papers D and E summarised the possible accounting approaches the Board is considering for insurance contracts. The papers were background information for other papers, and the Board was not asked to make any decisions on these papers.

Acquisition costs (agenda paper F)

[There is a small typo in the title immediately preceding paragraph 9 in the agenda paper - the title should read 'Acquisition costs and current exit value']

Again, the discussion centred round an example developed by staff. In the example, an insurance contract generates policyholder benefits with a present value of CU 900. The insurer has to incur costs of CU 100 to originate the contract, so will charge the policyholder at least CU 1,000. The contract has a single premium of CU 1,000 which is received at inception. The present value of the insurer's obligation is CU 900 (not CU 1,000). This is true in both the prospective and unearned premium approaches.

The Board agreed that in this example the insurer's liability is CU 900. They also agreed that acquisition costs should not be capitalised. They are only relevant in that they may be considered by the insurer in setting premiums. Furthermore, if these costs were separately capitalised, this would lead to problems of how to measure the costs subsequent to initial recognition.

The paper explored whether there is merit in separately presenting some other contractual rights or obligations, but the Board was not asked to make any decisions. The paper then considered which costs are acquisition costs. No decisions were made, but there was support for the costs encompassing more than just incremental costs. This is because the pricing of the contracts is a function of the costs incurred by the insurer, who will want to recover more than just incremental costs.

Liability adequacy test (agenda paper G)

Paragraph 10 of the paper summarised when staff determined that a liability adequacy test would be needed. The Board agreed with the conclusions except that many Board members felt that a test would be needed for subsequent measurement of both life liabilities and non-life pre-claims when a current entry value was used as a measurement basis.

Paragraphs 12-21 dealt with risk margins. In the example given in paragraph 14, the Board agreed that the liability determined using an adequacy test should be greater than CU105, although not necessarily CU 113 (as in paragraph 14c)). The measurement should be based on exit-value assumptions. As this represented a substantial change to the proposed model, staff will reconsider this example and re-present it at a later meeting.

Shortfall allocations were not discussed, but the Board did agree with the staff recommendations on subsequent accounting after a shortfall. Broadly, these were that if an insurer uses a current entry value approach for pre-claims liabilities, the liabilities also reflect the time value of money and risk margins. Thus interest should be added over time to the shortfall and the insurer should recognise income as it is released from the risk reflected in the margin in the shortfall. In an unearned premium approach, interest should not be accrued on a shortfall, to be consistent with the fact that interest is not accrued on unearned premium. However, because interest is not added, an additional shortfall may arise when the liability adequacy test is applied again. The Board also agreed that a shortfall should be reversed if it no longer exists.

Gain on initial recognition of insurance contracts (agenda paper H)

No decisions were made by the Board, although it was agreed that further work should be done to explore the consequences of not prohibiting the recognition of net profit on initial recognition. Further, analogies were drawn to IAS 39 and the recognition of day 1 profit. It was generally felt that there should be a principle that is applied consistently across all types of contract.

Non-life insurance contracts - Measurement attribute for pre-claims (agenda paper 10I)

The Board agreed with the staff recommendation that a prospective approach be taken for measuring non-life insurance pre-claims. Staff also proposed that, without creating a specific exception to the prospective approach, for short duration contracts unearned premium may often be a reasonable approximation to a prospective measurement. However, an insurer should not make this assumption without testing. This was discussed by the Board, with some Board members concerned that this would offer no relief to insurers, as in order to determine whether they could use an unearned premium approach, they would also have to measure using the prospective approach. Staff indicated that this was not the intention of the paragraph, and that they would reconsider the wording and bring it back to a later meeting.

The Board agreed that non-life claims liabilities should be discounted using a current discount rate. Project planning (agenda paper 10H)

This paper was not discussed at length. Staff clarified that under the proposed timetable the Board could expect to see a first pre-ballot draft of a discussion paper in July 2006.

Discussion at the March 2006 IASB Meeting

Policyholder participation rights

Some insurance contracts give the policyholder both guaranteed benefits (these are benefits to which a particular policyholder has an unconditional right that is not subject to the discretion of the insurer, for instance, a death benefit) and a right to participate in favourable contract performance, but the insurer has constrained discretion over the amount and/or timing of distributions to policyholders. Similar policyholder participation rights are also found in some investment contracts (financial instruments) sold by insurers. The Board discussed whether an insurer should classify policyholder participation rights:

• (a) entirely as a liability, or
• (b) entirely or in part as an equity component of a compound contract that also contains a liability component. The liability component is the obligation to provide guaranteed benefits.

To aid the discussion, the Board considered various examples. In some scenarios the Board indicated its leaning but in other scenarios the staff were asked to explore, in more detail, how the contracts work in practice.

Separate from the individual examples discussed, the Board was asked to consider available accounting models and indicate its preference. The options discussed were:

• (a) policyholder participation rights do not create an obligation until a particular policyholder has an unconditional right to a distribution arising from that right.
• (b) if the policyholder participation right does not create an obligation, that suggests that a participating policyholder is buying a compound instrument with two components: a liability (the stand-ready obligation to pay the guaranteed benefits) and an equity component (the participation right).

The Board suggested a third alternative which received majority support. Under that model, there would be no split accounting, as this was viewed as onerous and conceptually flawed because it is questionable whether simply because the liability definition has not been met, the default classification is equity – the Framework states that if the liability definition is not met, recognise income. Under this alternative, when dividends are declared, the participation therein would be expensed in the income statement. The Board did not favour an allocation of net income between shareholders and participating policyholders (similar to the allocation required by equity holders of the parent and minority interests required for consolidated financial statements).

Investment contracts

For policyholder participation rights in investment contracts, the Board agreed with the staff recommendation to account for them in the same way as for participation rights in insurance contracts.

[The following portion of the discussion was held on Friday 31 March 2006]

Estimating cash flows

The Board discussed an 'early version' of material that could be included in the forthcoming Discussion Paper. [This session was very difficult to follow.] There was a long debate around the following principle and its application. The Board tentatively agreed that:

In estimating the current [entry/exit] value of insurance liabilities, an insurer should develop estimates of cash flows that:

• (a) are explicit;
• (b) incorporate, in an unbiased way, all available information about the amount, timing and uncertainty of all cash flows arising from the liabilities;
• (c) are as consistent as possible with observable market prices; and
• (d) correspond to conditions at the end of the reporting period.

Risk margins

The Board agreed that:

• the objective of a risk margin is not to provide a shock absorber for the unexpected, nor is it to enhance the insurer's solvency. Instead, the objective is to convey decision-useful information to users about the uncertainty associated with future cash flows. A risk margin will satisfy that objective best if it is consistent with an unbiased estimate of the compensation that market participants would demand for bearing the risk in question; and
• the Board should not prescribe specific techniques for developing risk margins. Instead, the Board should explain in the Discussion Paper (and ultimately in an IFRS) the attributes of techniques that will enable risk margins to convey useful information to users about the uncertainty associated with risk margins.

Embedded derivatives

The Board discussed the treatment of embedded derivatives (including embedded options and guarantees) included in a host insurance contract that is measured at current entry value. This was a preliminary discussion and the Board was not asked for a view.

Discount rates

The Board agreed that the objective of the discount rate is to adjust estimated future cash flows for the time value of money. The discount rate should be consistent with observable market prices for cash flows whose characteristics match those of the insurance liability in terms of timing, currency and liquidity. The observed discount rate should be adjusted to exclude any factors that influence the observed rate but are not relevant to the liability (for example, risks that are not present in the liability but are present in the instrument used as a benchmark). The Board agreed that, at this stage, it would not provide further guidance on how to achieve that objective.

Recognition and derecognition

The Board agreed that the conclusions in IFRS 4 Insurance Contracts with respect to the derecognition of an insurance liability are still valid.

Project plan

The Board received the latest project plan for the project. The current expected publication date for the Discussion Paper is December 2006.

Discussion at the April 2006 IASB Meeting

Interest and discount rates

Staff first asked the Board whether they agreed with the recommendation in agenda paper 7G, paragraph 5 that the Board should not develop guidance in this project on the following topics:

• how to determine a discount rate for maturities beyond the term of instruments traded in observable markets; and
• how to develop interest rates for currencies in which there is little or no market in risk-free instruments.

The Board agreed with the staff recommendation.

Measurement attributes

The Board then discussed what measurement attribute should be used for insurance liabilities. Staff proposed that:

• a. The measurement attribute for insurance liabilities should be current exit value. Current exit value should be defined as the amount that the insurer would expect to have to pay today to another entity if it transferred all its remaining contractual rights and obligations immediately to that entity (and excluding any payment receivable or payable for other rights and obligations).
• b. An insurer should not be prohibited from recognising a net gain (net after acquisition costs) or net loss at the inception of an insurance contract. However, if an insurer identifies an apparently significant gain or loss at inception, it would need to check carefully for errors or omissions.
• c. The Board might conclude in the fair value measurement project that current exit value is synonymous with fair value. However, it would be premature to reach a conclusion on that point now in the project on insurance contracts, because the project on fair value measurement is still at an early stage. The staff recommends that the Board should, for the time being, define the measurement attribute for insurance contracts as current exit value. As work proceeds on the fair value measurement project, the staff will assess periodically whether it is appropriate to recommend merging the two concepts for the project on insurance contracts.

The Board were asked to vote on the above recommendation. 7 Board members voted in favour of the recommendation, 6 voted against, and 1 abstained. Generally, the Board members who did not vote in favour of the recommendations were concerned about the following issues:

• They preferred the alternative current value approach set out in the paper, whereby the margin is calibrated at inception to the actual premium charged. Under this approach, the margin reflects changes over time in the insurer's estimate of the amount of risk, but freezes the per-unit price of risk at inception. Further more, this approach would prohibit the recognition of any net gain at inception. Several Boar members were amenable to considering variations on this approach (for example where the per-unit price of risk is not frozen at inception).
• There were concerned about recognising a net gain at inception.
• There were concerns about how this approach tied into the revenue recognition project, and whether it was consistent with the proposals in that project.
• There was concern over how practical the approach recommended by staff was. It was possibly too idealistic, with too much emphasis on obtaining market prices where none exist.

Units of account

The Board discussed the level of aggregation of insurance contracts for measurement purposes. The Board generally agreed with the staff proposals on the level of aggregation – that a portfolio of contracts should contain contracts with similar risk characteristics. However there was some discussion over how much diversity can exist with a portfolio of similar contracts.

Unbundling

The Board was asked to consider whether a measurement model should unbundled the individual elements of an insurance contract and measure them individually. Staff proposed that unbundling deposit and service components for the purpose of recognition and measurement is likely to require arbitrary allocation and complex systems, and is unlikely to result in more representationally faithful financial statements. Unbundling should not be required.

There was some agreement with the staff proposal, but several Board members were concerned that the proposal meant entities had a free choice over whether to unbundled or not. There was also concern with how this tied into revenue recognition in other types of contract, where unbundling would be required in certain circumstances. Staff will consider whether there are circumstances in which unbundling should be prohibited.

Separate accounts

Staff asked the Board to consider the issue of separate accounts. Certain contracts link the benefit amount to the fair value of a designated pool of assets operated in a way similar to a mutual fund. That is, the contract holder bears the risks and rewards of the account's investment performance and the issuer derives only fee income as an asset manager. Some life insurers sell contracts that combine such elements with other elements, such as life insurance cover or guarantees of minimum investment performance. Staff proposed that an insurer should recognise separate account assets, and the related obligation to pay policyholder benefits, unless the insurer has a contractual obligation to pay all cash flows from the separate account assets to the separate account policyholders. that is, unless:

• a. The insurer has no obligation to pay amounts to the eventual recipients unless it collects equivalent amounts from the separate account assets. This condition is not breached if the insurer provides such benefits as guarantees of investment performance or guaranteed minimum death benefits, but the insurer would need to recognise its stand-ready obligation to provide those benefits, and measure that obligation at current exit value (if the guarantee meets the definition of an insurance contract) or fair value (if the guarantee is a financial instrument).
• b. Contract, law, or regulation prohibit the entity from selling, pledging, or lending the separate account assets except for the benefit of the separate account policyholders.
• c. The entity has an obligation to remit any cash flows it collects on behalf of the eventual recipients without material delay. In addition, the entity is not entitled to reinvest such cash flows outside the separate account, except for investments in cash or cash equivalents during the short settlement period from the collection date to the date of required remittance to the separate account, and interest earned on such investments is passed to the separate account.
• d. The insurer has substantially none of the risks and rewards of ownership of the separate account assets (other than the right to collect fees for providing investment management services).

It was noted that these are broadly the 'pass-through' criteria in IAS 39, but are being used as recognition, rather than derecognition, criteria. There was some concern about whether this was in conflict with the general recognition criteria in the Framework. Also, there was some inconsistency between criteria 'a' and 'd'. Possible solutions to this inconsistency included deleting 'd' or being consistent in the two paragraphs in the treatment of guarantees. This issue will be revisited by staff.

Customer relationships

In its February meeting, the Board decided that when an insurer recognises rights and obligations arising under an insurance contract, it should also recognise the portion of the customer relationship that relates to future payments that the policyholder must make to retain a right to guaranteed insurability. Staff propose that the (recognised portion of) the customer relationship should be presented as part of the liability. The Board agreed with the staff proposal, with several Board members commenting that the two should not be presented separately as they are inextricably linked.

Staff will investigate how best to provide useful disclosure about the extent to which the overall liability 'package' incorporates cash flows that are enforceable.

Profit margins

The Board has previously concluded that the measurement of insurance liabilities should incorporate a margin. The Board's previous discussions have focused on margins designed to convey decision-useful information to users about the uncertainty associated with future cash flows (risk margins).

At this meeting, the Board concluded that the measurement attribute for insurance liabilities should be current exit value and that the measurement of insurance liabilities should, in addition to a risk margin, also incorporate a margin that represents an unbiased estimate of the compensation that market participants would demand for providing services (a profit margin), other than the service of bearing risk (the risk margin covers the service of bearing risk). The Board also noted that in practice, it will be difficult to separate these components.

Unit-linked and index-linked payments

The Board started a discussion about the measurement of policyholder payments that are denominated in terms of an internal or external investment fund or an index. However, due to time constraints, it was agreed to continue this discussion at the next Board meeting.

Discussion at the May 2006 IASB Meeting

The IASB continued its discussion of various aspects of accounting for insurance contracts, the output of which will be a Preliminary Views discussion document (the PV document). This meeting discussed the following topics, some of which were carried forward from the April 2006 meeting:

• Universal life contracts
• Unit-linked and index-linked payments (the Board had a brief discussion of this paper in April 2006, but did not complete its deliberations)
• Credit characteristics of insurance liabilities
• Overview of relevant FASB projects
• Reinsurance
• Salvage and subrogation
• Business combinations and portfolio transfers

The Board was scheduled to discuss, but did not have time to address the following:

• Policyholder participation rights
• Changes in insurance liabilities

The Board noted the most recent project timetable, which includes a meeting with the Insurance Working Group in late June 2006 and a full schedule of topics for discussion at the July IASB meeting. If all topics to be included in the PV document are discussed by the end of that meeting, a first pre-ballot draft of the PV document could be ready in July or early August, with the intention of publishing the document by December 2006.

The IASB staff noted, as a procedural point, that the usual drafting procedures would be followed, with the exception that the threshold for publishing the PV document would be eight positive votes, rather than nine as would be necessary for an exposure draft or IFRS.

Universal life contracts

The Board discussed the appropriate accounting for 'universal life contracts', which is a type of permanent life insurance that allows the policyholder, after their initial payment, to pay premiums at any time, in virtually any amount, subject to certain minimums and maximums. Such a policy also permits the policyholder to reduce or increase the death benefit more easily than under a traditional whole life policy. To increase the death benefit, the insurance company usually requires the policyholder to furnish satisfactory evidence of continued good health.

The staff suggested that there were two possible accounting approaches, called for convenience the 'components approach' and the 'integrated prospective approach.' The staff introduced the benefits and limitations of each approach.

The Board had an inconclusive debate, but it was evident that Board members were uncertain of the real distinction between the two approaches. Some expressed concern about how the integrated prospective approach was being modelled, commenting that too many things hinged on issues surrounding the model. Several Board members noted that the component approach was more transparent than the integrated prospective approach.

Board members commented that resolving the issues surrounding the two accounting approaches would be assisted by a comprehensive numerical example.

The Board agreed to suspend discussion of these issues until the next meeting.

Unit-linked and index-linked payments

The staff introduced the topic by explaining that the staff were seeking to address a perceived accounting mismatch when an insurance fund is essentially a closed-end fund and all cash flows will ultimately be distributed to the policyholders. The staff proposed that if the assets of the unit-linked fund cannot (even using all available accounting options) be recognised and measured at fair value (for example, treasury shares), the carrying amount of the liabilities should exclude the portion of the benefit that depends directly on the difference between the carrying amount of the assets and their fair value.

Some Board members challenged the premise of the proposed presentation, noting that the mismatch was caused not by accounting but by the definitions of assets, liability and equity, under which treasury shares were not assets of the issuer.

There was no real support for the staff position with respect to unit-linked payments, and the staff will return with other proposals. The Board did raise the question whether a fair value option approach might be possible, but there was significant concern about defining the boundaries for such an option. Board members were concerned that such an option would result in 'do what you like' accounting for unit-linked insurance contracts.

No formal votes were taken on these issues, although it was evident that Board members were satisfied that index-linked insurance contracts would likely be accounted for as derivatives.

Credit characteristics of insurance contracts

The Board discussed whether the credit characteristics of an insurance liability should affect its measurement. Board members stressed that the credit risk being addressed was that of the insurance contract, not the insurer. However, the risks attaching to an individual insurance contract would have an effect on the credit risk of the insurer. After a short debate, the Board agreed:

• For the following reasons, the current exit value of a liability is, conceptually, the price for a transfer that neither improves nor impairs the credit characteristics of the liability:
  • The transferor would not willingly pay the price that a willing transferee would require for a transfer that improves those characteristics.
  • The policyholder (and regulator, if any) would not consent to a transfer that impairs those characteristics.
• At inception, the credit characteristics of an insurance liability are unlikely to have a material effect on either premium rates or the current exit value. A policyholder is unlikely to buy insurance if the policyholder thinks the insurer may not satisfy its obligations in full. If the credit characteristics affect the initial measurement materially, the insurer should disclose the effect.
• Conceptually, the subsequent measurement of an insurance liability at current exit value should reflect changes in the effect of its credit characteristics (ie changes in the probability of default or changes in the price for possible default).
• If the margin is calibrated initially to the premium and that margin is frozen at inception, it could be argued that the margin would incorporate the effect of credit characteristics at inception (argued above to be negligible) and would not reflect subsequent changes in the effect of those credit characteristics.
• If the measurement of an insurance liability does incorporate the effect of a change in its credit characteristics, the effect should be disclosed. (In developing the improvements to IAS 39 and the amendments to the fair value option, the Board noted that it may be difficult to identify the portion of a change in fair values that relates to a change in the effect of credit characteristics. However, this problem should not arise for insurance liabilities, because the effect would need to be included explicitly in a measurement model, rather than estimated from observable market prices).

Update on relevant FASB projects

The Board received a brief summary of developments in FASB projects relating to various aspects of accounting for insurance contracts.

Some Board members were concerned about not including the conclusions of the FASB's work on risk transfer in the PV document. However, it was noted that the FASB was using the IASB's definition of an insurance contract and that any differences should be minor.

The Board agreed with a staff recommendation that the PV document should not address accounting by policyholders for interests in and obligations under insurance contracts. However, several Board members asked the staff to explore ways raising the awareness of this issue among constituents.

Reinsurance

After a brief debate, the Board agreed that:

• The measurement attribute for reinsurance assumed (inwards reinsurance) should be current exit value.
• The measurement attribute for reinsurance assets (outwards reinsurance) should be current exit value.
• For risks associated with the underlying insurance contract, a risk adjustment typically:
  • increases the measurement of the reinsurance asset.
  • is equal in amount to the risk adjustment for the corresponding portion of the underlying insurance contract.
• The conclusion on risk adjustments for reinsurance assets may also be relevant for policyholder accounting. The Board will consider policyholder accounting after the discussion paper stage.
• The carrying amount of reinsurance assets should be reduced by the expected (probability-weighted) present value of losses from default or disputes, with a further reduction for the margin that market participants would require to compensate them for bearing the risk that defaults or disputes exceed expected value (expected loss model).
• Given the Board's tentative decision to use current exit value as the measurement attribute for insurance contracts, there is no need for specific restrictions to prevent the recognition of misleading gains or losses when an insurer buys reinsurance.
• A cedant should recognise at current exit value its contractual right, if any, to obtain reinsurance for contracts that it has not yet issued. In practice, that current exit value may not be material in many cases.

Salvage and subrogation

The Board agreed that:

• Insurance liabilities should be measured net of the impact of related salvage and subrogation rights that the insurer would acquire on paying a claim.
• Once an insurer acquires salvage or subrogation rights (generally by paying a claim under the insurance contract), the insurer has an asset. The insurer should measure that asset initially at current exit value.
• Until the Board has discussed reimbursement rights in the project to amend IAS 37, the Board should not conclude on how an insurer should measure salvage and subrogation rights after initial measurement.

Business combinations and portfolio transfers

The Board agreed that

• IFRS 4 permits an expanded presentation for insurance contracts acquired in a business combination or portfolio transfer. When it completes phase II of the insurance contracts project, if any significant differences remain between current exit value and fair value, it might be necessary to consider retaining the expanded presentation. If no significant differences remain, the expanded presentation would be redundant.
• When an entity takes over a portfolio of insurance contracts in a portfolio transfer, the current exit value of the portfolio at that date is likely to equal the consideration received, less the fair value of any other assets received (e.g. investments or recognisable intangible assets relating to customer relationships). If the current exit value is a different amount, the transferee should recognise the difference as income or expense.

Discussion at the June 2006 IASB Meeting - Education Session

The aim of the session was to provide the Board members with a briefing on the ASB's work on pension accounting, and to give them an opportunity to make observations and suggestions for the future of this project. A summary of the session can be found in agenda paper 11. Paper 11A goes into more detail, but was not available to observers. It will be available on the ASB's website shortly.

The session focussed on the work being done to develop a new accounting standard that can be applied globally. The aim of the project was to be principles-based. Thus, for example, the current goal is for there to be no distinction between the principles behind accounting for defined benefit plans and defined contribution plans. Andrew Leonard (from the ASB) noted in his presentation that there are several active IASB projects that need to be considered as part of the work on pensions. These include the projects on:

• the conceptual framework;
• non-financial liabilities;
• consolidation;
• measurement;
• reporting financial performance; and
• insurance.

Several Board members noted that the insurance project was of particular relevance as there were many similar issues being faced, particularly on stand-ready obligations. No decisions were made during this session.

Educational Session at the June 2006 IASB Meeting

The Board had an educational session on insurance. It was given a briefing from insurance supervisors on developments in insurance supervision. Three different organisations represented by five persons presented to the Board.

No decisions were taken during this session.

IAIS Second Liabilities Paper

Rob Esson, Chair of the Insurance Contracts Subcommittee, IAIS, made a presentation highlighting areas of contention and how IAIS looks to cooperate with the IASB in future.

Their liabilities paper provides a second set of IAIS observations on identified measurement themes common to both general purpose financial reporting and regulatory reporting that the IAIS understand the IASB is addressing in its consideration of Phase II of its Insurance Contracts Project.

Outline of CEIOPS structure and work on the Solvency II project

Alberto Corinti, Paul Sharma and Gabriel Bernardino from CEIOPS (Committee of European Insurance and Occupational Pensions Supervisors) gave three presentations on CEIOPS organisational structure, framework, technical provisions and development on disclosure requirements on the Solvency II project (the Solvency project is an EU initiated project which aims at creating a more risk-related solvency model).

International Actuarial Association

Finally, Sam Gutterman, from the International Actuarial Association, gave a presentation on the IAIS Liabilities Paper from the IAA's point of view, some insurance regulatory issues and key issue that need further actuarial assessment. Discussion at the July 2006 IASB Meeting

The IASB continued its discussion of various aspects of accounting for insurance contracts, the output of which will be a Preliminary Views Discussion Paper.

Timetable for Discussion Paper

The staff presented the latest project timetable and expected contents of the Discussion Paper. The staff expects that a Discussion Paper will be published in December 2006.

Board members expressed concerns about scheduling meetings with industry representatives during the same meeting week that the Board was scheduled to discuss many of the issues those constituents are likely to discuss with the Board. The staff agreed to consider how this schedule might be changed.

Board members expressed concern with including 'a summary of proposals by some insurance trade associations' as an appendix to the Discussion Paper. The staff clarified that the appendix would list where the proposals could be found (for instance, the URL for each proposal) rather than attempt to provide an overview or digest of those proposals.

It was noted that disclosure would not be addressed, as the staff think it premature to do so at this stage of the project. However, the staff noted that there was no intention to alter fundamentally the disclosure principles in IFRS 4.

It was also noted that the FASB would do something with the Discussion Paper, but at the moment what that would be is uncertain. Insurance is not on the FASB technical agenda yet, so it is likely that the Discussion Paper will form part of the FASB agenda proposal.

Changes in the insurance liability

The staff noted that the working approach in the Discussion Paper has been to treat the premium received on short-dated insurance contracts as revenue, but to unbundle the revenue received on long-dated contracts and recognise the deposit element separately.

Board members noted that the treatment of short-dated contracts was troublesome given the direction of the revenue recognition discussions; some stating that they were not prepared to include a preliminary view that was contrary to the direction of the revenue recognition project. Those Board members were of the opinion that unbundling provides better information. What was more important was a thorough discussion of the issue.

The Board accepted a staff suggestion that the Discussion Paper should not come to a preliminary view on unbundling short-duration contracts but should explain what unbundling meant in this context and what the implications of such a treatment would be.

The Board discussed an example that addressed revenue and acquisition costs. The Board agreed that the excess of the initial premium received over the initial measurement of the liability should not be netted against the acquisition costs incurred. Netting would be inconsistent with normal offsetting restrictions in IFRSs and would obscure input information about the level of acquisition costs.

Unit-linked and index-linked payments

Presentation of separate account assets and separate account liabilities

The Board agreed that an insurer should recognise separate account assets, and the related obligation to pay policyholder benefits, unless the insurer has a contractual obligation to pay all cash flows from the separate account assets to the separate account policyholders (a 'pass-through' obligation). The Board appeared to accept that this presentation could be a 'single line' presentation (a single line for unit/index-linked assets and a single line for the policyholder benefits liability).

Measurement of separate account assets

The staff explained that in most countries, insurers measure assets in unit-linked funds at fair value and measure the unit-linked benefits on a similar basis: if the obligation is to pay benefits equal to 100 units, the benefit is measured at 100 times the current unit price.

In May, the Board noted that accounting mismatches can arise if some or all of the unit-linked assets:

• (a) cannot be recognised (for example, if the unit-linked assets include shares or financial liabilities of the issuer itself (treasury shares) or goodwill in subsidiaries);
• (b) are recognised, but cannot be measured at fair value (for example, because an applicable standard requires another measure); or
• (c) are measured at fair value, but changes in their fair value must be recognised outside profit or loss.

The Board redebated this issue at some length in an attempt to develop an approach that would avoid these mismatches, but without success. The Board agreed that the Discussion Paper should include a full discussion of this issue, the conflicts that exist within IFRSs, and the challenges that the Board faces because of the mixed attribute model within which it is working. However, no preliminary view would be expressed.

Educational Session at the September 2006 IASB Meeting

Helmut Perlet (representing the CFO Forum), Jerry de St Paer (representing the Group of North American Insurance Enterprises (GNAIE)), and Masaaki Yoshimura (representing four major Japanese life insurers) presented a summary of recommendations those organisations have made regarding the development of an accounting model for insurance contracts.

The representatives made a brief introduction explaining the insurance industry's role in the economy and its objectives for developing a global accounting standard. They then summarised their proposals, which were also presented to the Insurance Working Group in June.

Below we highlight those proposals that were subject to discussion at the Board. A comprehensive list of the proposals made by the insurance industry is in the observer notes available from the IASB Website.

Initial measurement

The insurance industry is proposing that no gains or losses should arise on initial recognition.

The Board commented that this differs from the tentative decision made by the Board that gains or losses can arise on inception if the insurance company makes errors or omissions when pricing their contracts.

Liability measurement

Mr Perlet explained the view of the CFO Forum that the liability on both life and non-life contracts should be discounted to reflect the present value of future cash flows with allowance for inherent risk and uncertainty.

GNAIE on the other hand believes that life and non-life insurance contracts have significant differences that should be reflected in measurement. For most non-life contracts, it would be difficult to predict whether losses will occur, when they will occur, or the amount that should be paid to the policyholder. Their disagreement with an 'exit value' model, which the Board has indicated that it favours, is based on a belief that this value cannot be measured reliably because there is no active market for non-life insurance contracts where values can be obtained. Mr Paer explained that applying discounting to such contracts in many cases would add an element of uncertainty to the liability component that would produce incomparable and generally less useful results.

Board members commented on the model introduced by GNAIE. Many Board members said that it seemed like a step backwards from the current liability measurement model, which is based on 'exit value' and the Framework. It was noted that the model presented by GNAIE would conceptually not be in accordance with the current model applied for pensions in IAS 19 or for liabilities measured under IAS 37.

Separate customer intangible asset

The industry believes that a separate intangible asset should be recognised that represents costs of acquiring the insurance contract, in addition to an intangible representing future payments that the policyholder must make to retain a right to guaranteed insurability.

Board members seemed to have difficulty understanding what would justify recognising two different intangible assets as the policy would only represent one cash flow.

Unbundling

The insurance industry proposes that no underlying financial or non-financial contracts should be unbundled because policyholders view insurance products as one product. Unbundling of contracts would require extensive judgment and is viewed as unnecessary since the industry values all components in a contract on an aggregate level.

Board members discussed this briefly. Some questioned whether bundling when the entity has more than one component would disguise different profit margins.

Participating contracts

The proposal from the insurance industry is that liabilities should be the best estimate of future policyholder benefits. These should be based on assumptions reflecting what the policyholder will receive on the insurance contract. It was also stated that payments, such as dividends, to a policyholder were fundamentally different from dividends paid to equity-holders and should not be included in equity as the insurance company could choose to pay the policyholder without paying the shareholder.

The Board probed the proposal by the industry to understand how the liability is measured. Based on explanations from the insurance industry participants, measurement of the liabilities would depend on what the insurance company would pay to the policyholder rather than what the insurance company is contractually obliged to pay. This differs from the Board's tentative conclusion that the part of the liability that does not represent an unconditional obligation should be recognised in equity.

Discussion at the September 2006 IASB Meeting

Project plan

The Board reviewed the project plan. Although the staff remains confident that the Discussion Paper would be published in December 2006, some Board members were more sanguine, suggesting that the issues still to be reviewed by the Board were not trivial.

Reporting changes in insurance liabilities (other than premium presentation)

The Board discussed whether an insurer should be required to present separately any specified components of the changes in the carrying amount of insurance liabilities (to be specified later). The issue is closely related to the issue of whether an insurer should present all premiums as revenue, all premiums as deposit receipts, or some premiums as revenue and some premiums as deposit receipts (the 'gross or net' question).

The Board seemed not to agree the detail in the staff recommendations; rather it agreed that the Financial Statement Presentation project should drive the presentation. The Discussion Paper should ask constituents whether certain items related to the change in the measure of the insurance liability should be disclosed, either on the face of the financial statements or in the footnotes. The subsequent Exposure Draft would address these issues in greater detail.

Investment contracts: comparison of IAS 39 and IAS 18

The Board considered whether the Discussion Paper should document the key differences that exist between the proposed current exit value model for insurance contracts and the current treatment of investment contracts under IAS 39 and IAS 18, and seek feedback on whether the Board should consider eliminating these differences.

The staff identified the following significant differences:

• (a) Liability measurement at inception:
  • (i) the current exit value model is based on expected values. Under IAS 39 the liability is subject to a minimum of the surrender value; and
  • (ii) under IAS 39 and IAS 18, non-incremental origination costs are likely to give rise to a loss at inception, even if the contract is priced to recover those costs. Under the current exit value model, this is not likely to be the case (see appendix for further discussion)
• (b) Subsequent measurement of liability:
  • (i) the current exit value model is based on expected values. Under IAS 39 the liability is subject to a minimum of the surrender value; and
  • (ii) the current exit value model is based on current values. Under IAS 39, where an investment contract is measured at amortised cost, some assumptions are locked in: in particular, although the cash flows are based on current estimates,1 the measurement reflects the original effective interest rate (including the original quantity and price of risk).
• (c) Income and expense recognised in profit and loss at inception:
  • (i) the current exit value model recognises gains on inception (if any gain arises). Under IAS 18 gains are not likely to be recognised at inception unless it could be demonstrated that a service had been performed at that time; and
  • (ii) treatment of origination costs

The items identified by the staff highlighted areas in which the Board seemed uncomfortable with the model being developed for insurance and how it interacts with existing standards, creating the possibilities for accounting arbitrage. Some Board members were firmly of the view that if an insurance contract contained a financial instrument that was not inseparable from the insurance risk, that financial instrument should be accounted for using IAS 39. Other Board members noted that this idea almost presupposed unbundling insurance contracts.

The Board seemed to agree that a basic approach would be concentrate on the notion of the interdependence of cash flows already in IFRS 4. Therefore, if the cash flows are so interdependent that to unbundle them would lead to arbitrary allocations between the components of the contract, unbundling should be prohibited. However, if the cash flows are not interdependent, then the contract should be unbundled. The Board agreed to raise this issue in the Invitation to Comment.

Should there be a portfolio basis for measurement?

The Board discussed the issue of whether insurers should measure their rights and obligations under insurance contracts on a portfolio basis rather than contract by contract.

The Board agreed that risk margins should be determined for a portfolio of insurance contracts that are subject to broadly similar risks and managed together as a single portfolio (again, this wording is consistent with IFRS 4). However, the Board agreed that the diversification benefits between portfolios was not part of initial measurement. The Board saw a distinction between a portfolio of similar risks and a collection of portfolios of different risks. (Thus, if an insurance company managed a portfolio of marine risks and another of environmental risks together, the risks inherent in the two portfolios would fail the 'broadly similar' test, but the diversification within the marine book and within the environmental book would meet the 'broadly similar' test.)

Unbundling

The Board agreed to modify its previous position (April 2006) to require unbundling of insurance contracts unless the insurance element and the financial element were 'so interdependent that an entity cannot measure the financial element separately (that is, without considering the insurance element)' or similar words, in which case it would be prohibited. This position is based on the existing guidance in IAS 39 AG33(h).

Policyholder participation rights

The Board recognised that there was a dilemma created by the definitions of a liability and equity with respect to policyholder participation rights. In most cases, policyholder participation rights would not meet the definition of a liability, because there is usually no unconditional obligation to pay them. However, policyholders may not be shareholders, so the participation rights are not dividends.

Board members drew an analogy between policyholder participation rights and dividends on cumulative preference shares. Current accounting standards do not require recognition of such dividends unless they are declared, but the entity is often prevented from paying a dividend on ordinary shares unless it first pays a dividend on the cumulative preference shares. In other words, not all retained earnings can be attributed to the ordinary shareholders.

The Board agreed to explore whether it was possible to develop a presentation (either on the face of the financial statements or in the footnotes) that would enable an entity to distinguish those elements of shareholders' equity to which the shareholders did not have a claim, either by way of dividend or on liquidation. The presentation would show the restriction on distribution/ appropriation of retained profit attributable to the policyholders. (This would affect both the balance sheet and the statement of recognised income and expense.)

Universal life contracts

The Board discussed aspects of accounting for universal life contracts – those that permit the insured, after the initial payment, to pay premiums at any time, in virtually any amount, subject to certain minimums and maximums. Some Board members expressed deep dissatisfaction with some of the consequences of the model being developed by the staff. However, after discussion, the Board agreed not to change their prior articulated Preliminary View but directed the staff to conduct further research on the effects of 'guaranteed insurability' once the Discussion Paper is issued.

Crediting rates in universal life contracts

The Board discussed a proposal that estimates of crediting rates [in a given situation] should reflect what the insurer actually expects to do [in that situation], rather than assume that the insurer pays the absolute minimum that can be contractually required. Some Board members expressed deep discomfort about this concept, especially the implications of such an approach on the notion of 'exit value' discussed earlier in the meeting (see 19 September). The Board did not seem to conclude on this issue.

Discussion at the October 2006 IASB Meeting

At its September 2006 meeting, the Board received a briefing from insurance trade associations on their recommendations on a series of principles used when accounting for insurance contracts. At the October meeting the Board reviewed its tentative decisions in the light of the proposals from these organisations.

Below we have highlighted the proposals that were reviewed by the Board. For a more comprehensive list of the background we refer to the observer notes available from the IASB Website.

Non-life insurance claims liabilities

One of the insurance trade associations present at the September meeting stated that it believes that life and non-life insurance contracts have significant differences that should be reflected in measurement. It also stated that applying discounting to non-life contracts in many cases would add an element of uncertainty to the liability component that would produce incomparable and generally less useful results.

The Board reconfirmed their disagreement with this view and concluded, in line with their previous tentative decisions, that these liabilities should be measured on a discounted basis, including an explicit risk margin.

Non-life insurance pre-claims liabilities

The Board reconfirmed that it prefers a single measurement contract and also that these contracts should be measured at current exit value.

Initial measurement - gains at inception

The insurance industry is proposing that no gains or losses should arise on initial recognition. The Board was split. It decided that the discussion paper should address and explain the rationale for both the position where gains at inception could arise and the position where the margin that may arise would be adjusted to the observed price, with the consequence that a gain would not be recognised.

Risk Margin

The Board reconfirmed that the measurement of an insurance liability should include a risk margin (based on an explicit and unbiased estimate) that the participant would take for bearing risk in a contract.

Service Margin

The Board reconfirmed that an insurance liability may have, in addition to the risk margin, a service margin that the participant would require to render services. The Board expressed that it would not require bifurcation between the risk margin and service margin in all cases.

Discount rate

The Board discussed and confirmed their tentative decision that discount rates should be consistent with observable market prices for cash flows with characteristics that match the insurance liability in terms of timing, currency and liquidity.

Measurement attribute

The Board reconfirmed that the discussion paper should use "current exit value" as the measurement attribute.

Basis for estimates

The Board confirmed their previous conclusion that cash flows not related to the liability itself should be excluded from the measurement.

Review of assumptions

The Board concluded that all changes in estimates of both financial and non-financial variables should be recognised.

Unbundling

The Board had a longer discussion regarding unbundling. Some Board members thought that the wording set out in the agenda paper was inconsistent. The staff noted the comments from the Board and the Board confirmed their previous conclusion that an insurer should not unbundle if the components are so interdependent that measurement of isolated components would be arbitrary. It was also confirmed that the discussion paper should include examples.

Credit characteristics of insurance liabilities

The Board reconfirmed their previous conclusion that the current exit value of a liability reflects its credit characteristics.

Separate customer intangible asset as part of the initial investment made to acquire a customer relationship

The Board debated whether an intangible asset should be recognised to reflect the initial investment the insurer has done for acquiring a customer (and thereby recognise a separate asset on the balance sheet).

After a debate the Board concluded, in line with their previous decision, that acquisition costs should normally be recognised as an expense when it is related to cash flows already received or through future cash flows incorporated in the measurement of the liability.

The Board also discussed whether an asset should be presented separately from its insurance liability, if the liability includes cash flows related to a customer relationship. The Board was split, and it was decided that the discussion paper should be presented with arguments for both splitting the asset from the liability and for presenting the liability net.

Discussion at the January 2007 IASB Meeting

Policyholder participation rights

The staff presented a working draft of chapter 6 'Policyholder Participation' of the Discussion Paper.

The discussion focused on the question to what extent an insurer should classify the participating component of a participating contract as liability. The Board noted that the 'unitary view', which requires classifying the whole contract as a liability, is not an appropriate solution.

In previous meetings the Board had tentatively decided that an insurer should recognise a liability relating to expected dividends for participating policyholders if the insurer has an enforceable obligation. Economic compulsion was not considered to be sufficient to create an enforceable obligation. After a thorough discussion the Board came to the conclusion that a liability should be recognised when the insurer has a constructive obligation.

The staff was directed to further investigate this issue and to take into account the definition of a constructive obligation under both IFRSs and US GAAP.

Universal life contracts – discount rate(s)

The Board agreed that in measuring a universal life contract, each cash flow scenario should include interest credited at the rate that the insurer estimates will apply in the scenario, rather than the absolute minimum that can be contractually required.

Discussion at the February 2007 IASB Meeting

Unbundling

In September 2006, the Board tentatively concluded that an insurer should not unbundle the insurance, deposit, and service components of insurance contracts if the components are so interdependent that the components can be measured only on an arbitrary basis, but should unbundle them for measurement if such interdependencies are not present.

Based on concerns raised by constituents that unbundling would be arbitrary, artificial, and burdensome in most cases and that the practical effect would not be apparent, the staff brought the issue back. (The issues are outlined in the Observer Note available on the IASB's Website.)

The Board had a thorough debate on the relationship between unbundling and measurement of the different components of an insurance contract and finally reaffirmed the tentative decision on unbundling with a majority of 8 in favour and 6 opposed.

It was noted that the following scenarios should be considered in this connection:

• (a) The contract consists of components that have no interdependence. In this case the contract should be split into an insurance contract measured under the insurance model and other contract(s) to be accounted for under the respective IFRSs. Scenarios (b) and (c) would then be relevant for the insurance contract.
• (b) The components of the insurance contract are fully interdependent. The contract should be measured under the insurance model and, since in this case unbundling is not feasible, the components should be measured and presented together.
• (c) The components of the insurance are interdependent to some extent. The contract should be accounted for under the insurance model. To the extent unbundling is possible, the components should be measured and presented separately. The measurement consequences are that for the deposit and service components, IAS 39 Financial Instruments: Recognition and Measurement, IAS 18 Revenue, and probably other IFRSs apply.

Sweep Issues – substantive issues in Board members' comments on pre-ballot draft

Measurement attribute – Cash flow estimates

The Board was asked whether it wants to retain the measurement attribute 'current exit value' or whether this term should be changed to 'current exit price' as used, for example, in the Discussion Paper on Fair Value Measurements (DP FVM).

The pre-ballot draft of the Insurance Contracts Discussion Paper requires estimation of future cash flows taking into account the insurer's strategy for determining the level of service provided to policyholders and its approach to claims management, as well as the insurer's efficiency in providing that level of service and implementing its selected approach to claims management.

The Board noted that referring to entity-specific data rather than market data could but does not necessarily lead to different outcomes than under DP FVM. In absence of observable market data the DP FVM allows the use of entity specific data ('Level 3 inputs').

The Board decided to continue to use the term 'current exit value'. The staff was directed to explain in more detail in the Discussion Paper how current exit value differs from fair value and to point out that the Board is currently not aware of significant differences.

Other issues

The Board asked the staff to amend the Discussion Paper with regard to the guidance on determining risk margins, the interaction of the insurance contracts project with the revenue project, and customer relationship. The rephrasing was not discussed in detail.

Project plan – Issuance of the Discussion Paper

The Board decided (12 in favour, 2 opposed) to issue the Discussion Paper as amended above within the next several months.

May 2007: Discussion Paper Issued – Preliminary Views on Insurance Contracts

On 3 May 2007, the IASB published a Discussion Paper (DP) Preliminary Views on Insurance Contracts. Comments are requested by 16 November 2007. Thereafter, IASB will develop firm proposals for an exposure draft to be published towards the end of 2008. Allowing for a further period of public consultation, the IASB expects the new standard to be in place in 2010. IASB subscribers may download the DP now (one document for main text, a second for appendices). The DP will be available on the IASB's public website from 14 May. Printed copies will be mailed to IASB comprehensive subscribers or may be Purchased from the IASB. Click for Press Release (PDF 69k).

May 2007: Deloitte Newsletter – Implications of the IASB Insurance Discussion Paper

In May 2007, Deloitte (United Kingdom) published a Special Edition of the Insurance Market Update Newsletter (PDF 357k) on Phase II of the IASB's project to develop an IFRS for Insurance Contracts. The newsletter discusses the recent IASB Discussion Paper (DP) on Insurance Contracts. The newsletter expresses Deloitte's general support of the overall approach of valuing insurance liabilities on a market consistent basis. It notes, however, that the current exit value ('CEV') approach proposed in the DP raises many questions the industry will need to consider. It is important that market participants continue to provide input in the development of the principles into a standard across the life and non-life insurance industry. The newsletter identifies the key implications of the proposals in the DP. These are outlined below.

Discussion at the November 2007 IASB Meeting

The Board was presented an Agenda Paper dealing with accounting for policyholders' rights under insurance contracts. The staff explained that no specific standard or guidance exists for policyholder accounting. It was noted that in the past this was not considered to be a significant issue and for that reason no guidance was developed. The staff noted that the need for accounting guidance has grown over the last years and that US GAAP already includes some guidance in that area.

The Board discussed the issue of symmetry in accounting and if policyholder accounting should remain part of the Insurance Contracts project (as it is already within the agreed scope).

The Board agreed that policyholder accounting should remain part of the Insurance Contracts project and that there should be more focus on these issues. Also the Board tentatively agreed that no Discussion Paper would be required and any output would result directly in an Exposure Draft. It was not decided if it will be an amendment to existing standards or a stand-alone standard.

November 2007: Deloitte comments to IASB on insurance contracts

On 23 November 2007, Deloitte submitted to the IASB its Comments on the Discussion Paper: Preliminary Views on Insurance Contracts (172k). We generally agree with the DP's main proposal that insurance liabilities should be measured at a current value, on the basis of the 'three building blocks'. However, in looking at the detailed approach outlined in the DP, we express a number of comments and concerns, including the following:

Discussion at the January 2008 IASB Meeting

The Discussion Paper Preliminary Views on Insurance Contracts proposed three building blocks for use in measuring insurance liabilities. One of those building blocks is a risk margin. The presenters performed an analysis on determining such a margin from a financial reporting and a regulatory (capital requirements) perspective and presented the Board a summary of their results (the presentation can be downloaded from the IASB's Website).

As this was an education session, no decisions were made.

The representatives of the audit firm preparing the analysis on behalf of the Group of North American Insurance Enterprises (GNAIE) explained the importance of risk margin/market value margins and presented one of the most widely supported approach, the cost of capital method. Board members showed particular interest in the variations of this approach and especially in the underlying assumptions, the parameters employed and the calibration of the respective models.

One Board member noted that all variations presented seem to include changes in the reporting entity's own credit risk. The presenters did not disagree with this statement.

The presenters stated that proper consideration of tax effects is necessary. One Board member said the approach taken in the presentation would not appropriately reflect this.

Discussion at the February 2008 IASB Meeting

Overview of responses to the May 2007 Discussion Paper

The Board held an initial discussion of the responses to the May 2007 Discussion Paper Preliminary Views on Insurance Contracts based on a high-level overview of those responses prepared by the staff. No decisions were made.

General overview

The staff noted that 158 comment letters have been received and there were a few more expected. There was a high degree of agreement that the building block approach provided a useful framework for analysing issues related to insurance contracts; however, nearly all respondents had concerns with aspects of those building blocks. The staff noted that there was widespread support for the following main aspects of the building blocks:

• using current estimates of cash flows, rather than locked-in estimates; the effects of changes in estimates would be recognised immediately in profit or loss;
• consistency with observable market prices for factors such as interest rates and equity prices;
• using expected value (that is, probability-weighted average) rather than a single outcome, although there were concerns expressed about how this principle would be applied in practice;
• reflecting the time value of money; and
• including a risk margin.

However, there were significant concerns expressed about the following:

• recognition of profit on initial recognition of an insurance contract;
• what the risk margin represents (is it a surrogate for the entity's cost of capital or is it a profit margin) and the interaction with what the Discussion Paper called the service margin;
• market consistency of cash flows;
• whether, given that most insurance liabilities could not be transferred, entity-specific expenses were not more relevant to users;
• some constituents (mainly in North America and Bermuda) were opposed to discounting non-life insurance items; other jurisdictions supported the treatment;
• many constituents were concerned about consistency with other IASB standards and on-going projects, especially revenue recognition and [non-financial] liabilities.

Accounting for the whole contract?

The staff highlighted some of the issues related to whether an entity should account separately for the rights and obligations created by an insurance contract; or account for the contract as a whole. The staff noted that the issues to be debated during future meetings were relevant to several other projects, including revenue recognition; the elements and recognition chapters in the Framework; fair value measurement guidance; financial instruments and non-financial liabilities.

There were preliminary discussions of a few issues, but nothing substantive.

Settlement value as a measurement attribute

Some constituents supported the proposed measurement attribute (current exit value) but many others encouraged the Board to explore further a settlement approach (given that many insurers do not expect to transfer their liabilities but, rather, to pay claims in the ordinary course of business). However, there was no consistency of views about what this settlement model might look like.

The staff explored whether settlement value might be a candidate for the measurement attribute for some or all insurance liabilities. It was noted that in many cases 'settlement value' would be similar to 'exit value' but with more entity-specific values for items such as expenses. The staff also asked whether there was a genuine need for a measurement attribute for insurance contracts: they concluded that there should be as it would help to clarify the accounting for insurance contracts. Again, the Board will discuss this topic with a view to making decisions at a subsequent meeting.

Timetable

The staff presented a project timetable for the development of an exposure draft. Board members did not think they had enough information to determine whether the timetable was reasonable. However, there was consensus that the issue of policyholder accounting for insurance contracts should not delay this project.

Roundtables should be held, but not before the IASB had done more work to develop their thinking and are in a position to be responsive to the issues raised in the comments on the Discussion Paper.

Discussion at the September 2008 IASB Meeting

The staff presented the Board with an education session on the fulfilment value as a possible measurement basis candidate identified by many respondents to the Discussion Paper on Insurance Contracts. No decisions were made or sought.

The staff noted that fulfilment value would more appropriately reflect the intended settlement by the insurer (by continuous fulfilment and not by transfer or settlement at the balance sheet date). Constituents would seek for a measurement excluding the credit characteristics of the liability. The staff highlighted that they would expect fulfilment value to be identical or at least very similar with a current exit value notion. Board members were particularly interested in these differences and how they could arise. The staff highlighted these possible sources of differences:

• Estimates
• Risk margins
• Day one profit
• Own credit risk

The Board had a lengthy discussion on some aspects of these possible differences.

Some Board member were concerned calling the calculation a 'value' as they seemed not convinced that the amount determined presented a value.

The staff then briefly informed the Board about the next steps. The staff plans to present to the Board at the October 2008 meeting a list and description of all measurement candidates. After consulting with the Insurance Working Group, the staff will ask the Board in November to reach a conclusion on the measurement attribute.

September 2008: New Deloitte publication – The IFRS Journey in Insurance

A new Deloitte Research publication The IFRS Journey in Insurance: A Look Beyond the Accounting Changes examines the implications of the use of IFRSs in the insurance industry across the globe. The report notes that, in some markets, IFRSs will likely contribute to substantial changes in: Insurance product design, price and offerings Investment strategy Risk management practices Securitisation Merger and acquisition (M&A) activity

These changes will give rise to pressure for both convergence and divergence across insurance lines, thereby adding complexity and dynamism to the market structure of the insurance industry. By taking a proactive approach to understanding the impact of IFRS implementation on key business strategies, insurers can avoid the risk of being unprepared for the industry-wide shift while seizing on emerging opportunities for differentiation from competition.

Click to download The IFRS Journey in Insurance (PDF 438k).

Discussion at the October 2008 IASB Meeting

Hans van der Veen (Practice Fellow), together with Peter Clark, led an education session that discussed a list of measurement attributes identified by the project staff as 'viable candidates' for selection in the case of insurance contracts. The purpose of the discussion was to identify those candidates for which the Board needed or wanted further information.

AP 3A: Overview

Measurement attributes suggested by respondents to the IASB Discussion Paper

A Board member expressed concern about how the Board's current thinking on revenue recognition to insurance contracts; in particular how to articulate the notion of a performance obligation. The staff agreed that this needed more thought, especially in situations in which claims might trail an annual contract by several months. In many cases, settlement of the obligation was treated as an issue separate from revenue recognition.

A Board member asked for clarification as to the extent that unearned premium model was consistent with the customer consideration model being developed in the revenue project; in particular, would customer behaviour be considered. The staff admitted that the unearned premium model concentrated on the measurement of the unearned premium liability and was silent with respect to revenue recognition; this would need to be clarified.

Another Board member expressed concerns about the current pricing (or entry value) model. The staff noted that there was no support among members of the Insurance Working Group for this approach and that the staff did not intend to develop it further.

Features of a measurement attribute and building blocks

A Board member asked for clarification on the comment in paragraph 6(c) that some respondents to the DP 'argued that the risk margin should reflect the cost of bearing risk, but not include any further profit that the entity or a market participant would require for bearing the risk'. The staff admitted that they do not currently understand what the difference is, but note that some respondents think that the two are different while other respondents think that there is no difference! A Board member noted that some respondents see the two concepts as the difference between the exit price model and the 'settlement model'.

Addressing the issue of the 'cost' of bearing risk, a Board member reminded the Board and the staff that the definition of 'cost' in IFRS was the 'the amount of cash or the fair value of the other consideration given' In his view, this should make exit value and settlement value the same at contract inception.

AP 3B/3C: Candidate Measurement Approaches

The staff noted that the approaches listed in the agenda paper were not listed in any order of preference. In addition, the staff would discuss the objective of the margin(s) included in each if the candidates, but would not discuss in any amount of detail how those margins should be estimated. Finally, some generic issues, common to all approaches, would not be addressed: including policyholder behaviour and policyholder participation; the impact of diversification of risk margins; the attributes of the discount rate in relation to the characteristics of the cash flows of the insurance liability and certain financial statement presentation issues.

The candidates fell in to three groups:

• The current exit value model as proposed in the DP;
• Three variants of the 'current fulfilment model'; and
• An unearned premium model for the pre-claims liability of short-duration contracts.

A Board member challenged the 'current fulfilment' models presented because they were inconsistent with the customer consideration model being developed in the Revenue project. He saw no reason why revenue from insurance contracts should be recognised using different fundamental principles. In addition, the current fulfilment model was inconsistent with the principles being developed by the Board in the IAS 37 project. Another Board member supported this intervention. The staff noted that they had addressed this point later in the paper [paragraph 37]. The first Board member reiterated the point that the current exit value model was the only approach that was consistent with the Board's approaches in its revenue and IAS 37 projects. The staff agreed, but noted that the other possible approaches had been suggested by several respondents. It was a necessary part of the Board's deliberations towards developing an exposure draft to discuss those suggestions.

Board members noted that the current fulfilment models presented all relied to some extent on entity-specific cash flows rather than cash flows that would occur for all market participants. Some Board members were very uncomfortable with using entity specific cash flows because of the lack of rigor over what those cash flows might contain. Others could not find any insights from the summaries of the current fulfilment models presented.

In response to a question from the staff, Board members requested more information from the staff, in particular they wanted the staff to reflect the consistency (or lack of consistency) with the Framework, existing IFRS and other projects. Board members also noted that the answers developed by the staff needed to consider what might happen if the premium received was treated as a deposit rather than revenue.

Agenda Paper 3D was not discussed.

Discussion at the February 2009 IASB Meeting

The staff introduced the session by highlighting the objectives. The main objective was to identify viable candidates for measurement that are worth pursuing from the pool of existing candidates:

• Current exit value as proposed by the discussion paper Preliminary Views on
• Insurance Contracts (DP).
• Current fulfilment value including a risk margin reflecting the cost of bearing risk.
• Current fulfilment value as in candidate 2 plus an additional separate margin,calibrated at inception to the premium.
• Current fulfilment value including a single margin calibrated at inception to the premium (ie similar to candidate 3, but with one overall margin, not two separate margins).
• Unearned premium (only for the pre-claims liability of short-duration contracts).

The staff asked the Board what the measurement objective to be applied was:

• Current exit value provides a clear principle and this leads to most decision-useful information
• Fulfilment value provides the most relevant information
• Current exit value is conceptually preferable, but fulfilment value is more consistent with the Board's thinking on revenue recognition and would ameliorate practical issue when applying an exit price notion

The Board had a lengthy and lively discussion on the issue with no clear direction. It was clear that the Board was split over the 'right' measurement attribute for insurance contracts. The chairman noted that the Board now has 4 projects that seem to be inconsistent with each other.

Some Board members asked what makes insurance so special. Others expressed the view that unbundling would take away many of the issues raised during the deliberations. Board members were also concerned about creating hypothetical market transactions where such transactions rarely ever occur. One Board member noted that people were paranoid about recognising day one gains, but not losses and looked for means to avoid recognising such gains.

Finally, the chairman took an indicative vote to which measurement attribute Board members would tentatively prefer. There was a slight majority for a fulfilment value approach.

The staff continued to ask the Board which other potential candidates should be included in the narrower selection and presented them with a list. Some Board members expressed their sympathy for some of those candidates in the list (allocated transaction price approach, an IAS 37 (as currently deliberated) approach and an IAS 39 approach).

Discussion at the March 2009 IASB Meeting

(FASB staff participated by video link.)

The purpose of this session was to get a high-level direction from the Board on the cash flows that would be included in the measurement of insurance liabilities for both an exit notion or a fulfilment notion. After a brief update on the expected time table for the project the staff turned to the actual topic of the session.

The staff pointed Board members towards a detailed table in the agenda papers that contained a detailed list of guidance on determining current estimates of expected cash flows (largely taken from the Discussion Paper) showing the similarities and differences when applied to an exit or fulfilment notion.

Staff highlighted the high degree of similarity of both approaches from a cash flow estimation perspective.

While many Board members where generally supportive of the analysis presented, some were concerned over the interaction of components of measurement that were to be discussed at future meetings (in particular, the margin). Others expressed reservation that the analysis implied that the margin was realised over the premium period, not over the risk-taking period, which might be significantly longer in certain circumstances. On Board member was particularly concerned that changes in administrative expenses, for example, would be recognised in total in the period the change in estimate of these expenses occurred. This member preferred recognition of the change over future periods.

Another Board member pointed out that he could not assess the appropriateness of the analysis presented if he did not know the proposals on the other measurement components.

The session closed with no explicit decisions made.

Discussion at the April 2009 IASB Meeting

Margins

Margins: Losses on initial recognition

The Board noted that they had previously decided that the over-all margin at inception should be measured by reference to the premium and that no 'day one' gains should arise. At this meeting, the Board agreed that if a premium was not sufficient to cover the obligations then the difference would be recognised in profit or loss on inception.

A Board member suggested that the exposure draft should describe this situation in terms similar to 'On contract origination, if the contract represents and asset no asset [and thus a gain in profit and loss] is recognised; if the contract represents a liability, recognise the liability and the associated expense in profit or loss'.

Should the measurement approach include specified margins?

There was little support for a staff recommendation that a measurement approach should include a separate risk margin that is remeasured at each reporting date. At least one Board member suggested that he did not know what that margin would be or how to calculate it!

Are margins part of the insurance liability?

The Board was split on whether all margins identified by the staff are part of the insurance liability rather than a separate liability outside the insurance liability. There was a high level of concern over the consequences of the staff recommendations.

Acquisition costs

The staff noted that the treatment of acquisition costs was equally relevant to the fulfilment notion and exit price notion. The discussion concentrated on what constituted an acquisition cost. US GAAP (for example, FAS 91 on loan origination costs) has a rather broad definition that includes selling, underwriting and initiation costs; IAS 39 limits transaction costs to incremental costs.

The Board agreed that acquisition costs should be defined narrowly – those incremental to the contract (which, by definition, means they must be direct costs).

Acquisition costs should be expensed and some of the premium recognised as revenue. The staff suggested that this treatment provides transparency about acquisition costs incurred during the period and acknowledges that pricing of insurance contracts includes 'premium loads' to recover such costs.

Discussion at the April 2009 IASB Meeting

Policyholder behaviour

The Board had a preliminary discussion on future insurance contract premium payments (and other cash flows resulting from those premiums, e.g. benefits and claims). In particular, the Board considered whether insurance contract recurring payments – that is, those premiums that will occur as long as the policyholder does not cancel the existing contract-should be included in the measurement of the insurance contract liability. Should the answer to that question be 'yes', the Board would need to address how the 'boundary' for an existing contract should be determined.

The Board addressed the second part of the issue (the boundary). The staff analysis noted that there was no disagreement that future contracts do not enter into the current contract liability measurement (although they may be relevant in determining a customer relationship intangible asset). Thus, the discussion centred on existing contracts, which the staff had divided into two segments:

• contracts that compel the insurer to accept future premiums
• contracts that guarantee continuing insurability if the policyholder continues to pay premiums (a sub-set of these contracts); and
• other contracts that have neither of these characteristics (that is, the policyholder cannot compel the insurer to accept future premiums).

The Board was divided: some supported drawing the boundary to include some element of the 'other contracts'. Other Board members were clearly worried that if the boundary was extended to include 'other contracts', that would represent a major, untested leap in accounting measurement and would be quite different from the measurement of intangible assets in IAS 38. One Board member likened the 'other contracts' to nothing more than a time series of written options and was very uncomfortable with recognising these as assets, given the consequences for other areas of IFRS. Other Board members were sympathetic to this view.

Board members also noted that several of the issues in this topic were very similar to issues surrounding renewals in the Board's projects on revenue recognition and leases. They wanted a consistent answer for all. In addition, the accounting for customer behaviour had to be consistent with that for acquisition costs. No decisions were made and the staff will return at a later date.

Discussion at the May 2009 IASB Meeting

In April 2009, the IASB had a preliminary discussion on future insurance contract premium receipts (that is, policyholder behaviour and the related issue of contract boundaries). This session discussed a staff analysis and their recommendations on this topic.

Accounting for future premiums that depend on options

The staff noted that in many long-term insurance arrangements, the insured has the right to continuing cover provided it continues to pay the contact premium. The insurer has effectively written an option for the policyholder. The option compels the insurer to accept the policyholder's premiums (as determined by the insurance contract) and continue the insurance coverage. The insurer has a premium for the current year and a series of written options into the future years. The staff had identified three approaches to accounting for renewal options, which they thought were consistent with the approaches the Revenue Recognition team explored in its paper on Contract Boundaries:

• (a) Ignore the option.
• (b) Measure the option.
• (c) Look through the option (ie treating cash flow subject to renewal and cancellation options as part of the existing contract).

The Board debated a staff recommendation that the measurement of an insurance contract should include the expected (that is, probability-weighted) cash flows (future premiums and other cash flows resulting from those premiums, for example, benefits and claims) resulting from that contract, including those cash flows whose amount or timing depends on whether policyholders exercise options (such as renewal and cancellation options) in existing contracts. Put otherwise, the measurement of an insurance contract should look through renewal and cancellation options.

Some Board members were unhappy about how the staff had analysed the issue. Some thought that the 'option' that the insured had to renew the insurance contract was the same as an option as understood in the Revenue Recognition Discussion Paper-others thought that it was. Some Board members would prefer measuring the renewal option at initial recognition, rather than looking through, as the staff proposed.

Another Board member rephrased what he thought the staff was trying to express: that the initial recognition of an insurance contract needed to identify what the Insurer was receiving and for what it had been received. He suggested that on initial recognition, the insurer had received the premium for (i) the first years' cover; and (ii) the right to renew at the same premium next year. This Board member did not want to establish a general principle of always looking through renewal options and asked the staff to be cautious about how it expressed the principle.

Another Board member thought that looking through the option would allow you to get to an expected value measure: it includes some time value, but whether it was the 'right one' was debatable. This Board member was not opposed to looking through the option, but again was concerned about how the principle was expressed. In particular, in his view, the future premiums were not contractual, since the insured has no obligation to pay the premium in the future. Thus, the cash flows are not contractual.

Ultimately, the Board accepted the staff recommendation, but with significant concerns about how it was expressed and articulated. The staff will return with more refined proposals at a subsequent meeting.

Discussion at the June 2009 IASB Meeting

Project timetable

The staff presented a revised project timetable, one that suggested that the exposure draft of the Board's proposals would be published in April 2010 for 120 days' comment, with redeliberation completed by June 2011.

This revised timetable was not well received by the IASB Chairman and several Board members. The staff was instructed to ensure that the exposure draft was published no later than December 2009.

Measurement approach for insurance contracts/ Using the updated IAS 37 model as a candidate for measuring insurance contracts

The Board agreed that sufficient progress had been made on the IAS 37 model for liabilities that a modified IAS 37 approach should be considered as a candidate for measuring insurance liabilities. At the same time, the 'current fulfilment value that includes a margin for the cost of bearing risk and a residual margin' approach was removed from consideration.

In proposing the IAS 37 measurement model, the Board noted that the objective in IAS 37 is to measure the amount that the insurer would rationally pay to be relieved of a liability. In the absence of an active market, the modified IAS 37 model clarifies that the insurer can estimate that amount by looking at the burden to the insurer of having to fulfil the obligation over time, or what it would rationally expect to receive from a third party to assume that liability. The margin would be calibrated such that there was no day one gain or loss, except that the insurer would recognise revenue at the inception of the contract to the extent that it provides recovery of the incremental acquisition costs incurred.

Although agreeing that IAS 37 should be added to the measurement candidate list, several Board members wanted greater assurance that the modified IAS 37 model was sufficiently robust to be applied to insurance liabilities. In addition, the Insurance staff team needed to provide further thoughts about how the IAS 37 model would be applied to insurance contracts and what additional Application Guidance might be necessary. Board members wanted a joint session with the insurance and IAS 37 teams to provide them with greater assurance and comfort on this fundamental issue.

One Board member also wanted greater comfort on the risk margin: was it a surrogate for the entity's cost of capital or was it compensation for bearing the insured risk. Some other Board members were not certain that there was a difference between the two. However, there was agreement that the Board should be explicit about the measurement objective inherent in the risk margin.

Current exit price

Subject to the modified IAS 37 model being articulated appropriately with respect to insurance, the Board agreed not to continue considering current exit price as one of the measurement candidates for insurance contracts.

Some Board members were concerned that the exit price provided a 'sanity check' for the measure of the insurance liability. Board members were reminded that the requirement to look at what the entity would rationally accept or demand to assume the liability from another provided a check on the 'would rationally pay' criterion in the measurement requirement.

Field tests

The Board agreed a staff proposal to undertake 'targeted field tests', to begin before the exposure draft is issued, to assess whether the proposals will achieve their objective and how the proposed approach would change current practice. The staff expects to engage approximately 15 insurers (preparers), with follow-up involvement from user groups.

The staff had hoped to complete their work in advance of the exposure draft being issued; however, given the explicit direction of the Board to have an exposure draft by December 2009, not all work might be completed prior to the exposure draft being issued.

Discussion at the July 2009 IASB Meeting

Measurement approach for insurance contracts

The Board was encouraged by the staff to narrow still further the candidates for the measurement approach to insurance contracts to the 'modified IAS 37' model only. However, in light of its discussion of the IAS 37 model earlier in the day, the Board was not in a position to make this decision. Instead, the Board requested a more detailed analysis of what the 'modified IAS 37' model might look like, together with a comparison to the current fulfilment model.

Unearned premium model

The Board agreed that an unearned premium approach should be the required measurement approach for insurance pre-claims liabilities arising from 'short duration' (such as property and casualty and marine) contracts. This approach was accepted as a simplification.

Other aspects of the unearned premium model would be discussed at a subsequent meeting.

Discussion at the July 2009 Joint IASB-FASB Meeting – update from the International Association of Insurance Supervisors

Robert Esson, chair of the Insurance Contracts Subcommittee of the International Association of Insurance Supervisors, made a short presentation on four aspects of the IASB's insurance contracts project that were of particular concern to insurance regulators at present.

Timing of the insurance contracts project

Mr Esson noted that, including work done by the IASB's predecessor, the insurance contracts project had been running for over 10 years and that any delay beyond the projected May 2011 deliverable would risk losing the international consensus that exists currently. He noted that certain regions would likely develop their own solutions if there was a significant delay. An IASB solution is the IAIS's preferred solution, as they would seek to use IFRS financial information as input to (rather than to determine) insurance regulatory requirements.

Acquisition costs

Mr Esson noted that, especially in long-term insurance contracts, acquisition costs can exceed the first year's premium, but that overall the contract is expected to be profitable. This suggests that the insurance contract has value and that the value is bigger after the payment of acquisition costs.

In addition, he recalled the IAIS's recommendation to the Boards about the how to define the contract boundaries, which should help the Board with the issue of the renewal options in long-term contracts.

Day 2/Day 366

The run-off of margins was a significant issue that had been largely ignored in the past ten years and 'desperately' needed a solution before the ED was published. Any answer had to be simple, understandable and capable of being audited. He provided some examples that illustrated the issues and asked the Boards whether the margins run off based on release from risk or based on the expected cash flows.

Financial instruments

Mr Esson suggested that insurance companies were the largest purchasers of financial instruments in the world and that there was a need for consistency between the asset and liability side of the balance sheet – especially in relation to long-term insurance. In his view, there needed to be coherence between the assets and liabilities. He was concerned that the timings of the financial instruments project (that is, insurers' assets) and the insurance contracts project (the liability side) were problematical and could raise significant issues on transition. Insurers were very interested to see how the two projects interacted-in particular how will assumption unlock and margins run off for liabilities and whether amortised costs (as proposed in the recent IASB ED) would 'hedge' these liabilities.

Mr Esson took questions from Board members, during which he pointed out that the IAIS's view was that a useful set of IFRS financial statements would be a very important input to regulatory activities. Understanding an insurer's exposure to risk was important; so too was having useful and understandable measures in the financial statements.

Discussion at the July 2009 Joint IASB-FASB Meeting

Measurement approach

The IASB staff briefed the Boards on each other's latest decisions (taken earlier in the week) on their preferred measurement approach. The FASB supported the current fulfilment value approach; the IASB was continuing to consider both a 'modified IAS 37' model and the current fulfilment value approach.

The FASB supports the building block approach for Day 1 measurement, but does not agree with including a transfer notion with respect to subsequent measurement – because there is often no transfer market for insurance liabilities (this is why a 'pure' fair value measure will not work).

There was a good but inconclusive debate between IASB and FASB members, which demonstrated some of the basic measurement issues, including what was the liability being measured – the performance obligation or the claims liability? Board members noted that whatever model was accepted, it needed to be logical, easy to explain, supported by preparers and useful to users.

No decisions were made by either Board. Both would consider this further and make decisions in September and return to a joint discussion in October.

Acquisition costs

Both Boards agree that acquisition costs should be expensed; the IASB's tentative view is that it would release some of the premium (customer consideration) to match the incremental costs of acquiring the individual insurance contract. The Boards discussed whether they could resolve this issue.

An IASB member suggested that the IASB should be asking whether the insurer should recognise the insurance contract itself as an asset on Day 1 and amortise that asset over some period. Heretofore, the insurance industry had used deferred acquisition costs as a surrogate for the contract value.

The FASB Chairman challenged the IASB's agreed position, asking why an insurance contract was any different from other long-tail business for which significant acquisition costs were incurred.

The FASB affirmed its view (5 in favour of expense); the IASB was split: 4 would expense; 8 would release revenue. An IASB member also polled his colleagues as to how many would prefer to measure the value of the insurance contract asset – at least 5 would.

The IASB will need to return to this issue at a later date.

Discussion at the September 2009 IASB Meeting

Timetable and items to be excluded from the exposure draft

The Board noted the proposed timetable for the remaining deliberations leading to the publication of the exposure draft and subsequent outreach activities, re-deliberations, etc.

One consequence of the proposed timetable is that policyholder accounting, with the exception of the accounting for reinsurance (both by cedants and reinsurers), would not be addressed in the ED. At least one Board member challenged this decision, noting that while it made the timing awkward, the accounting by the insured might provide useful insights on contentious issues in insurers' accounting.

In particular, the Board member was concerned that the cash surrender value of a life insurance policy had been excluded from the measure of a liability in the insurer's financial statements, while it was almost certainly a relevant measurement attribute for the policyholder. In addition, it was likely that the Board would require recognition of an asset for future policy renewals on long-term contracts; however, the Board was highly unlikely to require recognition of a liability in the financial statements of the policyholder. In both cases, the lack of symmetry was a concern.

Another Board member was concerned that the Board had not learned the lessons of the Leases project, in which it had been heavily criticised for addressing only lessee accounting and leaving lessor accounting until a later date. The Board member was concerned that IAS 8 would lead policyholders to the IFRS on insurance contracts and infer, perhaps inappropriately, symmetrical accounting.

Other Board members were also surprised by the inclusion in the timetable of the use of other comprehensive income (and hence the possibility of recycling): this was the first time the Board had been warned that this issue was on the table.

The Chairman closed debate on these matters.

Measurement approach

The Board discussed the remaining measurement approaches (both of which would be modified to exclude day one profits):

• measurement based on the approach being developed in the project to amend IAS 37 Provisions, Contingent Liabilities and Contingent Assets (the updated IAS 37 model).
• a current fulfilment value that includes a composite margin.

The Board was evenly divided. Some favoured the fulfilment value approach, noting especially that the FASB had made a tentative conclusion in favour of this measurement approach. These Board members also saw a degree of consistency between the fulfilment model and the Board's conclusions on revenue recognition. Others thought that there was too much to be resolved in the 'updated IAS 37 approach' to enable them to support it.

Others specifically rejected the fulfilment value approach, in particular the analogy to the revenue recognition model. Those who supported the 'updated IAS 37 approach' noted that the approach remeasures the margin and was consistent with the building block approach put forward in the exposure draft. While the 'updated IAS 37 approach' had 'warts and blemishes', it was better than fulfilment value.

The Board voted 8 to 7 in favour of the 'updated IAS 37 approach'. This was a key vote because the margin, if it were to be maintained in a vote on the ED as a whole, would be insufficient to issue the ED. The Board concluded that procedurally it could continue, since it was the whole package that was the subject of balloting.

In any event, the ED would include a thorough discussion of the fulfilment value approach and the Invitation to Comment would seek views on the alternatives.

Subsequent release of residual and composite risk margins

This discussion began with the staff admitting that they were unable to present the Board a recommendation, since they were split among themselves. Some staff members believed that the attribute (driver) selected for release of residual and composite margins should result in recognising those margins in income in a systematic way that best depicts the insurer's performance under the contract. The other view was that the attribute in all cases should be the release from risk. Not surprisingly, the Board was finely balanced between both views.

The staff noted that:

• The 'updated IAS 37 approach' includes a separate risk margin and that the residual margin should be released over the coverage period only because the risk margin under that approach is intended to capture the risk associated with the claims handling period.
• The fulfilment value approach includes only a composite margin which should be released over a period that includes the claims handling period because the period used should reflect the risk associated with the settlement of claims.

The Board debated the issue in considerable detail, but in the end voted (8 to 7 again) to support the first alternative. The risk margin should be released based on a 'release from risk' notion, while the residual should be released on a passage of time basis. Board members noted that in the 'updated IAS 37 approach' the residual margin was essentially a plug, and that this item should be run off over the shortest possible period.

Initial recognition: Day One losses

The staff noted that, because of differences in the way in which insurance contracts were priced compared to the measurement models under consideration, a day one loss might arise in some situations. The Board confirmed that should such a loss arise, it should be recognised in profit or loss.

Relationship between the residual and composite margins and subsequent changes in estimates

The staff presented three possible approaches to addressing the subsequent changes in the residual and composite margins.

• Approach A would result in subsequent changes in estimates being reported in profit and loss.
• Approach B would adjust the margin for changes in cash flow, resulting in no impact on profit and loss.
• Approach C, which the staff had found almost impossible to defend, would update the margin as a fixed proportion of cash flows, determined at exception.

The Board supported Approach A by a large majority. Many thought that Approach B obscured too much information.

Discount rate

The Board agreed that the discount rate chosen should reflect the characteristics of the liability. It should not capture characteristics of assets held to back those liabilities if the liabilities do not share those characteristics. In addition, the Board agreed that it should not provide specific guidance on how to estimate a discount rate for insurance liabilities, beyond providing a cross-reference to the guidance for fair value measurement.

Discussion at the October 2009 IASB Meeting

Unbundling

The Board considered when an insurance contract that contains insurance, deposit (financial) and service components should be accounted for as if they were separate contracts (unbundling). The Board considered the requirement to unbundle when the components were not interdependent.

After a long debate, during which the Board discussed consistency of this requirement with the proposed guidance for multiple segment contracts in the revenue recognition project, the Board asked the staff to redefine the conditions and guidance when the contract was interdependent and could not be unbundled (that is, valued separately).

Presentation of the performance statement

The Board continued with an educational session on presentation of insurance contracts in the performance statement.

The Board was presented with five presentation options:

• (a) Treat all premiums (including the portion that pays for the deposit component) for all insurance contracts as revenue.
• (b) Unbundle all (or specified) insurance contracts into an insurance component, as in (a) and a deposit component – a fee approach.
• (c) Treat all premiums for all insurance contracts as deposits, and all claims and expenses as repayments of deposits. Use the margin model for the margin.
• (d) For insurance contracts that meet specified criteria (for instance, life insurance contracts, or long duration contracts), treat all premiums for all contracts as deposits, as in (c). For all other insurance contracts, treat all premiums as revenue, as in (a).
• (e) Permit insurers to choose for each class of insurance contracts between a revenue presentation, as in (a), and a deposit presentation, as in (c).

After a thorough discussion, during which the Board considered the level of granularity required, the Board seemed to revert to unearned premium model for short term policies and (c) or (d) for other insurance contracts. The Board will reconsider these models at its November meeting, after received feedback from insurance working group.

Deposit floor for Insurance contracts

The Board rediscussed the issue of deposit floor for insurance contracts. The implication of usage of measurement model based on expected cash flows resulting from insurance contracts was that no deposit floor applied for measuring insurance contracts.

In the debate on this implication of the measurement model, the Board discussed the scope of an insurance contract as well as consistency of the deposit floor in banks and insurance.

The Board tentatively confirmed that no deposit floor applied in measuring insurance contracts. Nonetheless, the Board asked the staff to further analyse the implications of that decisions on more complex insurance products. Moreover, the Board directed the staff to analyse possible arbitrage opportunities arising from this decision in groups consisting of both a bank and an insurance company.

Timetable

Given the decisions taken on the previous sessions (including lack of final decisions on several subjects), the Board decided to reconsider the timetable for the project at its November meeting.

Discussion at the October 2009 Joint IASB-FASB Meeting

Resolution of significant differences in technical decisions by the two Boards

The staff used this meeting to reconcile the significant areas where the Boards have reached different decisions. The resolution of the differences on the project is integral to the timely completion of deliberations and subsequent issuances of an exposure draft. The staff presented three areas where the Boards had reached different conclusions:

1. Policyholder accounting
2. Measurement objective
3. Acquisition costs

Policyholder accounting

The scope of the project initially included accounting by both the issuer of the insurance contract (the insurer) and the purchaser of the insurance contract (the policyholder). However, the IASB tentatively decided at a previous meeting not to address policyholder accounting in the exposure draft. The FASB had not yet discussed whether policyholder accounting should be included or excluded from the exposure draft.

The Boards discussed whether policyholder accounting should be included or excluded from the exposure draft. The Boards agreed that the staff should further evaluate the potential scope of the project and come back at a later Board meeting to discuss whether policyholder contracts should be within the scope of the Exposure Draft.

Measurement objective

The Boards discussed the measurement approaches for insurance contracts. At previous Board meetings, the IASB tentatively selected the measurement approach being developed in the project to amend IAS 37, modified to exclude day one gains, and the FASB tentatively selected a current fulfilment approach with a composite margin.

The Boards discussed the similarities and differences between the two measurement models. The Boards noted that the words used to describe the models were causing confusion and emphasised the importance of using the correct words. The Boards agreed that the staff would present to the Boards at a future meeting the concepts of both measurement models, using the correct words to describe each model.

Acquisition Costs

Previously both Boards had reached a tentative decision that acquisition costs should be expensed. Subsequently, the IASB had tentatively decided that at inception an insurer should recognise revenue premium to cover acquisition costs incurred. Therefore, acquisition costs should be limited to the incremental costs of issuing (that is, selling, underwriting, and initiating) an insurance contract and should not include other direct costs. In contrast, the FASB had believed the insurer should not recognise any revenue (or income) to offset the acquisition costs incurred.

The Boards extensively questioned why insurance contracts would recognise revenue differently from other industries. Many Board members believe that no performance obligation is satisfied upon signing of the contract and, therefore, no revenue should be recognised at inception. It was tentatively decided by the Boards that an insurer would not recognise any premium at inception to offset the acquisition costs.

Discussion at the November 2009 IASB Meeting

Recognition of an insurance contract

The Board discussed a staff recommendation that an insurer should recognise an insurance contract when it becomes party to the contract. This definition is consistent with IAS 39.

The Board did not agree with the staff recommendation and suggested that more clarification around what it mean 'to become a party to the insurance contract' is needed. Concerns were raised that internationally there are a variety of regulatory and legal practices around entering into insurance contract that may affect the answer to the question posed by the Board. For example, in some jurisdictions the act of making an irrevocable offer of an insurance contract may expose the insurer to insurance risk from that point, even before the policyholder accepts the offer. It was not clear how the definition of 'becoming a party to contract' would apply in that case.

Another concern was around the accounting for a time period between entering into the contract and the beginning of a coverage period. In some cases this period can be relatively long, and during that time the policyholder is able to cancel the policy. The staff proposed treating that period as part of an insurance contract, because treating that contract as fully executory until the beginning of the coverage period would not fully reflect the risk an insurer is exposed to from any changes in circumstances in the meantime. A number of views were expressed by the Board members on this proposal. Some members viewed the contract before the start of the coverage period as fully executory. Others observed that once the policy has been issued, even if the loss event occurs before the start of the contractually stated coverage period insurer may be obligated to meet that claim. These members believed that the insurance contract should be recognised from the moment the coverage period begins, but there needs to be more clarification around when the coverage period begins, as this may vary in different jurisdictions and may not be based purely on the contractual terms. Some suggested that the definition should be amended such that: 'an insurer should recognise an insurance contract when it becomes party to the contractual provisions or legal or regulatory requirements'.

The Board asked the staff to clarify how the proposed recognition model would apply in particular fact patterns.

Derecognition of insurance liabilities

The Board agreed that an insurance liability should be derecognised when it no longer qualifies as a liability of the insurer, applying the derecognition principles of IAS 39.

Participating contracts

The Board had an education session to discuss the examples of the participating contracts and the proposed accounting for these contracts. A heated debate ensued about whether a participating feature met the definition of a liability or whether it could be viewed as equity. (Will be discussed further at the Wednesday 18 November session.)

Discussion of Participating Insurance Contracts at the Wednesday 18 November Session

The Board discussed the main features of the participating contracts and were looking for a general principle of accounting for them. Participating contracts can be characterised by a policyholder paying a higher premium in order to participate in some of the risks and rewards of the underlying pool of insurance contracts. There are typically two elements in such contract: 'guaranteed minimum benefits' and a discretionary 'participating feature'. The participating feature usually has several elements where insurer can exercise discretion but is ultimately constrained by legal, regulatory and contractual terms. This management discretion means that some part of the participating feature may not meet the definition of liability in the Framework. Two proposed ways of accounting were discussed.

View 1: Treat cash flows arising from a participating feature in an insurance contract as integral to that contract in the same way as all other cash flows arising from the contract, including them in the measurement of an insurance liability on an expected present value basis, with no separate recognition.

View 2: Classify participating feature based on whether it meets the definition of liability, leading to bifurcation of the insurance contract. Under this approach 3 options are possible for the participating feature: 1) always recognise it separately as equity given the discretionary terms; 2) split the feature into two elements and classify it as liability to the extent legal or constructive obligation exists; 3) classify the feature as a liability or equity based on whether the features predominantly are that of equity or debt.

Many Board members disagreed with View 2 approach treating policyholder benefits that do not meet the definition of liability as equity because these funds were not due to equity-holders. Proponents of View 1 stated that treating participating features as part of an insurance liability recognised the fact that such features are embedded in an insurance contract and may not have commercial substance without it. It also avoided complex measurement required to bifurcate both the contract liability and insurance premiums. Some thought it may lead to better performance measurement because under view 1 liabilities and expenses for policyholder benefits would be recognised in the same period as the underlying insurance performance.

Supporters of View 2 approach argued that recognition of liability beyond legal or constructive obligation resulted in a departure from the framework. They viewed these benefits as discretionary until declared, and would record them in equity, but possibly in a separate undistributable reserve. Once declared, the liability would be recognised with a charge to the income statement.

IASB has tentatively voted for View 1, FASB for View 2. The two Boards will continue their deliberations.

Discussion at the December 2009 IASB Meeting

The use of OCI

The Board considered whether it should permit or require insurers to use other comprehensive income (OCI) for the remeasurement of insurance liabilities if financial assets held to back those liabilities are not carried at fair value through profit or loss. Respondents to the Discussion Paper (DP) Preliminary Views on Insurance Contracts argued that some or all changes should be permitted to be recognised in OCI to avoid accounting mismatches, as the assets backing the liabilities are not at fair value through profit or loss and/or to distinguish short-term market volatility that might reverse over the long term of the insurance contract.

The Board agreed with the staff's proposal not to change the accounting for assets or permit the use of OCI for insurance liabilities as this would create an exemption from other standards that would normally apply to the accounting for assets.

The Board then deliberated whether it should permit the use of OCI to report some changes in insurance liabilities. The Board considered that permitting or requiring the use of OCI is likely to require complex, and to some extent onerous, procedures to determine which part of the insurance liability is backed by assets not measured at fair value, to track 'cost' information for that part of the liability, and to determine whether amounts should be recycled from OCI to profit or loss. The Board noted that any accounting mismatches could be avoided by selecting the fair value option in IFRS 9 and by a large majority agreed not to permit the use of OCI or change the accounting for insurance assets.

The Board continued to deliberate whether the use of OCI would be useful to distinguish short-term market volatility from the entity's long-term performance. Some respondents to the DP argued that IAS 19 on pensions and other post-employment benefits permit the use of OCI for those liabilities and that similar accounting should apply to insurance liabilities. The Board noted that it is not always possible to keep consistency with existing standards when developing new standards and that since it is the Board's intent to review the accounting for retirement benefits, analogy to existing pension accounting is not appropriate.

Shadow accounting

On the question of whether shadow accounting should be permitted, the Board noted that in the proposed Insurance Standard gains and losses on assets do not affect the measurement of non-participating insurance contracts. In relation to IFRS 9's OCI presentation alternative, there is no recycling of realised gains or losses. Shadow accounting would result in complex presentation that would not be easy for users to understand. The Board agreed with the staff recommendation that shadow accounting should not be retained.

Joint Discussion with FASB

The Boards were presented with a concise presentation of the accounting for insurance contracts with a comparison of the effects of applying the 'allocation of the original transaction price' approach, 'explicit building blocks' approach and applying the revenue recognition model to insurance contracts.

The Boards discussed the effects of application of the revenue recognition model to insurance contracts based on a numerical example. Even though some Board members saw some merit in applying that model, most Board members found it unappealing as the results were seen as not understandable for the effects of pooling, especially for insurance contracts with more 'moving parts'. Some Board members would like to discuss an alternative application of revenue recognition model to insurance contracts. The staff clarified that it went over a number of possible applications, but the results were similar in broad terms to those presented in the example.

The Boards also discussed the explicit building blocks approach. Some Board members were concerned with the possible effects on smoothing of revenues. The following discussion of this model focused on risk margins that should compensate for the inherent risk characteristics of the contracts. Some Board members were concerned with the application of this approach to contracts with multiple performance obligations and possible need for disaggregation of the margin that would lead to increased complexity.

Measurement objective

The Boards discussed the measurement objective of the insurance contracts. One Board member expressed his frustration with the whole Insurance Contracts project as he believed that the insurance industry was similar to other financial services industries and basic accounting models should apply to it, with some necessary modifications or additional (application) guidance. Some Board members expressed their already well articulated opposition to the separate risk margin component in the measurement objective. They believed that the risk characteristics of insurance contact were already embedded in the inflows and outflows of the contract, and the proposed measurement objective confused the inflows and outflows. Other Board members disagreed. They understood the risk margin component of the measurement objective as the expression of the risk embedded in the insurance contract and as a compensation for additional capital held that reflected this riskiness.

After a significant discussion both Board narrowly agreed that a reporting entity should measure an insurance contract equal to its current estimate of the amount to fulfil the present obligation created by that contract by using a building blocks approach.

The Boards also agreed that a reporting entity should estimate that cost using present value techniques that consider:

1. the unbiased, probability-weighted average of future cash flows;
2. the time value of money;
3. a risk adjustment for the effects of uncertainty about the amount and timing of future cash flows; and
4. an amount to eliminate any positive day one difference.

Margins

The Boards continued their discussion with assessing how to determine the risk adjustment (point 3 in the discussion above). The Boards considered three possible definitions of the risk margin notion:

1. the price of risk a market participant would require when taking over the obligations from the insurer;
2. the price an insurer would require to induce it assume the risk from the policyholder or another party;
3. the amount an insurer would rationally pay to be relieved of the risk.

Discussion at the 5 January 2010 Special IASB Meeting

Unbundling

The Boards started their discussion of insurance contracts with the issue:

• whether to mandate separate recognition and measurement of various components of the contracts (insurance, investment, service) as if they were separate contracts, and
• whether to account for them in accordance with the respective standards (with the possible outcome that they would be based on a different measurement attribute).

The staff proposed that unbundling of a component of a contract for recognition and measurement should be required if that component was not interdependent with other components of the contract.

Most IASB members agreed with such an approach. Nonetheless, the FASB members were concerned with the concept of unbundling and challenged the aim to be achieved by unbundling. In particular they felt uncomfortable that practical measurement issues should influence recognition and presentation and challenged the implications of unbundling for presentation purposes. After a brief discussion the staff clarified that in their view unbundling would be quite rare as in most of the cases the individual components were interdependent. Some Board members challenged that conclusion and were concerned that a recommendation to unbundle only when interdependent for recognition and measurement was premature and further analysis of its impact was needed and it was contrary to the recommendation to disaggregate components for presentation purposes.

Several Board members raised the implications of unbundling on the policyholder's accounting (to be discussed on a next Board meeting) and the impact on universal life policies that were usually unbundled under current requirements.

Finally, the IASB voted in majority for the staff proposal to unbundle a component if that component was not interdependent with other components of the contract, whereas the FASB was against. The FASB members wanted more analysis of the effects of unbundling on embedded derivatives, presentation as well as further broader considerations (for example, how was the notion of interdependence related to the closely related notion currently employed for some of the embedded derivatives under IAS 39).

Notwithstanding further decision on unbundling, the Boards agreed that in cases where unbundling would not be required it should be prohibited.

The Boards continued to discuss whether to prohibit an insurer from unbundling the deposit component for presentation in the performance statement unless unbundling of that component was required for recognition and measurement. Most of the Board members were not prepared to make that decision before a broader discussion of the presentation of insurance contracts in the performance statement. Moreover, some of the Board members were concerned that such a decision might lead to inconsistency in the presentation between the income statement and statement of financial position and they wanted to understand whether such inconsistency was justified.

Presentation of the Performance Statement

The Boards continued their discussion of presentation in the performance statement. The staff discussed five presentation alternatives supported by examples (written premium, earned premium, unbundled, summarised margin, and expanded margin approaches).

The Boards agreed in principle that revenue should be reported on an earned basis rather than on a written basis. Nonetheless, the staff was asked to further analyse how the earned basis would be defined.

Without making any decision the Boards discussed whether an insurer should report as revenue the part of the premium that does not relate closely to the insurance coverage and other service provided under that contract (that is, whether insurers should report as revenue the premium that relates to expected future repayments to the same policyholders).

The discussion of the presentation alternatives was inconclusive, with no specific model gaining much support. In general, margin approaches seemed to have some support in the IASB, even though multiple practical issues were raised. The staff was asked to perform additional analysis and recommend a model based on that analysis. Nonetheless, it seemed that many Board members were not prepared to endorse a single model for presentation as, in their view, a single model might not provide useful information for all types of insurance contracts. Some Board members supported the unearned premium approach for non-life, non-deposit short term contracts. The Boards will continue discussion on the presentation of the insurance contracts at a future meeting.

Embedded Derivatives

Finally, the Boards discussed the accounting treatment for derivatives embedded within an insurance host contract. The Boards were split between measuring those embedded derivatives using the same measurement approach applied to the insurance contracts and fair value.

In the discussion, most Board members seemed to favour a mixed approach to embedded derivatives that would require bifurcation of embedded derivatives and their measurement at fair value in some circumstances and treating them as part of the insurance contracts in other circumstances. The Board asked the staff to analyse the issue and present an updated analysis at a future Board meeting.

Discussion at the January 2010 Joint IASB-FASB Meeting

Measurement objective and risk adjustment

The Boards discussed:

• (a) whether the proposed building block approach would apply (i) to both future cash inflows and cash outflows arising from insurance contracts, or (ii) only to future cash outflows.
• (b) whether the measurement objective should reflect the cost of fulfilling the obligation (as proposed by staff in December papers) or a different fulfilment notion and how the proposed risk adjustment relates to the measurement objective.
• (c) further guidance on the risk adjustment, including the sources of information an insurer might use to estimate it.

Building block approach

The Boards agreed (IASB: 2 opposed; FASB: 2 opposed) that a building block approach that includes a risk adjustment for the effects of uncertainty about the amount and timing of future cash flows should be used for measuring the net combination of rights and obligations of insurance contracts. This implies measuring the gross cash flows rather than the net obligations. Getting to that decision was difficult. Board members from both the IASB and FASB expressed concerns that measuring the risk margin separately from other cash flows and options in the insurance contract. Some were concerned that the model proposed by the staff introduced one-way bias and lacked sufficient rigor to prevent it from being a 'pick a number' measurement. There was a long debate during which the staff tried to clarify what it was proposing. Some Board members were less than convinced and thought that they owed it to their constituents to evaluate the measurement methods identified, especially with respect to the measurement of risk. Other Board members thought that it would be impossible to prescribe one approach; however robust disclosure would provide some discipline that might, over time, improve measurement.

The Boards agreed that the contract position of an insurance contract should be presented net rather than gross.

Measurement objectives

The Board discussed a staff proposal that the measurement objective for insurance contracts should be expressed as '[an entity's current estimate of] the present value of resources required to fulfil the net obligation created by the insurance contract'.

Board members criticised the proposed measurement objective for several reasons. An IASB member disliked the lack of specificity in 'present value', noting that the discount rate must be specified. A senior member of staff noted that, unless otherwise indicated, IFRSs required use of the default risk-free rate. In proposing this measure, the discount rate did not take into account any risk adjustment - that was measured separately.

Other Board members criticised the proposed measurement objective as lacking any rigor sufficient to eliminate some of the more extreme measurement candidates identified in the agenda papers.

The Board did not conclude on this topic and will need to debate it again later.

Risk adjustment

In a very contentious debate, the Boards discussed whether the risk adjustment should be the amount the insurer would require for bearing the uncertainty about the resources it would require to fulfil the (remaining) net obligation from insurance contracts; and whether that risk adjustment should be remeasured throughout the life of the contract.

Several Board members expressed concerns about aspects of the proposals, although some defended them as the best possible solution available. The comments rehearsed many of the misgivings expressed in previous parts of this session. The Boards finally concluded that they would accept the staff recommendations (IASB 8 in favour; FASB: 3 in favour).

Policyholder behaviour

The Boards discussed the treatment of contractual features that permit policyholders to take actions that change the cash flows that will result from a contract. The discussion was focussed mainly towards the FASB, because the IASB had already reached tentative conclusions on the issues.

By a majority of 3 opposed; 2 in favour the FASB did not agree a staff recommendation that policyholder options be measured on a 'look through' basis using the expected value of future cash flows related to the option (to the extent they are within the boundary of the existing contract). As the IASB had previously accepted this recommendation (and the consequence that no 'deposit floor' would apply), this issue will need to be resolved between the Boards.

The FASB agreed that expected cash flows from options, forwards, and guarantees not related to the contractual coverage in the insurance contract should be excluded from the expected insurance cash flows for that contract in measuring that contract.

The FASB also agreed that these options, forwards, and guarantees should be accounted for in accordance with IFRS or GAAP for that instrument, e.g., insurance contract accounting for those options which themselves result in insurance contracts.

Residual margins

The Boards agreed that if the initial measurement of an insurance contract results in a negative day-one difference, an entity should recognise that difference in profit or loss. In doing so, the Boards expressed unease about calling such contracts 'onerous', which some saw as a distraction.

Subsequent release of the residual margin to the income statement

The Boards discussed but did not conclude on how the residual margin should be recognised in the income statement. The Boards noted that the residual margin number was essentially a plug to avoid a Day 1 gain. The Boards did agree that the forthcoming exposure draft should specify how the plug should be amortised (that is, the entity would not have the discretion to decide). The staff was asked to return to a future meeting with proposals.

Changes in expected present value of cash flows

The Boards agreed (IASB: 9 in favour; FASB: 4 in favour) that changes in the expected present value of cash flows should be recognised in income immediately.

Timetable for Board discussions

The Board was presented with, but did not discuss, a timetable for future Board discussions assuming that the exposure draft is issued in May 2010. The staff noted that 'several' of the additional Board meetings being scheduled would be needed if the timetable were to be met.

Discussion at the Joint IASB-FASB Special Meeting 10 February 2010

The Boards have been presented with a model of accounting for reinsurance contracts based on the proposed 'building blocks' insurance contracts recognition and measurement model. Accounting by both the reinsurer and the cedant was considered.

Accounting by reinsurers

Because reinsurance contract is a type of insurance contract purchased by an insurer, the Boards unanimously approved the staff recommendation for reinsurers to use the same recognition and measurement principles for issued reinsurance contracts as insurers use for issued insurance contracts. Board members noted that in applying the same principles to measuring contract liability, the reinsurer and the cedant would still have different assumptions resulting in different amounts being recognised in their financial statements.

Accounting for reinsurance asset by cedants

The Boards considered a proposal to measure the reinsurance recoverable asset as:

• a. the present value of expected future cash flows required to fulfil the reinsurance portion of insurer's obligation
• b. plus the risk margin (but not residual margin) that is included in the measurement of the reinsured portion of the contract obligation
• c. plus residual margin arising from the reinsurance contract
• d. less the impact of possible impairment of reinsurance asset due to credit losses and coverage disputes measured on an expected value rather than on incurred loss basis

The staff clarified that the risk margin to be included in the measurement of reinsurance asset is the reinsured portion of the cedant's risk margin on its direct insurance liability. The Board members questioned why this risk margin increases the value of the asset. The staff explained that this margin simply mirrors the effect of the uncertainty around the insurer's direct contract liability that was passed to the reinsurer, and it can be viewed as protection asset.

In discussing the reinsurance asset residual margin, the staff clarified that this margin is not linked to the residual margin on the initial direct insurance contract. It is also not the residual margin that reinsurer would recognise in its own financial statements. Instead it represents the balancing figure between elements (a) and (b) and the premium paid under the reinsurance contract. The question of whether this margin can be negative is yet to be discussed.

The proposed adjustment for impairment raised questions of potential double counting. One question was whether, if the insurer expects to receive only the present value of expected cash flows (element a), then does that mean that both margins need to be written off immediately as impairment? The staff explained that adjustment for impairment is to incorporate future credit losses expected to take place after inception and not on initial recognition. Staff will bring back, for discussion at a future meeting, the potential issue of double counting, better wording for the impairment adjustment, and some examples of reinsurance asset calculations. Leaving aside the potential need for rewording of impairment adjustment, the Boards approved the proposed measurement model.

Offsetting

The Boards unanimously voted not to allow offsetting of reinsurance recoverable (assets) against insurance liabilities either in the balance sheet or in profit or loss unless there is a legal right of offset.

Derecognition

The Boards unanimously agreed that reinsurance does not result in derecognition of related insurance contract liabilities unless the obligation specified in the insurance contract is [legally] discharged, cancelled or expired.

Accounting for ceding commissions by cedant

The staff proposed that the cedant should treat ceding commission received from the reinsurer consistently with proposed accounting for acquisition costs. The Boards have tentatively agreed in the past to expense insurance contract acquisition costs as they are incurred. Therefore, the ceding commissions received would also be recognised in profit or loss. Because the ceding commissions would result in recognition of income by the cedant, there was a general concern for reinsurance contract structuring opportunities to affect the split between ceding commission and reinsurance premiums.

The Board members questioned whether ceding commissions only relate to proportional reinsurance, where the link to the underlying direct insurance contract's cash flows is clearer. The staff will research the issue further for non-proportional reinsurance. For proportional reinsurance only the Boards unanimously approved the staff recommendation for the cedant to recognise ceding commissions in the same way as acquisition costs.

Issues of symmetry

The Boards deliberated the issue of symmetry in accounting for cedant's reinsurance asset and insurance liability. Board members agreed that proposed model would result in the same measurement method applied to both reinsurance asset and insurance liability, except that reinsurance asset includes an impairment adjustment while insurance liability does not include insurer's own credit risk. The Boards also looked at the issue of symmetry in accounting for the reinsurance liability by the reinsurer and the reinsurance asset by the cedant, but decided not to proceed further with this question.

Policyholder Accounting

The staff have looked at whether the proposed insurance model can be applied to policyholder accounting and what issues, if any, can this highlight for accounting by insurers. Overall, the staff propose that the building blocks insurance model can be applied to policyholder accounting but would need further research. Of the particular issues reviewed for policyholder accounting, only two were highlighted as potentially impacting on insurer's accounting as well, if symmetry between insurer and policyholder accounting models is important. Those issues were the tentative decisions on expensing of acquisition costs under both IASB and FASB models and on participating rights under FASB model. From policyholder's point of view, all premiums paid would represent an asset including the acquisition costs. This would not be symmetrical with insurer's accounting. The FASB model proposes to recognise participating features as part of insurance contract liability only if there is a legal or constructive obligation to pay these cash flows; otherwise they would be a component of equity. From the policyholder's point of view the higher premium paid for the participating feature would represent an asset, highlighting the difference from the insurer's accounting. The Boards agreed (FASB – unanimously, IASB – all but one member) not to consider further, at this stage, the issues of symmetry between insurer's and policyholder accounting other than to review the treatment of acquisition costs and participating rights.

A further question was whether the exposure draft (ED) should include policyholder accounting. The boards agreed not to include policyholder accounting in the scope of the ED. However, the definition of insurance would apply equally to insurers and policyholders.

Discussion at the February 2010 Joint IASB-FASB Meeting

Presentation from the Chair, IAIS Insurance Contracts Subcommittee

Robert Esson made a short presentation on behalf of the International Association of Insurance Supervisors. He stressed that the supervisors were increasingly concerned about the boards' approach to considering issues on theoretical grounds on an individual basis. He acknowledged that this was a necessary step; however, the IAIS believed that the boards should also consider the impact of their tentative decisions made on the totality of financial reporting by insurers. In his view, the boards ought consider the business structure for insurers and determine whether, in totality, the tentative decisions made so far would lead to useful information for users of the financial reports of insurers.

In particular, he stressed that any financial reporting model introduced by the boards would involve some degree of pragmatism. What was important is that the financial reporting should reflect the economics of the business and not introduce volatility that is not reflective of the economics of the business.

Throughout the presentation, Mr Esson noted that the IAIS had identified a key principle that should prevail: that a model using unbiased, probability-weighted cash flows would provide an answer to many of the problem in the insurance contracts project. In particular, he noted the problems created by forcing the residual margin to calibrate the profit or loss on inception of the contract to zero. If the model were permitted to weight acquisition costs as a '1.0' (that is, certain) cash flow, the residual margin would be lower, acquisition costs would still be expensed, but the deferred profit embedded in the residual margin would not be distorted. He acknowledged that unbiased probability-weighted cash flows were not perfect, but they were significantly better than the direction that the boards were taking.

Board members asked for clarification of certain issues, but it seemed that many of the more vocal board members were not persuaded by the presentation.

Insurance contracts - unbundling

The boards discussed whether an insurer should recognise and measure those components of a contract as if they were separate contracts (unbundling). The staff introduced the technical discussions by noting that the IASB and FASB staffs were split on the issue.

The IASB staff were largely supportive of the following positions:

An insurer should unbundle a component of an insurance contract if that component is not interdependent with other components of that contract. This would also apply to those components of insurance contracts that are embedded derivatives.

If components are interdependent, an insurer:

• should not be permitted to unbundle those components of the contract for recognition and measurement.
• should not separate any deposit element from the remainder of the premium for presentation in the performance statement.

The FASB staff had prepared an Alternative View:

• the notion of interdependency should apply only to situations in which the components cannot function independently, that is, only to those situations where a truly symbiotic relationship is necessary for the individual components to function;
• embedded derivatives in an insurance host contract should continue to be subject to existing guidance for derivative instrument accounting and bifurcated when appropriate. There should not be an exception from [IFRS] for insurance-the general notion in the insurance contracts project should be to address insurance specific issues; and
• contracts subject to unbundling should be presented on an unbundled basis on both the balance sheet and income statement.

The discussion that followed was often difficult to follow as board members flipped between agenda papers at will. However, it was clear that there was a lack of consensus between the FASB and the IASB – although some IASB members were supportive of the FASB staff view. One IASB member noted six significant problems with the proposed model and felt that the notion of 'interdependency' was at the root of all of them.

An IASB member noted that the notions of independence versus interdependence were difficult to analyse, but that he was sympathetic to using a unitary whenever possible: he was uncertain that it was worth the effort to separate the components of an insurance contract. What was important to users was the aggregate measure, not the individual components and he urged the boards not to over-engineer the IFRS. An IASB staff member noted also that the additional work implied by the FASB view would entail significant effort without much additional benefit (especially in jurisdictions outside the US and European Union).

In an attempt to achieve some direction, the IASB staff suggested a modified proposition:

Unbundling for recognition and measurement should not be required if the components are significantly interdependent.

Board members objected to this because there was no consensus on what 'interdependent' meant in this context. The meeting agreed on examples that demonstrated the extremes of the spectrum (for example, term life (interdependent) and investment contracts (unbundled)) but were uncomfortable with the contracts those two extremes. A bare majority of the IASB (8-7) supported this proposition; but none of the FASB members present did.

Embedded derivatives

The boards discussed the effects of the unbundling approach on the accounting for embedded derivatives. A major concern, particularly for FASB members, was that derivatives masquerading as insurance (e.g. credit default swaps) should not be treated as if they were insurance contracts.

The IASB staff noted that the definition and elaboration of the term 'insurance contracts' was critical to this issue and opted to defer further discussion and return to the boards with modified proposals at a later date.

Financial statement presentation

The Board discussed the presentation of insurance contracts in the statement of comprehensive income. The staff presented three examples:

• (a) the summarised margin presentation;
• (b) the expanded margin presentation; and
• (c) the 'traditional' premium allocation presentation.

These approaches were presented to the boards in December 2009.

The IASB staff noted that the measurement approach adopted by the project drives the fundamental structure of the presentation model. To achieve this, the statement of comprehensive income should give the following information (as a minimum) on the face of the statement:

• (a) the release of the expected margin during the period flowing from the measurement model, showing the release of the risk adjustment separately from the release of the residual margin either on the face of the statement of comprehensive income or in the notes
• (b) the difference between the expected and the actual cash flows
• (c) changes in estimates (remeasurements)
• (d) results from investments, showing separately
  • (i) interest income; and
  • (ii) interest on the insurance liability

The IASB and the FASB agreed that the measurement approach should drive the presentation model for the performance statement. The boards also agreed that they should not select a 'traditional' premium allocation approach as the presentation model for all types of contracts (although it may still be used as a basis for the presentation for a simplified measurement approach based on premium allocation [e.g. for non-life contracts]).

In addition, the IASB had a strong preference for the 'expanded margin' presentation approach, while the FASB preferred the 'summarised margin' approach – although the FASB would want disclosure of 'key business drivers'.

Variable and unit-linked contracts-separate accounts

The boards discussed the accounting for account-driven contracts generically referred to as 'unit-linked' or 'variable insurance' and annuity contracts. In particular, they considered questions about whether the invested fund into which the premium is deposited represents an asset and corresponding liability of the insurance entity. The staff noted that the fundamental question to this discussion was identifying appropriately 'whose assets and liabilities' were involved. The staff introduced and the boards discussed some of the models of separation and segregation that exist in various jurisdictions, noting that the US notion of 'separate accounts' was probably the most extreme example, because the account has a separate legal existence and is insulated legally from the general account liabilities of the insurance entity.

The boards agreed that assets and related liabilities associated with unit linked contracts, including those defined as separate accounts, should be reported as the insurer's assets and liabilities in the statement of financial position.

In addition, the boards agreed that issues involving the consolidation of investment funds associated with unit-linked contracts (including separate account contracts) be addressed in the consolidations project rather than in the insurance contracts project.

The boards did not discuss or vote on whether unit-linked contracts should be measured in the same manner as other account-driven contracts.

Discussion at the March 2010 Joint IASB-FASB Meeting

Release of residual margins and recognition of revenue

The Boards discussed how a residual margin, determined at inception, should be released to profit or loss subsequently. The staff explained that in preparing their recommendations, they had focused on the insurer's performance under the contract by delivering an asset to the policyholder. The staff also reminded the Boards that the proposed insurance model is a hybrid of:

• a direct liability measurement, using current estimates of expected cash flows, time value of money and a risk adjustment; and
• an allocation element (the residual margin) that eliminates a day one gain and is subsequently released as income over an appropriate period. The staff proposed that this 'appropriate periods' was the period over which the insurer performed under the contract.

The residual margin

In outlining their recommendations, the staff suggested that 'for subsequent reporting periods the residual margin...will accrete interest.' This suggestion generated a significant amount of discussion among Board members. Some Board members saw the residual margin as a 'plug' designed to avoid a 'Day 1' gain or loss. As such, it was much the same as deferred income, on which no one usually accretes interest. Others disagreed, seeing the residual margin as part of the larger present value computation that is performed by the insurance company when pricing the contract. As such, accreting interest was totally consistent with the revenue recognition model being developed by the Boards. Still others disagreed with this second analysis, noting that in insurance the premium is received on Day 1 unlike most revenue recognition situations in which the interest accretion acknowledges the implicit financing given by the entity between the time of performance and the receipt of customer consideration.

The Boards and staff attempted to clarify the issue by using the staff examples, but these only added confusion – even to those Board members who had tried to audit the examples.

The Boards agreed that it was vital that the model not be lost for the sake of the disagreement about whether interest is accreted. A Board member noted that he would not like to see the Boards revert to a composite margin approach. The risk and residual margins were related but distinct, and the accounting model proposed by the Boards should recognise this fact.

The staff agreed to withdraw the issue of whether interest was accreted on the residual margin over the period of time that it was released. Revised proposals will be presented either later in this meeting cycle or in April.

Period of release

The Boards then discussed the period over which the risk margin should be released. Board members were again concerned that the staff proposal seemed to be more complicated than was necessary. In particular, they thought that the recommendation sought to frame the principle around the extreme rather than the general (for example, hurricane or winter storm damage, in which the window for claim events is relatively narrow, rather than claims occurring evenly over a period).

A FASB member suggested an alternative approach, which the staff preferred to the formulation of their original recommendation. Consequently, the Boards were asked to vote on a recommendation that the residual margin should be released on a straight-line basis unless another pattern reflected better the exposure to risk over the coverage period.

A comfortable majority of the IASB and FASB separately supported this recommendation.

One FASB member thought that it was premature to commit to this approach. This FASB member thought that the inbound and outbound cash flows and margins were inextricably linked and that using composite margin that is remeasured over the performance period is the best way to portray that.

Acquisition Costs

The Boards have consistently held the view that insurers should recognise acquisition costs as an expense when incurred and, at inception, a part of the premium equal to the acquisition costs incurred should not be recognised as revenue. Responses to the field test questionnaire indicated that this proposal would have a significant effect for life insurers and would not give useful information. At the time of the decision, the Boards were still discussing the extent to which the insurance project should be consistent with the revenue recognition project or should focus on the direct measurement of the contract liability. Since then, the Boards have affirmed that the measurement model to be applied is a hybrid of the direct measurement and allocation of a positive difference between expected premiums and cash outflows plus a risk margin. Therefore, the staff requested to explore the question of acquisition costs and presented the Boards with the following four alternatives:

• A. recognise all acquisition costs as an expense when incurred and not recognise a part of the premium as revenue (Boards' current decision);
• B. the direct measurement of contract liability should be calibrated to the premium excluding incremental acquisition costs;
• C. incremental acquisition costs should be included in the contract cash flows to determine the residual margin at inception of contract; or
• D. an intangible asset should be recognised measured at the amount of incremental acquisition costs.

Several Board members were opposed to changing the current decision as it would imply that insurance is being treated in a special way and expressed strong support for alternative A. They were also of the opinion that these costs do not form part of the contract liability and, therefore, should be expensed.

A few other Board members favoured alternative C as they see this as consistent with the building block model developed specifically for insurance, and in that way insurance is special, whereas other Board members indicated that they could support either alternative B or C, depending on how acquisition costs are defined.

One Board member, originally supporting alternative A, suggested a modified alternative A using an example whereby an insurance contract includes a clause stating that if the contract is not renewed, the customer owes an amount to the insurance entity for acquisition costs incurred. This 'debt' of the customer will usually be offset against the settlement value of the contract. In this scenario, the insurer will recover the acquisition costs either through renewal or through a reduced settlement value. The modified alternative A would entail all acquisition costs being expensed and a receivable recognised for the costs expected to be recovered.

The Boards deliberated the matter for some time but could not reach a common view. The majority of Board members requested more time to consider the matter and a further analysis of the mechanics and implications of each alternative. In order to give the staff some direction, the Boards were asked to vote for either alternatives A, B/C, or D. The majority of FASB members supported alternative A, whereas the majority of IASB members supported alternative B/C. The Boards asked the staff to explore these alternatives further including the modified alternative A and bring the issue back for further discussion at a future meeting.

Educational session: measuring the risk margin

At the request of a FASB member, the FASB staff had prepared a paper that examined and explained the role that risk adjustments play in standard option pricing techniques. The FASB member wished to explore whether the Boards' challenge in attempting to adjust for the risk margins could be accommodated more efficiently using option pricing models as opposed to the alternatives being considered.

The FASB staff also presented a selection of current (and significant historical) academic research on the use of option pricing models in the measurement of liabilities. It was unclear how many of these studies were based on data not based in the United States or on US GAAP (nor was this question asked by any Board members).

The principal paper was being discussed in 'education session' format, and Board decisions were not requested. However, it was apparent that both Boards were split, with some preferring using option-pricing models to measure insurance contracts and others preferring the current staff position.

Members of both Boards expressed concern that using option pricing models to price the risk margin was essentially inviting preparers to use a 'pick a number' approach to measurement. There was no apparent means to limit approaches to measurement or to inputs, so it was difficult to see how using option pricing models would be better than the model currently being developed. In defence, the chief advocate of the FASB model noted that, in some cases, there was less subjectivity in the option pricing model-approach than, for example, value-at-risk approaches.

A FASB member was concerned that the Boards were suggesting a greater rigor for insurance contracts than they require for other [fair value] measurements: was this because the Boards had abandoned the exit price as the measurement objective and had yet to articulate clearly a replacement? The lack of a clear measurement objective was at the root of the Boards' problem.

An IASB member concurred, suggesting that the Boards were trying to achieve an 'exit price', or something very close to it, without using that phrase or 'fair value'. The exit price was, for him, the right answer and the Boards should be honest about using it as the measurement objective. Exit price is well understood by both users and the measurement professionals and would have well-established measurement methods already embedded in IFRSs and US GAAP.

The discussions did not suggest broad support for using option pricing techniques in determining inputs to the measurement of insurance contracts. However, that may change as Board members reflect on the discussions between today and when they debate the paper in technical session in the week of 22 March.

Definition of an Insurance Contract

The Boards agreed to retain the definition of insurance contract in IFRS 4. This definition contains both the concepts of compensation accompanied by the requirement for significant risk and a specified uncertain future event that adversely affects the policyholder. (US GAAP uses the terms indemnification and compensation.) Insurance risk and financial risk

After some debate, the Boards agreed that the description of 'significant insurance risk' (IFRS 4.B22-B28) be carried forward to the exposure draft. The Boards were concerned about the practical application of 'commercial substance', but were ultimately convinced that the Application Guidance in IFRS 4 had proved operational.

The role of timing in insurance risk

The Board analysed the role of timing risk in the definition of insurance risk. Currently, the FASB's definition of insurance risk requires the presence of both underwriting and timing risk. The definition in IFRS 4 contains both elements, but does not require both to be present. The staff analysis suggested that the 'equal prominence' requirements contained in US GAAP led to inappropriate results at the margins; however IFRS 4 would produce more logical results.

After discussion, the Boards agreed that the role of timing risk in the definition should be a disqualifying, rather than a primary condition for judging insurance risk in a contract. The role of timing risk should be emphasised by:

1. Adding the following (or very similar words) to IFRS 4 paragraph B2:
2. Contractual provisions that delay timely reimbursement to the policyholder can eliminate or significantly reduce uncertainty because they prevent the insurer's payments from directly varying with the claims.
3. Changing the evaluation of insurance risk from absolute amounts to present values.

The Boards subsequently debated the application of these decisions by using a simple example. A majority of the IASB and a minority of the FASB accepted that in applying the analysis of insurance risk to possible outcomes under a contract, should the focus be on the range of possible outcomes and the significance of reasonably possible outcomes relative to the mean. A majority of the FASB thought that the focus should be on the existence of a possible outcome in which the present value of the net cash flows is negative (although it was acknowledged that this might be a subset of the first alternative).

Scope

The background to this discussion is a key difference in the scope of existing IFRS and US GAAP for insurance contracts. IFRS 4 addresses insurance contracts; US GAAP addresses insurance entities.

Warranties

The Board noted that IFRS 4 takes the position that all product warranties meet the definition of an insurance contract, but distinguishes two categories:

• Product warranties issued by another party for goods sold by a manufacturer, dealer or retailer are within the scope of IFRS 4.
• Product warranties issued directly by a manufacturer, dealer or retailer are outside the scope of IFRS 4.

After a tortured debate, the Boards agreed that product warranties issued directly by a manufacturer, dealer or retailer should remain outside the scope of the Insurance Contracts IFRS.

Fixed-fee service contracts

The Boards were not in favour of including fixed-fee service contracts within the scope of the Insurance Contracts exposure draft. Some Board members thought that this type of contract was often very difficult to classify and judgement was required, consequently the IFRS should not be explicit. Some Board members were concerned that to scope such arrangements into the IFRS would be to separate normal business from insurance on an arbitrary basis.

Residual guarantees

The Board agreed that the following contracts should be excluded from the scope of the insurance contracts exposure draft:

• residual value guarantees embedded in a lease*;
• employers' assets and liabilities under employee benefit plans and retirement benefit obligations reported by defined benefit retirement plans;
• contingent consideration payable or receivable in a business combination.
  *If the residual value guarantee was issued by a third party and was specific to the property leased, that would be an insurance contract; if the residual guarantee was issued by a third party and was a guarantee of the price of a generic item of property (for example, a car of that model and year), that would be a derivative.

Risk adjustment

The staff noted that in the Boards' educational session on this topic on 17 March 2010 the risk adjustment included in the proposed measurement for insurance contracts. The discussion in that session focused on:

• the objective for a risk adjustment under the proposed measurement.
• the numerous methods that could be used to calculate a risk adjustment.
• the connection between these two; that is, the degree to which available methods could or should be narrowed down as a result of the objective for the risk adjustment.

The debate that followed was as testy as that in the education session. The Boards were not in favour of the original staff recommendation (not requiring a particular method for determining a risk adjustment), nor did they wish to limit the alternatives in an artificial way. Hence, they were faced with developing an objective for the risk margin or abandoning the idea totally and adopting a composite margin.

After a long debate, the Boards remained divided. The IASB voted 8 in favour of developing an Objective for the risk adjustment; 7 in favour of adopting a composite margin approach. The FASB voted the opposite way: 1 in favour of developing an Objective and 4 in favour of adopting the composite margin approach.

In a follow-on vote, a majority of the IASB voted that the refined objective should be the amount the insurer would rationally pay to be relieved of the risk (i.e., the objective of the risk adjustment used in the revised IAS 37).

Participating contracts

This topic was revisited in an attempt to achieve consensus between the Boards. Like the Boards, staff on the project were split, some viewing payments arising from the participating feature as contractual cash flows as any other cash flows arising under the contract; and some would recognise the liability up to amount of the legal or constructive obligation and regard the remaining part as equity.

Another energetic debate ensued. Some Board members were concerned that participation features should be limited to the insurance risk element and should not extend to pools of investment risk. Were investment risks to be included, the conclusions reached in the Liabilities and Equity project might have to be revisited-for example with respect to cumulative preferred shares.

The Boards' views on what constituted a constructive obligation were tested and explored. Many Board members suggested that they wanted to support the view that payments arising from the participating feature as contractual cash flows as any other cash flows arising under the contract, but were concerned that this allowed too much discretion. Others thought that the notion of a constructive obligation applied correctly and intelligently would get you to the correct answer.

Ultimately, the IASB Chairman called the vote. The IASB were strongly in favour of the view that payments arising from the participating feature as contractual cash flows as any other cash flows arising under the contract; the FASB were evenly split between the two views until one FASB member, professing agnosticism on this topic, switched to support the IASB majority.

Possible disclosure requirements

The Board agreed in principle that the insurer should describe and explain its participating contracts and the conditions impacting amount and timing of payments. Details should be given regarding in which pool policyholders participate, this may be a specific pool of contracts or assets or the overall performance of the entity. Information about which amounts would eventually flow to shareholders and which to policyholders is important information to users of the financial statements. Users would also be interested in any loss-absorbing characteristics of liability components.

The Board agreed that a starting point would be the disclosures required in IFRS 4 IG32(g), IG64 (c) and IG65F. The Board had some specific comments on proposed disclosure of asset risk and risk mitigation through participating policies - in particular about the practicability of the disclosures - that the staff shall address in drafting.

Disclosure

The Boards discussed an overall approach to disclosure for insurance contracts. The staff had proposed the following general principle:

An entity shall disclose information that:

1. explains the characteristics of its insurance contracts;
2. identifies and explains the amounts in its financial statements arising from insurance contracts; and
3. helps users of its financial statements to evaluate the nature and extent of risks arising from insurance contracts.

The Boards encouraged the staff to work with the revenue recognition team to develop consistent disclosure principles that would rephrase objective (c) to concentrate on helping users 'to evaluate the amount, timing and uncertainty of cash flows': this was seen as less ambiguous than the current phrasing. Coordinating with the revenue recognition team was necessary as they face the same challenge, and the Board wished to avoid covering the same territory twice. Disaggregation was also an issue that was not addressed in the disclosure principle. Some Board members saw disaggregation as vital to insurance contract disclosure given the amount of netting that accompanies the recognition and measurement of insurance contracts.

Other Board members were concerned that, without a clear understanding of the presentation of insurance contracts in the financial statements, deciding what else needs to be disclosed was challenging. However, any disclosure must help the user to identify how the insurer makes money, what types of contracts it writes, in what jurisdiction it writes them, how much discretion management has in measurement, where the risks are in the business, and how those risks are reflected in measurement, among other things. Another issue raised was that of operational risk – where the entity operates, the regulatory environment, and any restrictions place by operation of law or prudential supervisors on the types of business an insurer was permitted to underwrite. In general, Board members agreed that the disclosure principle and accompanying proposed disclosures were a good start, but needed more specificity before they could be commented on with any degree of comfort.

An IASB member suggested that the disclosures required in Australia, Canada, and New Zealand (that is, those jurisdictions that require a model similar to that being proposed by the forthcoming ED) should be studied and incorporated as appropriate in the ED's disclosure package.

The Boards agreed in principle on the approach to disclosure (no formal vote was taken).

The Boards reviewed briefly possible disclosures. No formal views were expressed, but several Board members thought that it was premature to consider specific disclosures before the accounting requirements had been concluded.

Discussion at the April 2010 Joint IASB-FASB Meeting

Discount rate to be used for insurance contracts

Discounting is a significant issue for long-term insurance contracts. Some argue that insurers often price the policies using as a discount rate a rate of return on their investments, and to use a different rate, such as a risk free rate would lead to day one losses.

Taking account of past decisions to use 'building blocks' measurement model, not to fair value liability and specifically not to include own credit risk, the staff developed an objective for the discount rate. It is to adjust the estimated (probability-weighted) cash flows for the time value of money in a way that reflects the characteristics of the liability, and not those of the assets used to fund insurance liabilities, unless the cash flows to the policyholders are linked to the performance of such assets, as in the case of participating contracts. In particular, the discount rate should take into account the liquidity risk, as this is a risk present in the liability and is not reflected in the other 'building blocks'. Both the IASB and FASB members were unanimous in supporting this objective and liquidity risk was thought to address some of the 'day one loss' concerns.

There was some discussion about how best to estimate the discount rate. The staff suggestions were: 1) not to prescribe a detailed guidance beyond that of the measurement objective or 2) to suggest using a high quality corporate bond as an easy to use and comparable discount rate, that is consistent with the IAS 19 pension accounting. The first method would result in the discount rate being a risk free rate plus a liquidity premium. Using the high quality corporate bond was not supported, because while more practical, it seems to be a proxy for own credit risk, some countries do not have such bonds and it is less theoretically sound. The debate then focused on own credit risk, since it is not specifically addressed in the proposed objective. A number of FASB and IASB members wanted to include it. Including it would improve matching of the performance of insurance contracts and the insurance investments where investments are carried at fair value. However, referring to the recent IFRS 9 project decisions on own credit risk, the FASB suggested for discount rate to be based on the characteristics of the liability, being risk free rate plus liquidity risk and to include in the ED separate questions about an adjustment incorporating own credit risk. Both Boards voted unanimously. The Boards then voted unanimously to include specific guidance from the relevant IASB/FASB literature on the principles of how to estimate the discount rate to avoid double counting of risk.

On participating contracts the staff recommend considering the return on the linked assets where this influences, even if partially, the insurance contract cash flows. If the linked assets represent a 'replicating portfolio' that fully matches actual cash flows of insurance liability in all cases and can be measured directly, then no need to use a building blocks approach. If not, the return on linked assets should be considered in arriving at a discount rate that reflects characteristics of the liability, as per objective. The FASB members clarified that for assets the discount rate discounts contractual rather than expected cash flows. Need to avoid double counting of the risk of uncertainty of cash flows in both expected cash flows and discount rate. Using a replicating portfolio, if it exists, avoids this double counting. IASB – all but one member of FASB – unanimously supported the staff's suggestion, subject to seeing it clarified as above.

Discount rate to be used for insurance contracts

Discounting is a significant issue for long-term insurance contracts. Some argue that insurers often price the policies using as a discount rate a rate of return on their investments, and to use a different rate, such as a risk free rate, would lead to day one losses.

Taking account of past decisions to use 'building blocks' measurement model, not to fair value liability and specifically not to include own credit risk, the staff developed an objective for the discount rate. It is to adjust the estimated (probability-weighted) cash flows for the time value of money in a way that reflects the characteristics of the liability, and not those of the assets used to fund insurance liabilities, unless the cash flows to the policyholders are linked to the performance of such assets, as in the case of participating contracts. In particular, the discount rate should take into account the liquidity risk, as this is a risk present in the liability and is not reflected in the other 'building blocks'. Both the IASB and FASB members were unanimous in supporting this objective and liquidity risk was thought to address some of the 'day one loss' concerns.

There was some discussion about how best to estimate the discount rate. The staff suggestions were:

1. not to prescribe a detailed guidance beyond that of the measurement objective, or
2. to suggest using a high quality corporate bond as an easy to use and comparable discount rate, that is consistent with the IAS 19 pension accounting.

The first method would result in the discount rate being a risk free rate plus a liquidity premium. Using the high quality corporate bond was not supported because, while more practical, it seems to be a proxy for own-credit risk, some countries do not have such bonds, and it is less theoretically sound. The debate then focused on own-credit risk, since it is not specifically addressed in the proposed objective. A number of FASB and IASB members wanted to include it.

Including own-credit risk would improve matching of the performance of insurance contracts and the insurance investments where investments are carried at fair value. However, referring to the recent IFRS 9 project decisions on own-credit risk, the FASB suggested that the discount rate should be based on the characteristics of the liability, being the risk-free rate plus liquidity risk, that the ED should include separate questions about an adjustment incorporating own-credit risk. Both Boards agreed unanimously. The Boards then voted unanimously to include specific guidance from the relevant IASB/FASB literature on the principles of how to estimate the discount rate to avoid double-counting of risk.

On participating contracts, the staff recommend considering the return on the linked assets where this influences, even if partially, the insurance contract cash flows. If the linked assets represent a 'replicating portfolio' that fully matches actual cash flows of insurance liability in all cases and can be measured directly, then no need to use a building blocks approach. If not, the return on linked assets should be considered in arriving at a discount rate that reflects characteristics of the liability, as per the agreed objective. The FASB members clarified that for assets the discount rate discounts contractual rather than expected cash flows. There is a need to avoid double-counting of the risk of uncertainty of cash flows in both expected cash flows and discount rate. Using a replicating portfolio, if it exists, avoids this double-counting. IASB – all but one member/FASB – unanimously supported the staff's suggestion, subject to seeing it clarified as above.

Contact boundaries

The IASB discussed where the boundary of an existing insurance contract should be. The contract boundary determines which future cash flows are included in the measurement of the insurance contract. The staff noted that in May 2009 the IASB tentatively determined the boundary between existing and new contracts as the point at which the insurer can cancel the contract or change the pricing or other terms.

Since then, the International Association of Insurance Supervisors (IAIS) had suggested that the cash flows to be taken into account when measuring an insurance contract would be bounded by the earlier of (as applicable):

• the contractual termination date as extended by any unilateral option available to the policyholder, or
• the insurer having a unilateral right to cancel or freely re-underwrite the policy, or
• both the insurer and policyholder being jointly involved in making a bilateral decision regarding continuation of the policy.

The contract boundary is defined as including all cash flows arising under the contract as a result of events occurring during the period ending on the earlier of:

• the contract coverage period (as extended by any renewal options available to the policyholder) and
• the point at which the insurer has an unrestricted ability to cancel or re-underwrite and re-price coverage of the individual contract. For this purpose, restrictions would be ignored if they have no commercial substance (that is, no discernible effect on the economics of the contract).

After a long debate, the Board seemed to coalesce around the articulation of the contract boundary developed by the IAIS rather than the staff recommendation. They agreed that this should form the basis of the next steps in this part of the project, although the staff was asked to explore the effect of events arising from contractual terms. (The particular example will be the operation of a non-claims clause in a motor insurance policy in which renewing motorists are classified in 'classes' depending on claims experience under a contractual (or legal) formula; and whether moving from one class to another constitutes a new contract.)

Recognition

The Board discussed the recognition of rights and obligations arising under an insurance contract, including the treatment of the contract in the period (if any) between when the two parties (insurer and policyholder) enter into the contract and the start of the coverage period. The staff noted that the FASB had already tentatively decided that an entity should recognise an insurance obligation at the earlier of (a) the entity being 'on risk' to provide coverage to the policyholder for insured events and (b) the signing of the insurance contract.

Although Board members had some concerns about their understanding of 'on risk', it was evident that the vast majority (if not all) of the Board agreed that the principle could be re-expressed as 'as insurance obligation arises when the insurer has insurance risk'.

The Board agreed with the staff recommendation (as had the FASB), subject to drafting.

Discussion at the May 2010 Joint IASB-FASB Meeting

The Boards held an extended discussion, which seemed to be designed to confirm the elements of the alternative approaches to measuring risk in an insurance contract to be included in the forthcoming exposure draft. The debate was difficult to follow and demonstrated that both Boards and their respective staff remain split both within themselves and between the two groups. Many of the interventions essentially reiterated Board members' previous positions and opinions and did not serve to advance the discussion to any meaningful extent. The net result was one of the worst debates on this project for many months.

Risk adjustment or composite margin

The Boards continue to be finely divided on whether to adopt a risk adjustment with a residual margin or a composite margin approach: the FASB 3-2 in favour of a composite margin approach; the IASB 8-7 in favour of a risk adjustment/ residual margin approach. Consequently, the ED will discuss both.

The Boards agreed (FASB: 5 in favour; IASB: 8 in favour) that should an insurance contract include a separate risk adjustment, the ED should limit the range of permitted techniques by specifying the range of techniques that the Boards consider consistent with the measurement objective (this is similar to the approach to measurement methods adopted in IFRS 2).

Composite margin

The Boards discussed potential approaches to the release of a composite margin subsequent to initial recognition. The staff proposed that the release should be governed by two 'drivers' that would be specified in the ED. The suggested release formula was:

At least one Board member challenged the staff's proposed 'drivers', noting that, in his opinion, the drivers did not capture what the Board should be measuring: the currency amount of premiums and the currency amount of claims had little to do with the risk and uncertainty inherent in insurance contracts.

Other Board members saw the proposed release formula as a sort of 'percentage of completion' formula for the contracts, which they considered to be a useful way of releasing the composite margin.

Ultimately, the staff proposal was accepted by the FASB (3 in favour) and the IASB (13 in favour). The Boards seemed to choose not to reconsider the issue about the recognition of changes in estimates in a composite margin approach.

Level of measurement (unit of account)

The Boards discussed the level of aggregation that an insurer should adopt for measurement purposes.

Ultimately, the Boards agreed that if measurement includes a separate risk adjustment, that adjustment should be determined for a portfolio of insurance contracts. The risk adjustment should not reflect the effects of diversification between portfolios or negative correlation between portfolios (FASB: 5 in favour; IASB 14 in favour).

In addition, the Boards agreed unanimously that the ED should carry forward the definition of a 'portfolio of insurance contracts' in IFRS 4: 'contracts that are subject to broadly similar risks and are managed together as a single portfolio'.

Disclosure

The Boards discussed the proposed disclosure requirements for the forthcoming exposure draft. In particular they discussed a revised disclosure principle:

To help users of financial statements understand the amount, timing and uncertainty of future cash flows arising from insurance contracts, an entity shall disclose qualitative and quantitative information about:

• the amounts recognised in its financial statements arising from insurance contracts; and
• the nature and extent of risks arising from those contacts

A Board member noted that the disclosure principle should also include the 'nature' of cash flows, because an insurance contract involves a number of cash flows.

Another Board member challenged the staff to demonstrate how the disclosures proposed were responsive to users' needs and suggested requirements.

Some Board members challenged the practicability of the requirements as written, noting that for some large multi-national insurers, the staff proposals would result in a 'phone book' of disclosures. No vote was taken on these proposals.

Unbundling

The Board discussed whether investment/ financial and service components contained in a contract together with insurance should be recognised and measured separately as if they were separate contracts. In particular, the Boards discussed the proposed unbundling principle:

A component of an insurance contract should be unbundled if it functions independently from other components of that contract. A component functions independently if it is not significantly interdependent with other components of that contract.

The Boards continued to be unhappy about whether the distinction between 'independent' and 'interdependent' could be made operational. Several Board members were deeply troubled about the implications for embedded derivatives and the potential for accounting arbitrage between insurance contracts and financial instruments. Ultimately, the Boards could not conclude on this issue and decided to discuss other aspects of unbundling hopeful that those discussions would assist them to articulate the unbundling principle in a coherent manner.

The Boards discussed how it might require unbundling of an investment component, especially in a long-duration insurance contract. The Boards agreed that contracts with an explicit policyholder account balance ('account-driven contracts') should be unbundled. In addition, contracts such as participating and nonguaranteed-premium contracts that have characteristics significant to account-driven contracts should be included with account-driven contracts.

The Boards agreed that the staff should build on existing US guidance (ASC Topic 944-20-15-29) to address account-driven contracts. The Boards agreed that the investment component of insurance contracts that have no characteristics significant to account-driven contracts would usually not be separated. Such contracts have no explicit account balance, nor do they share the fundamental characteristics of account-driven contracts. However, if such contracts were to include two or more components for reasons other than economic, those components would be unbundled because they function independently.

The treatment of embedded derivatives was less conclusive. The IASB voted narrowly in favour (9 in favour; 5 opposed) that embedded derivatives should be unbundled using the existing IFRS bifurcation requirements. On the other hand, the FASB were unanimous that any component, including embedded derivatives, should be unbundled if that component is not significantly interdependent with other components of the insurance contract.

The staff will take this bundle of decisions and work with the Board off-line to try to get to a common position, including trying to identify an 'unbundling principle.' That position would be deliberated in public in the ordinary manner. It was noted that the FASB's Derivatives Implementation Group had addressed a number of issues that focussed on general insurance contracts, but not long-term contracts.

Scope: Financial guarantees

The Board discussed whether financial guarantee contracts should be included in the scope of insurance contracts or in the scope of the financial instruments project. In particular, they discussed financial guarantee insurance contracts (for non-payment of interest and principal on debt instruments); mortgage guarantee insurance contracts; and credit insurance contracts (for trade receivables).

At least one Board member was concerned that many of the contracts under discussion would be derivatives but, because they met the definition of an insurance contract, would be accounted for at other than fair value. The staff tried to reassure the Board that this would not be the case, since the treatment was not dependent on holding the underlying.

The Boards ultimately agreed (FASB: 4 in favour; IASB: 13 in favour) that contracts that meet the definition of insurance should be accounted for as insurance contracts. The Boards agreed that the intent of the project was that like or similar transactions should be accounted for similarly. That objective leaves little alternative other than to account for financial guarantees that indemnify the holder as insurance contracts.

Scope: Fixed-fee service contracts

After a short discussion, the Boards did not agree that fixed-fee service contracts that meet the definition of an insurance contract should be within the scope of the IFRS/ ASC on insurance (FASB: 5 opposed; IASB: 4 in favour). Consequently, such contracts will be excluded from the Standard. This is consistent with the treatment of such contracts historically.

Discussion at the Special 1 June 2010 IASB Meeting

Business combinations and portfolio transfers

The Boards debated the appropriate accounting treatment of a portfolio transfer, that is, insurance contracts assumed in a transaction other than a business combination. After considerable debate, the Boards agreed that the insurer should compare the amount that results from the determination of the expected present value of the cash flows [plus the risk adjustment, in the model that uses such an adjustment] with the consideration received for those contracts and:

1. if the consideration received exceeds the expected cash flows, the insurer should treat the difference as the [residual margin] [composite margin] (depending on the model eventually agreed by the Boards) at that date;
2. if the expected cash flows exceed the consideration received, the insurer should recognise that difference in profit or loss at that date.

The Boards noted that before the amount in (b) is recognised, the entity assuming the insurance contract portfolio should also assess whether it has acquired any other assets, including any separately identifiable intangible assets (for example, a customer base). If it has, those assets should be recognised.

With respect to contracts acquired in a business combination, the Boards agreed that the insurer should compare the expected present value of the cash flows [plus the risk adjustment, in the model that uses such an adjustment] with the fair value of those contracts and:

1. if the fair value of the contracts exceeds the expected present value of the cash flows [plus the risk adjustment, in the model that uses such an adjustment], the insurer should treat the difference as the [residual margin] [composite margin] at that date;
2. if the expected present value of the cash flows [plus the risk adjustment, in the model that uses such an adjustment] exceeds the fair value of the contracts assumed, the insurer should initially measure the contracts assumed at the expected present value of the cash flows [plus the risk adjustment, in the model that uses such an adjustment], rather than their fair value. This exception from the general requirement in IFRS 3 Business Combinations and ASC Topic 805 Business Combinations would increase the initial carrying amount of goodwill recognised in the business combination.

Board members from both Boards noted that this conclusion demonstrated that they had both agreed to use the wrong measurement attribute – fair value would be better – but at least they were consistently wrong.

Transition

Application of transitional models to insurance accounting and measurement related issues

This meeting did not address effective date or whether early adoption should be permitted. Those issues would be decided later together with decisions on IFRS 9 and other standards planned to be completed by 30 June 2011. There was a considerable and heated debate over whether to adopt a prospective or a retrospective model for transition because of the allocation of the residual/composite margin. In the building blocks model residual/composite margin is calibrated at the contract's inception and is not subsequently re-measured. This presents a problem in determining this margin on transition.

The staff proposal was to measure insurance contracts on transition as the expected probability weighted present value of the cash flows [plus the risk adjustment in the model that uses such adjustment] plus [residua]/[composite margin].

The [residua]/[composite margin] is determined as the positive difference between the carrying amount of insurance contracts under previous accounting policies and the expected present value of the cash flows [plus risk adjustment is applicable]. The negative differences, when carrying amount under previous is less than the building blocks measure, are first offset with positive differences on other insurance portfolios on pro-rata basis, and the net negative difference at the entity-wide level, would be taken to retained earnings.

Both Boards have rejected using a different unit of account on transition (entity level). They preferred a portfolio based approach and agreed on a retrospective transition model.

The FASB and some IASB members strongly oppose treating all debits as reducing retained earnings but all credits as margins affecting future profits. The concern on FASB's side was that the residual/composite margin is calibrated to old accounting policy measures and will affect future profit, undermining performance consistency of insurance contracts over time and across entities and jurisdictions. Some members wanted to calibrate composite margin to what the insurer would charge for a similar contract at transition date. Others noted that updating the measure in such a way is both difficult and not representative of the true composite margin relating to future cash flows. Some wanted just to determine composite margin as the difference between future expected remaining cash inflows and outflows at transition date. However this calculation would often result in no margin, because after inception of the contract, remaining cash outflows typically exceed cash inflows.

All Board members agreed that some margin had to be recognised on transition to represent the uncertainty of the present value of expected cash flows.

To overcome this problem an IASB member put forward a proposal to measure insurance contracts on transition, as follows:

1. On transition the entity determines the expected probability weighted present value of the cash flows (at portfolio level)
2. It then determines a risk adjustment regardless of the margin model adopted by the Boards. If a composite margin model is chosen, this risk adjustment becomes the new composite margin. In the residual margin model, this would be the residual margin.
3. The expected present value of cash flows plus the risk adjustment is compared to the entity's carrying amount under the previous accounting policies, and any difference, positive or negative, is taken to retained earnings.

IASB approved this proposal by 9 votes. FASB vote was 2 out of 5 members agreed and one member said he could agree with this proposal.

Treatment on transition date of intangibles arising from a business combination

The Boards unanimously agreed, in determining the amount of insurance contracts on transition, to treat intangibles arising from business combinations and relating solely to the existing insurance contracts as part of the carrying amount under the previous accounting policies. This has the impact of writing-off these intangibles to retained earnings. These intangibles arise from application of IFRS 4.31 and are often referred to as present value of in-force business or present value of future profits, or value of business acquired, and do not include intangibles relating to future contracts, such as customer relationships.

Treatment on transition date of deferred acquisition costs

In the insurance accounting model deferred acquisition costs (DAC) are expensed as incurred. The Boards unanimously approved to include any DAC the entity may have recognised previously as part of the carrying amount of insurance liability under the previous accounting policy. This has the impact of writing off these deferred costs to retained earnings.

Transition disclosure

The Boards agreed to provide an exemption similar to the exemption in paragraph 44 of IFRS 4. This would exempt an insurer from disclosing previously unpublished information about claims development that occurred earlier than five years before the end of the first financial year in which it applies the proposed standard. All other disclosure requirements of IAS 8 and IFRS 4 would apply. The FASB asked the staff to clarify that as this is a mandatory change in accounting policy, it should not follow the disclosure requirements of Subtopic 250-10-50 intended for voluntary changes.

The Boards also agreed to require a separate disclosure on transition and subsequently of the run-off of the margin determined on transition.

Application of IFRS 9 and reclassification of financial assets

The Boards agreed that an entity issuing insurance contracts should be permitted, but not required, when it adopts the future insurance contracts standard, to redesignate a financial asset as measured at fair value through profit or loss at the start of the earliest period presented, if doing so would eliminate or significantly reduce a measurement or recognition inconsistency (sometimes referred to as an 'accounting mismatch') that would otherwise arise from measuring assets or liabilities or recognising the gains and losses on them on different bases. The entity should recognise the cumulative effect of that redesignation as an adjustment to opening retained earnings of the earliest period presented and remove any related balances from accumulated other comprehensive income.

In addition, the IASB agreed that the proposed transition would apply equally to insurers already applying IFRSs or US GAAP, and to insurers adopting IFRSs for the first time.

Discussion at the Special 10 June 2010 Joint IASB-FASB Meeting

Participating investment contracts

The Boards discussed whether investment contracts with a discretionary participation feature should be within the scope of a standard on:

• insurance contracts, and so should be measured in the same way as participating insurance contracts, or
• financial instruments, and so should be measured at amortised cost or fair value through profit or loss.

The staff recommended a split approach – that the IASB and FASB agree different positions:

• that the IASB treat investment contracts with discretionary participation features as insurance contracts; and
• that the FASB should treat these items as financial instruments within the scope of their proposed financial instruments standard, currently on exposure for public comment.

The FASB confirmed that such contracts would be within the scope of their proposed financial instruments standard.

IASB members were divided on this issue. Those opposing the staff recommendation were concerned about scoping into a proposed IFRS on insurance contracts things that were explicitly not insurance contracts. This was to create 'industry' standards, something contrary to the IASB's philosophy. In addition, some were concerned about structuring possibilities, for example, that some transactions could avoid financial instrument accounting altogether. Those who supported the staff recommendation acknowledged the opponents' view but were prepared to accept it on mainly pragmatic grounds. Some would support the proposal only in situations in which the investment contracts participated in a pool for which a significant majority of the participating contracts were insurance contracts.

The IASB was evenly split (6/6 of the Board members at the meeting). As a result, the Chairman stated that the IASB ED would expose the staff recommendation (that is, including investment contracts with a discretionary participation feature within the scope of the proposed insurance IFRS), and discuss the treatment of such contracts as financial instruments subject to normal IFRS financial instruments accounting in the basis for conclusions, with a specific question in the Invitation to Comment.

Contract boundary

On a related issue, the IASB agreed that the contract boundary for 'investment contracts with a discretionary participation feature' be defined as the point at which the contract holder no longer has a contractual right to receive benefits arising from a discretionary participation feature.

Risk adjustment techniques

The Boards discussed which techniques should be available for measuring a risk adjustment and, in particular, whether a cost of capital technique would meet the proposed objective for the risk adjustment. This discussion followed on from one on 18 May 2010, when they decided that if the measurement model for insurance contracts were to include a separate risk adjustment, the range of available techniques for measuring that risk adjustment should be limited in some way.

The staff proposed that the techniques be limited to the following, with the technique used being driven by the expected distribution of expected losses:

• a confidence level technique (or value at risk);
• a conditional tail expectation technique (or tail value at risk); or
• a cost of capital technique.

The staff recommendation was not well received. In particular, the cost of capital approach was criticised because it did not meet the Boards' measurement objective, in that it measured what an investor would require to assume a book of business, whereas the Boards are seeking to measure the insurance liability.

Some Board members thought that the only measurement technique that met the Boards' measurement objective was the conditional tail expectation/tail value at risk technique: in particular it addressed the particular challenge of measuring risks with low frequency and high severity, which would have risk adjustments higher than those risks with high frequency and low severity.

A FASB member did not think that the Boards had enough information or analysis about risk valuation methodologies to make an informed decision. In addition, the Board member was concerned that the staff was seeking to accommodate certain regulatory accounting practices within the envelope of investor-focused financial reporting. This was not necessarily the Boards' responsibility.

The Boards could not conclude on this issue. The staff will return during the IASB meeting 15-17 June with another attempt to achieve consensus.

Discussion at the June 2010 Joint IASB-FASB Meeting

Draft application guidance on future cash flows

The Boards have discussed the application guidance proposed by the staff about what expected future cash flows should be included in the measurement of insurance contract. The aim of the discussion was to seek feedback for staff to take away and update the drafting.

The proposed principle is to include future cash flows from the fulfilment of an insurance contract. The cash flows should reflect the insurer's estimate of its cost to fulfil, so except for market variables the inputs are entity specific, and the emphasis is on the cash flows of existing contracts rather than from potential new contracts. The guidance specifies that insurer should include among the costs necessary to fulfil the contract all of the costs directly associated with it (direct costs) and a systematic allocation of costs that relate to the contract or contract activities (indirect costs). An appendix to the guidance provides examples of direct and incremental costs that are to be included and those costs to be excluded as not relevant to the fulfilment of obligation notion.

The guidance discusses a replicating portfolio for all or part of the insurance liability cash flows. While not mandating a replicating portfolio method, the staff paper suggests if such portfolio exists to calibrate the estimates calculated by insurer using another method to it.

Further the guidance explains that in estimating cash flows at the reporting date the measure should be current reflecting the probabilities and expectations as at that date and should not use the benefit of hindsight, nor should it include possible cash flows under possible future contracts.

The staff later clarified that cash flows can be estimated at their nominal or real value (i.e. adjusted for future inflation) as long as the assumptions are used consistently.

Overall many members felt the guidance was drafted well, however, there were few comments and clarifications proposed. The focus of the comments from FASB members was that some of the proposed costs to be included in the cash flows did not tie in well with the fulfilment notion. For example, the costs of insurer in paying on-going commissions to intermediaries for policies remaining in force would not be a cost of fulfilling an obligation to a policyholder. Equally policy administration and maintenance costs proposed to be included are not costs of fulfilling an obligation. This discussion highlighted the difference in the way IASB and FASB viewed the fulfilment notion. The IASB approach was more focused on whether the costs were direct and incremental to the contract rather than on whether they were directly linked to meeting the obligation to a policyholder.

On the application of a replicating portfolio the Board members asked the staff to clarify whether it needs to be calculated in all cases to enable the calibration to it, even if a different method is used by insurer.

Further, the Board members suggested clarification of the guidance on the impact of future events on the estimates of cash flows, to make the distinction clearer between the types of future events that need to be considered because they impact cash flows of the existing contracts and those future events that need to be ignored because they do not impact existing contracts.

Finally, the staff were asked to tighten the wording of the overall principle to link it more closely to the more detailed guidance that follows it.

Foreign currency cash flows

After a high level theoretical debate whether components of insurance liability meet the definition of a monetary item, the Boards have unanimously approved the staff proposal to treat insurance contracts in their entirety, including all the components, as monetary items. This would mean that insurance contracts with expected foreign currency cash flows would be subject to the foreign currency retranslation rules. The Boards further agreed with the staff that pre-claims liabilities of short-duration contracts measured an unearned premium approach would also be considered monetary items. This is because the unearned premium approach is viewed as a shortcut measurement method to the full building blocks looking at the underlying cash flows approach and therefore there should not be a difference in the foreign currency treatment. This would differ from the current treatment of such contracts. Currently they are viewed as prepayments of future services and therefore non-monetary.

Recoverability of the acquisition costs

The Boards held a long and ultimately inconclusive discussion on acquisition costs. In many insurance contracts, the commission is obtained from the premium, almost as a premium add-on. The question then becomes, if they're going to be recovered (for example, from a broker, in the event of a policy lapsing), why are such costs expensed; should they not be an asset? FASB members noted that there is no actual guarantee of recoverability (dependant on lapse), so the contingent right to recover costs does not meet the criteria of an asset, which is why the FASB wishes to expense all acquisition costs.

Some IASB members noted that there appeared to be a disconnect between the way acquisition costs were treated depending on whether they were received from policyholders via gross premiums and then paid to brokers, or whether the premium was paid net via the broker. These members argued that there was no inherent difference in the economics of the situation, only in the presentation, so there was no reason to treat them differently. The reason for different presentation arises largely from the broker not having an account with the insurer (hence an asset raised), where a policyholder would have an account (likely an investment policy of some sort, as this is primarily an issue in life insurance where acquisition costs are significant) where the payout would be reduced by some sort of lapse-penalty, hence a reduction in the underlying liability.

The boards discussed the possibility of expensing acquisition costs as incurred unless recoverable, possibly limited only to broker recoveries (as lapse-penalties are likely to be included within the contract cash flows, hence within the liability if it relates to a policyholder). This did not receive significant support, as Board members argued that there still isn't any contractual right to receive cash, so no asset (dependent on some future event – the lapse – so a contingent asset at best).

The next question related to whether (assuming recoverability), the acquisition costs should be recognised in profit or loss as an expense. If not, what was the appropriate accounting? The initial proposal that P&L treatment was not appropriate and that broker recoveries should be recognised as prepayments and insured recoveries included with the liability were not well received. Board members argued that this is just another way of deferring and amortising the expense – just like DAC – which the Boards had already agreed not to do.

The boards then argued that, as acquisition costs are defined as incremental, the insurer is effectively using revenue (through the release to P&L) to create an asset that will generate future revenue streams – which seems counterintuitive.

The boards then tried to work through an example, but there were disagreements about the parameters for the example. The Chairman decided to terminate today's discussion – to be continued Wednesday. Application guidance for risk adjustment techniques

The Boards discussed the draft application guidance for measuring risk adjustment, to be included in the forthcoming exposure draft on insurance contracts. In their 18 May 2010 joint meeting, the Boards decided that, if the measurement model for insurance contracts were to include a separate risk adjustment, the range of available techniques for measuring that risk adjustment should be limited.

The Board reconsidered the articulation of the objective and characteristics of the risk adjustment. After a significant discussion the Board agreed to modify the objective of the risk adjustment to 'the maximum amount the insurer would rationally pay to be relieved of the risk that the ultimate fulfilment cash flows may exceed those expected'.

The Boards considered whether the risk margin might be negative. The staff noted that it might be theoretically possible to have a negative margin, but such occurrences should be rare.

Some Board members expressed their preference for an exit price notion for measurement of insurance contracts. Some of these Board members noted that the new objective came close to the exit price notion without calling it that name. Other Board members disagreed and noted that the difference to the exit price (fair value) would remain in the absence of service margin and own credit risk. The majority of the Boards rejected the exit price notion as in their opinion there is not enough transactions on the marketplace to calibrate the exit price. As such entity-specific perspective inputs into measurement cannot be avoided.

The FASB chairman expressed his view that the high level guidance on the risk adjustment techniques supplemented with disclosures should be the middle ground between the various alternatives.

The majority of Board members agreed to emphasise the one-sided nature of the risk (exceed the expected cash flows rather than differ from the expected cash flows). For those members, the risk margin is compensation for the uncertainty and reflects risk aversion (as a pricing mechanism) of the reporting entity. Some Board members also noted that the risk aversion is a broader concept than one-sided risk.

Finally, the Boards considered whether to include more discipline in the objective of the risk adjustment. Nonetheless, most of the Board members were concerned that any tightening would lead to additional complexity and introduction of new concepts that would lead to additional rules. As such the Boards confirmed the objective of risk adjustment as 'the maximum amount the insurer would rationally pay to be relieved of the risk that the ultimate fulfilment cash flows may exceed those expected'.

The Boards also continued their discussion (from their June 10 meeting) on which methods should be permitted to measure risk adjustment. After a discussion, in which several Board members expressed their concerns about application of the confidence level method and its limitations (applicable only to normal distributions whereas distribution of losses for insurance contracts is usually skewed, ignoring the tail risk) as well as limitations of the other methods (for instance, the assumption of the $ for $ liability compensation for relieving from potential risk under the conditional tail expectation approach) the Boards agreed to provide description of three methods as part of the proposed application guidance: confidence level, conditional tail expectation and cost of capital.

Although some Board members suggested limitation of use of any of the methods, the Boards decided not to prescribe any method as they believed that each technique covers a specific part of risk distribution and its use depends on particular circumstances.

One Board member noted that these methods should include both quantity and price of the risk and noted that the methods as proposed encompass only the quantity element. Nonetheless, the Boards did not agree to prescribe any method that includes price of risk due to its complexity and the fact that it would lead to exit price measurement.

As such the Boards approved the proposed draft application guidance on risk adjustments, containing characteristics of techniques that can be used as well as description of three techniques that might be used – confidence level, conditional tail expectation and cost of capital and their comparison. The Boards agreed not to include any additional methods in the draft application guidance.

Reinsurance

The Boards considered several follow-up issues related to reinsurance that were raised at the 10 February meeting.

The Boards also agreed that at inception of the reinsurance contracts the reporting entity should re-measure the underlying reinsurance asset, as the risk profile might have changed from the last reporting date. The Boards agreed that a cedant shall not recognise any negative residual or composite margins when measuring a reinsurance asset, but instead if the consideration paid by the cedant for the reinsurance contract is less than the measurement of the reinsurance asset the cedant shall recognise that difference as a gain in profit or loss at inception of the reinsurance contract.

The IASB agreed that a cedant should recognise any ceding commissions arising from reinsurance contracts as reduction in the premium paid to the reinsurer.

The FASB agreed that these commissions should be recognised as a gain in profit or loss, to the extent that these ceding commissions refer to the reinsurer's share of the cedant's incremental acquisition costs. The cedant shall recognise that gain at the earlier of the day on which it recognised the reinsurance contract and the day on which it incurred the incremental acquisition costs. The cedant shall treat the remaining share of ceding commissions as a reduction of the premium ceded to the reinsurer.

Even though the FASB members agreed with the proposal on ceding commissions they noted that that tentative decision might change as a result of reconsidering the treatment of acquisition costs.

One IASB member asked about the presentation of these commissions. The staff clarified that according to the expanded margin presentation model (that was tentatively agreed) these commissions would be presented as revenue in the same amount as the acquisition costs incurred. Several IASB members expressed their concerns about such accounting outcome. As a result the Boards will re-address the issue at a later stage.

Overview of the insurance model

The staff presented a paper summarising the package of tentative decisions made in the Insurance project. As the FASB indicated that it will be reconsidering the treatment of the acquisition costs what could have a significant impact on further parts of the project, the Boards decided not to continue their debate. The Boards observed that the objective of the insurance contracts seem to evolve over time from the fulfilment value approach to the contract activity approach that include all the direct and incremental cash flows. Both Boards seem to agree with such characterisation. As such the Boards observed they might want to revisit some decisions to see whether they are consistent with the changed objective.

The Board also observed that they will need to revisit several aspects of the proposed model - treatment of acquisition costs, unbundling, contracts with participating features and presentation of the performance statement (mainly the expanded margin approach).

IASB/FASB Differences in tentative decisions – reconciliation

The Boards turned to discuss a summary of issues for which the two Boards had come to different conclusions, with the view that they attempt to come to a common view, so as to limit the number of divergent positions in the forthcoming ED to as few as possible.

Acquisition costs

The IASB proved that it remains split among itself, and even with the staff characterisation of their previous decisions, in particular whether it would be more appropriate to describe the 'expense as incurred' approach as 'contract cash flows'.

Other Board members disagreed. The staff tried their best to clarify what the agenda paper was attempting to achieve, but with only limited success.

After a vigorous debate, the IASB voted 8-7 in favour of retaining the approach that expenses acquisition costs at inception, but recognises a revenue offset to the extent of the incremental acquisition costs.

The FASB confirmed their position, that acquisition costs are excluded from the initial margin.

Margin: risk adjustment

The IASB confirmed their preference to include a risk adjustment plus a residual margin in the initial measurement of the insurance contract (9 in favour). The FASB confirmed that they still favoured using a composite margin, which they see as more relevant for the fulfilment approach adopted.

Margin: should interest be accreted on the residual/composite margin?

Another interesting debate occurred. However, after it became evident that two senior IASB staff members disagreed on this issue, the IASB agreed not to conclude on this matter and the staff will return with a coordinated recommendation. The FASB confirmed that they preferred not to accrete interest on the composite margin (3 in favour).

Participating contracts

The IASB confirmed (2 opposed) that they would include participating payments in the same way as any other contractual cash flow within the expected present value. The FASB confirmed that they would include participating payments to the extent that the insurer has an obligation to pay.

Definition: when does insurance risk exist?

The IASB agreed (10 in favour) to conform to the FASB's tentative decision (and thus amending the current IFRS 4 definition with a new test): insurance risk would exist if there is at least one scenario in which the present value of net cash flows could exceed the present value of premiums.

Embedded derivatives

The IASB agreed (14 in favour) to conform to the FASB's tentative decision that the unbundling principle in the Insurance Contracts standard should be followed for derivatives embedded in an insurance contract - i.e., that such items should be unbundled unless the components are so interdependent that they cannot be measured separately. The staff believed that this would lead to the same outcome as using the principle expressed in IAS 30 AG33(h).

Derecognition

The IASB and FASB conformed their decisions (no votes): the derecognition principle in IAS 39 should be used-i.e., derecognise a liability when extinguished (i.e., when the obligation is discharged, cancelled or expires)-but with an explanatory comment that when an insurance contract is extinguished, the insurer is no longer at risk and no longer required to transfer any economic resources for that obligation.

Portfolio transfers

The FASB agreed (3 in favour) to align to the IASB's tentative decision, that a loss should be recognised on a portfolio transfer if the present values of the cash flows (including any risk adjustment) exceeds the consideration received.

Indication of intention to dissent

The IASB chairman asked whether any of the IASB intended to present an Alternative View in the exposure draft. Mrs McConnell and Messrs Engstrom, Leisenring and Smith indicated that they would do so (Mr Leisenring's dissent would have effect only if the ED is balloted before 30 June 2010, which seems unlikely).

Mr Herz noted that the FASB still had several issues to resolve before they were in a position to know what form their due process document would take. They would be discussing these issues in the week of 20 June 2010.

All other insurance issues scheduled for this meeting were cancelled.

Alternative views in the Exposure Draft

The IASB members who had indicated an intention to present an Alternative View in the forthcoming Insurance Contracts Exposure Draft outlined the likely reasons for their dissents.

John T Smith

Mr Smith would dissent for many of the reasons he dissented to the issue of IFRS 4 Insurance Contracts. In addition, he objects to the treatment of the risk adjustment, the treatment of renewal options, and the accounting for investment contracts with a discretionary participation feature issued by an insurance company. He summarised his reasons by saying that he does not think the package of decisions in the ED advanced financial reporting. He thought that IFRS users knew that IFRS 4 was imperfect; he did not want to convey the message that the ED was a better answer.

Jan Engstrom

Mr Engstrom noted that he was still assessing whether he would dissent.

He is concerned that the scope was too broad. He agreed that health, life and catastrophe (high severity, low risk) contracts should have 'insurance accounting'. However, he saw many general insurance contracts (fire, auto, etc) as being no different in substance to service contracts and to force them into the proposed insurance accounting model would not help the insurance companies or their investors.

He disagrees with the treatment of acquisition costs. He noted that other types of business incur substantial costs when securing a contract (he used a defence supply contract as an example). Payments to agents and other experts were expensed in the period incurred; he did not see these 'contract acquisition costs' as any different in substance to insurance contract acquisition costs and asked why they should get different accounting.

Finally, he is not convinced that he understands (and therefore can accept) the overall model to be proposed in the ED.

Patricia McConnell

Mrs McConnell had not yet confirmed her intention to dissent.

However, she was particularly concerned about the treatment of acquisition costs and issues of display and disclosure.

James Leisenring

Mr Leisenring noted that his dissent was moot, since the ED would not be balloted until after his term as a Board member expired. However, he would have dissented for a number of reasons.

Fundamentally, he believes that the approach to insurance accounting to be proposed in the ED is inconsistent with the IASB Framework in that it recognises things as assets and liabilities that demonstratively do not meet the definitions of assets and liabilities in the Framework.

He does not believe that the scope is operational, especially with respect to health care and investment contracts. He does not see the logic for not recording the cash surrender value of an insurance policy as a liability when it is, in substance, the same as the demand deposit floor, which is recorded as a liability.

He would also object to a number of the display issues highlighted by other Board members.

Discussion at the July 2010 Joint IASB-FASB Meeting

The IASB Chairman extended to FASB and FASB staff publicly the sympathy of all at the IASB on the death of Jeff Cropsey, who died suddenly in early July. He had been, Sir David noted, an extremely important part of the insurance contracts team and his contributions would be missed.

Unbundling insurance contracts

The Board discussed the results of the staff's additional research in developing the concepts behind a principle for when to separate ('unbundle') components of insurance contracts and discussed the proposed approach to unbundling to be included in the forthcoming exposure draft on insurance contracts.

The staff had explored both a 'significant interdependence' approach and a 'variability in the overall cash flows' approach, but had concluded that neither on its own was sufficient. Consequently, they proposed an approach that would limit unbundling to the particular components that the boards identified as the most relevant and prominent unbundling cases, namely policyholder account balances and embedded derivatives that are separated under existing bifurcation guidance.

The Boards had a thorough debate. Some supported the proposal; others wanted to identify either significant interdependence or variability in cash flows as the principle and then list what would reasonably be expected to be unbundled; at least one IASB member proposed an entirely different approach. A FASB member was concerned that the two principles identified by the staff worked with different components of the items that would be unbundled, but neither worked with all of them. He was concerned that the Boards were micro-managing the issue.

The FASB seemed more inclined to support the variability in cash flows principle, but a strong majority of the IASB favoured significant interdependence—a concept already in IFRS 4.

The Boards moved on to discuss the components that would be unbundled. A FASB member was concerned that a proposed requirement to use the market rate in certain circumstances would be unnecessarily onerous and would result, at least in the US environment, in a 'search and destroy mission' by entities seeking to ensure that all possible information had been taken into account when determining the rate. The Boards agreed that this was not the intent and that the crediting rate for the account balance should be determined by the investment performance of the underlying investments (similar to pension accounting).

After these clarifications, the Boards confirmed that the unbundling principle should be:

A component of an insurance contract should be unbundled if it functions independently from other components of that contract. A component functions independently if it is not significantly interdependent with other components of that contract.

An insurer shall unbundle the following components of a contract that are not closely related to the insurance coverage specified in that contract:

• (a) policyholder account balances that bear a crediting rate determined by the investment performance of the underlying investments (supplemented with additional guidance);
• (b) embedded derivatives that are separated under existing bifurcation guidance; and
• (c) goods and services provided under the contract that are not closely related to the insurance coverage, supplemented with the clarification that the intention is not to create or require an exhaustive search for goods and services that are not closely related but to deal with situations where goods and services have been combined with the insurance coverage for reasons other than economic.

Unit-linked issues (follow-up)

The Boards discussed two follow-up issues for unit-linked contracts: the accounting mismatches that arise from the measurement of the assets backing unit-linked contracts; and the presentation of assets, expenses and income arising from those contracts.

Accounting mismatches

The Board noted that several issues arise in asset measurement for portfolios associated with unit-linked contracts, in particular when funds are consolidated or when the fund is an internally managed virtual fund. Three items were identified as posing problems: issuer's own shares held in the fund (in those jurisdictions in which this is permitted); real estate and investments in associates.

The staff proposed that these items should be added to the list of items that qualify for the application of the fair value option, in the interest of eliminating accounting mismatches. In addition, it would be necessary to specify that holdings of the insurer's own shares would qualify for recognition as an asset only in the circumstance in which the shares back unit-linked contracts (e.g., because they are in an index tracker fund or similar).

The Board had another vigorous discussion. One IASB member warned that the proposals were set the Board on a 'slippery slope', in particular with respect to own shares. Staff responded that the accommodation was being made only when there was a contractual link between the unit-linked insurance contract and the underlying fund.

In the end, the IASB voted (10 in favour) for the staff proposal, clarified to stress the contractual link between the unit-linked insurance contract and the underlying fund. The FASB was content with the modified proposal.

Presentation issues

With little discussion, both Boards agreed that an insurer should present the pool of assets underlying unit-linked contracts as a single line item and not commingle them with the insurer's other assets.

In addition, the Boards agreed that that an insurer shall present income and expense from the pool of assets underlying unit-linked contracts as a single line item, presented on the face of the statement of comprehensive income or disclosed in the notes, and not commingle them with income or expense from the insurer's other assets.

Simplified measurement (short-duration contracts)

The Boards have decided tentatively to require the premium allocation model for pre-claims liabilities of short-duration insurance contracts. This requirement puts some pressure on the line between short-duration contracts and other insurance contracts. This session was devoted to identifying the characteristics of a short-duration contract.

One related question facing the Boards was whether an insurance entity underwriting both short-duration and long-duration insurance contracts should use the same accounting model for all contracts; or whether all short-duration contracts should be accounted for using the premium allocation model and all other insurance contracts should use the building block approach. The staff's preference is the former approach.

The Boards ultimately agreed that the required application of the premium allocation model should be restricted to the pre-claims liability of short-duration contracts, which incorporate all the following features:

• (a) the coverage period is approximately 12 months or less;
• (b) the insurer is unlikely to become aware of events during the coverage period that could cause significant decreases in the expected cash out flows[*]; and
• (c) do not contain significant embedded options or guarantees

Treatment of acquisition costs

The Boards discussed the treatment of acquisition costs. The Boards were confused because it seemed that one option was to expense as incurred and the other was to defer and amortise over the contract period (i.e., 12 months). Board members thought that these two were essentially the same. No firm decision was made (or if there was one, it was not obvious).

Discount rate: locked-in or updated?

Some IASB members would prefer to stay silent on the issue of the discount rate, mostly on the grounds that for short-duration contracts the effects of discounting will not be material. However, the IASB did agree to use a current rate for the accretion of interest to an unallocated premium liability (subject to the usual materiality constraint).

The FASB will vote on this issue later in July.

Residual margin for Investment Contracts with a discretionary participation feature [IASB-only issue]

With almost no discussion, the IASB agreed that the residual margin of a discretionary participating feature should be recognised in profit or loss over the life of the contract in a systematic way that best reflects the asset management services, as follows:

• (a) on the basis of passage of time, but
• (b) if the insurer expects to provide asset management services in a pattern that differs significantly from passage of time, it shall release the residual margin on the basis of assets under management.

Confirmation of Alternative Views and Abstentions

Mr Smith confirmed his intention to present an Alternative View in the exposure draft, for the reasons given in June (see IASPlus.com notes for that meeting). Mr Engstrom also confirmed that he is considering presenting an Alternative View, for reasons expressed in June.

Dr Paul Pacter will abstain, given that he has not participated in the development of the exposure draft other than this meeting.

Dr Elke Koenig said that she would vote in favour of the exposure draft, having followed the project closely and benefitting from being an observer at the IASB table since her appointment earlier in 2010.

Scope

The Boards briefly discussed the scope of the Insurance Contracts Exposure draft. The FASB raised the issue of the employer providing health insurance to its employees on an ongoing basis being potentially within the scope of the new Insurance Contracts guidance. The IASB staff responded that such employer provided health insurance would meet the criteria of employment benefits under IFRS, thus being scoped out from IFRS 4 Insurance Contracts as well as from the forthcoming Exposure draft.

July 2010 Exposure Draft

On 30 July 2010, the IASB published for public comment an exposure draft of a proposed IFRS for insurance contracts. Exposure Draft ED/2010/8 Insurance Contracts proposes a single IFRS that all insurers, in all jurisdictions, could apply to all contract types on a consistent basis. The proposed IFRS would apply to writers of both insurance and reinsurance contracts.

A summary of the key proposals follows:

ED/2010/8 is open for comment until 30 November 2010. Click for:

• IASB press release (PDF 36k)
• Access to the exposure draft (link to IASB website)

Deloitte press release on IASB Insurance Contracts proposals

Deloitte has issued a press release commenting on the issue of ED/2010/8 Insurance Contracts. The ED proposes fundamental changes to the financial reporting of insurance companies applying IFRS, with a goal of making it more consistent and transparent than it has been so far.

Excerpts from the press release:

"Given the increased adoption of IFRS worldwide, it is no exaggeration to suggest that this proposed accounting standard would have a global impact and could fundamentally change the way insurance companies measure, report, and evaluate performance of their insurance contracts," said Joel Osnoss, Global IFRS Leader, Clients & Markets, Deloitte Touche Tohmatsu. Francesco Nagari, Global IFRS Insurance Leader at Deloitte United Kingdom, commented: "The publication of the Exposure Draft is a landmark stage in the IASB's 13-year project to develop a consistent standard for insurance accounting and will have a significant impact on insurers across the world. Under the proposed IFRS, all insurance contracts, both life and non-life, will be measured using the same building blocks based on discounted probability-weighted best estimate cash flows."

Click for full Press release Deloitte on the publication of the IASB Exposure Draft of the new International Reporting Standard for Insurance Contracts.

Deloitte's IFRS Global Office has published an IFRS in Focus Newsletter – Insurance Contracts (PDF 105k) explaining the proposals in the Exposure Draft.
 

Discussion at the December 2010 IASB Meeting

The IASB staff introduced the session by reminding the Boards of the extensive outreach activities that have been undertaken during the exposure draft comment period. Those activities have included webcasts, conference appearances, meetings with industry groups in many countries and regions, ratings agencies, regulators and supervisors, analysts and others. These activities together with a preliminary reading of comment letters received on the IASB Exposure Draft and the parallel FASB Discussion Paper have enabled the staff to identify the critical issues that need to be given priority as the Boards commence redeliberations in January 2011.

The staff introduced a proposed project timetable that would permit the IASB to ballot an IFRS in June 2011.

IASB staff presented a paper that reminded the Boards why the IASB (and subsequently the FASB) had undertaken this project. The overriding reasons were that the current accounting and financial reporting requirements are opaque and impair comparability. There was no substantive discussion of this paper.

IASB staff also presented a refresher on the proposed measurement model. It was noted that IFRS 4 (uniquely in IFRSs) permits different accounting policies within an organisation, such that an insurer with operations in four jurisdictions might consolidate information based on four different sets of accounting requirements. Generalised comparisons between insurance accounting in a number of jurisdictions could be made, but detailed comparisons were extremely difficult. The impetus for change has come from the industry as well as users, who wanted a unified model, not only for external financial reporting but for operational reasons as well. Again, there was no substantive discussion of this paper.

Issues identified in the outreach activities

Need for an IFRS

The IASB staff confirmed that, outside the United States, there was a high degree of support for an IFRS on insurance contracts.

However, the outreach activities also highlighted a concern that to address thoroughly all issues raised during the exposure period in the five-to-six month period proposed by the IASB was potentially overly ambitious.

Principal areas of concern and/or controversy

As a result of the outreach and preliminary review of comment letters received so far, the staff has identified five critical topic areas:

• Volatility in profit or loss
• Unbundling insurance contract components
• Residual vs. Composite margin
• Presentation (especially with respect to profit and loss/ other comprehensive income items)
• Short-duration contracts

There was a general discussion of these areas, which the staff tried hard to keep out of technical re-deliberation. Board members declared various degrees of sympathy or lack of sympathy with some of the issues identified, giving the staff and their fellow Board members an idea of interesting debates to come.

For example, some Board members were not disposed to using an IFRS to avoid volatility in profit or loss. These Board members wanted to portray economic reality and the economic mismatches that exist as a result of insurance activities. Others observed that some of the measurement guidance proposed (and the resulting effects in profit and loss) fitted well with developed markets such as those in North America, Europe and Japan, but were decades ahead of insurance markets in some other IFRS jurisdictions (e.g., parts of Asia).

It was noted that in several key areas, such as the discount rate and presentation issues and the cross-cutting issues with financial instruments and revenue projects, there was no consensus among either the major audit networks or large industry players.

Another critical decision would be the extent to which the IASB's decisions in IFRS 9 guided their decisions for insurance. The mood of the meeting was that it would be necessary to be consistent between the two.

Boundary issues between what are insurance contracts and derivatives, and between financial guarantee contracts will need careful consideration.

With respect to risk adjustment, the comments fell largely into two groups: those with an interest in having an accounting treatment as close to the Solvency II regulatory requirements, and others.

On unbundling, views in the comments letters examined so far and other outreach have been mixed. The ED sought to clarify the principle outlined in the IASB's Discussion Paper, but it was clear from the feedback that this attempt had not succeeded. There were questions about whether one could use unbundling the effects of the measurement rules. On the other hand, some wanted unbundling so that they could measure some components at fair value and others at amortised cost.

Discussion at the January 2011 IASB Meeting

Tuesday, 18 January 2011

The IASB and FASB staff for Insurance Contracts introduced the summary comment letter analyses for the ED/2010/8 (IASB) and the Insurance Contracts Discussion Paper (FASB). The staff and the Boards identified several 'first level' issues identified in the comment letters and as a result of other outreach activities (including Round-table meetings with constituents, field tests and other meetings with constituents) during the exposure period.

The Boards, and in particular the IASB, are faced with a desire and need expressed by IFRS users, to issue an IFRS as quickly as possible. However, balancing that are concerns that high-quality financial reporting standards are issued by both Boards and that quality not timeliness should be the overriding objective of the Boards.

Board members noted that there was no clear consensus emerging from those who did not like the Boards' proposals. There were a number of strong minority views, but there was no preponderance of any particular alternative.

Critical issues identified by the staff include the discount rate; risk margins and risk adjustment; unbundling components of insurance contracts; the modified/ simplified approach for short-duration contracts; and presentation.

When asked whether the staff had been able to identify an 'anchor' issue around which strategic direction could be achieved and the amount of revisiting issues during redeliberations could be minimised, it was apparent that there was no such issue, although presentation and the risk margin/ risk adjustment might together provide some direction.

No decisions were made during the meeting. However, several Board members from both Boards gave indications of areas in which they had strong views. For example, financial statement presentation: that any IFRS should portray economic mismatches accurately and that accounting should not mask the economics.

Detailed redeliberations are expected to begin in February 2011, with some of the 'first order' issues likely to be discussed, including risk adjustment vs composite margin and composite vs residual margin approaches. Both are issues on which the IASB and FASB have fundamental disagreements.

Wednesday, 19 January 2011

Education session: The discount rate

The Boards held an education session on the choice of the discount rate. Introducing the session, the IASB staff noted that the IASB's ED/2010/8 (and the related FASB Discussion Paper) had two proposals for the discount rate. For participating insurance contracts, for which some or all of the amount and timing of cash flows arising under the contracts may depend on the performance of the assets, the performance of the assets needs to be considered in measuring the corresponding insurance contract liability, either in the discount rate or elsewhere in the building blocks. For non-participating business, the boards proposed that the discount rate should be a risk-free rate plus a liquidity adjustment and to disregard the insurers' own non-performance risk.

As a result of outreach activities and comment letters, the staff identified three groups of discount rates that might be candidates for the most appropriate discount rate:

• building a discount rate bottom up starting at a risk-free rate and then adding certain factors that are relevant to the measurement of the liability
• starting top-down from actual or estimated asset earnings and then eliminating certain factors identified that are irrelevant to the measurement of the liability, or
• use an observable discount rate (for example high quality corporate bond rate) as a practical expedient to approximate either a bottom-up or a top-down approach.

The Boards received three presentations in support of different 'top-down' approaches from Robert Esson (NAIC); Francesco Nagari and Andrew Smith (Deloitte LLP); and Nick Bauer (Eckler Ltd). Each presentation was designed to answer:

• How does this discount rate reflect the characteristics of the liability?
• Which factors/risks are included and excluded by this discount rate?
• What are the sensitivities of both assets and liabilities to these factors in the rate?
• How complicated is it to derive this rate in practice?

Board members challenged each presenter over certain aspects of their presentation, seeking clarification or expressing concerns about the method suggested.

No decisions were asked for or made.
 

Discussion at the February 2011 Joint IASB-FASB Meeting

Acquisition costs

The Boards discussed the accounting for acquisition costs for insurance contracts. The debate was difficult to follow and not helped by the staff, who attempted to 'clarify' a critical element of their recommendation but succeeded only in confusing Board members. Board members were evidently uncomfortable about developing a reporting model for acquisition costs in an insurance contract that was fundamentally different to that developed for revenue contracts.

The Boards tentatively decided that for contracts issued, some acquisition costs should be included in the initial measurement of insurance contracts as contractual cash flows and all other acquisition costs should be expensed as incurred and this determination should be performed at the portfolio level.

The Boards then discussed whether acquisition costs included in the cash flows of insurance contracts should be limited to those that are direct (e.g., salaries) and incremental (e.g., bonuses and commissions) at the portfolio level, or 'direct and direct and incremental'. The staff thought that this construction was necessary to prevent abuse because of US-based experience that involved innovative approaches to what 'direct and incremental' means. The Boards also discussed whether there should be a further limitation to successful contracts only. (Several Board Members appeared confused about the distinction being drawn, since a portfolio could only consist of issued (successful) contracts.) Board members were split on this issue and given that not all Board members were present, this issue will be brought back at a future meeting.

Discussion at the February 2011 IASB Meeting

Education session on 'unbundling'

The Boards held an education session to understand the effect, costs and benefits of separating insurance contracts into insurance and non-insurance components; referred to as 'unbundling', in which external presenters outlined practical considerations in response to the unbundling proposal set forth within the IASB's Exposure Draft and FASB's Discussion Paper.

In providing relevant examples, including simplified unit-linked insurance contract examples, external presenters suggested certain potential concerns with current unbundling proposals, including:

• Significant amounts of time and costs involved in unbundling, although no distinction of anticipated costs were made
• Application of judgement to allocate acquisition costs and surrender charge income to the different components of a contract in unbundling, whereby the treatment of acquisition costs may be different between current proposals within financial instruments, revenue recognition and insurance contracts
• Application of judgement by insurers in determining how much of the portfolio's expense cash flows should be attributed to the investment management of any unbundled component and how much relates to the insurance component
• The lack of explicit investment management fee specificity within insurance contracts leading to application of further judgement in either allocating the fee or treating the whole balance as related to the financial liability
• Profit profiles for insurance components depending on amortisation of residual margins, which may not be significantly different from unbundled account balance
• Different measurements for contracts that are similar economically if some are unbundled and others bundled.

Noting the above, certain possible benefits for unbundling were noted, including:

• The consistent treatment of financial instrument elements within insurance contracts to that of standalone financial instruments
• The possible reduction of accounting mismatches associated with deposit elements, embedded derivatives.

Certain members of the Boards considered whether variances in bundling / unbundling, by way of examples provided by the external presenters, were the result of economic or accounting consequences, while also considering if more value would be provided by disclosing the source of earnings within the financial statements as opposed to applying the unbundling proposal. Other members noted that unbundling often limits the variability in reporting, while also providing further clarity as to underlying costs and earnings in the period.

No decisions, however, were sought or reached at this meeting.

Project assumptions

The staff presented the current assumptions under which the insurance contracts project is being developed for the consideration and approval of the Board members. Key assumptions include:

• that the development of a standard for insurance contracts is appropriate;
• the standard focuses on insurance contracts only, not the entities or underlying assets;
• insurance contracts will be considered as a bundle of rights and obligations generating a package of cash flows;
• insurance contracts will be measured at the portfolio level;
• the use of observable market consistent inputs in a current estimates model;
• contracts will be measured from the perspective of the insurer fulfilling them; and
• insurer's own credit shall not be considered.

The staff asked the members of the Boards to ratify these assumptions.

In general, the members of the Boards had no significant disagreements with the assumptions, although a small number of additions and considerations were suggested, particularly to include explicit references to consideration of the interaction between the IFRS on insurance contracts and IFRS 9 for the measurement of assets held by insurers to fund the insurance contracts cash flows.

Discount rate for non-participating contracts

The staff presented a paper on the discount rate to be used in discounting non-participating contracts, and recommended that the Boards confirm that:

• the objective to adjust the future cash flows for the time-value of money and reflect the characteristics of the insurance contract liability;
• the method for determining the discount rate shall not be prescribed; and
• guidance shall be provided on determining the discount rate which shall be adjusted for risks that are not included elsewhere in the measurement model.

The Board members held a significant debate on the calculation of the discount rate for non-participating contracts and addressed numerous issues, including:

• the calculation of an illiquidity adjustment;
• the use of top-down and/or bottom-up approaches, and the differences that may arise as a result;
• whether the substance of the transaction could permit the use of a standard borrowing rate as a proxy after removal of the insurer's own credit risk;
• the impact of discount rates on pricing decisions and products; and
• comparison to the discount rate discussed in the leases project currently underway.

Overall, the Boards concluded that there were no significant objections to the proposed objective for discounting, but that additional clarification of the wording was required, and that they would not prescribe a model for the calculation of the discount rate. Insurers would be permitted to use any methodology provided the resulting discount rate meets the IASB's objective.

Although the Boards concluded that guidance should be provided on the calculation of the discount rate, a number of concerns about staff recommendations were raised, and the Boards decided that the staff should consider these concerns during the drafting phase and the Boards would rule on the wording at that point. The Boards also decided to include a requirement that yield curves for each major relevant currency should be disclosed.

Discount rate for non-participating contracts

The Boards continued their discussion of discount rates for non-participating contracts by discussing the staff query whether to allow the substitution of a specified rate (e.g. one based on the interest rate of a high quality corporate bond) as a practical expedient to allow insurers to determine their discount rate in certain circumstances.

The Boards expressed mixed views, raising points for and against the development of an approach that uses a proxy rate. Ultimately, no conclusion could be reached. As such, the Boards cautiously agreed that a proxy rate might be used, but instructed the staff to explore that possibility and provide the Boards at future meetings with information regarding the selection of such a rate and the circumstances in which it could be used.

Cash flows

The staff presented a paper to the Boards addressing the estimation of future cash flows, the treatment of specific cash flow items such as general overheads, and the level of detailed guidance proposed in the Exposure Draft / Discussion Paper. The staff requested that the Boards:

• clarify the measurement objective of expected value to refer to the mathematical mean;
• clarify that implementation would require enough scenarios to be considered to satisfy the measurement objective rather than requiring all possible scenarios to be considered;
• confirm which costs could be included within the cash flow;
• confirm that indirect costs should be expensed; and
• eliminate "incremental" from the definitions.

The Boards agreed with the staff that the measurement objective should be based on the mathematical mean of the expected future cash flows although there was some concern about the application of this to general insurance business due to the variability of future cash flows. In addition, the Boards generally agreed that sufficient, rather than all, scenarios should be considered by the insurers. The Boards also agreed that only costs directly related to contract activity should be included within the liability cash flows rather than the wider concept of attributable costs proposed by the paper. This redefinition replaces "incremental" and would also drive the designation of which costs could be included. The Boards instructed the staff to draft appropriate wording in line with this decision when preparing the final standard.

Explicit risk adjustment

The staff presented a paper to the Boards on the results of consultations on the use of an explicit risk adjustment but the Boards were not asked to decide between an explicit risk adjustment or a composite margin at this stage. Instead, the staff asked the Boards to consider whether an explicit risk adjustment would, in principle, provide useful information to users of financial statements. The staff noted that there were two distinct streams of comments. Some users felt that information on the risk adjustment was useful and necessary, while others felt that the costs, difficulty and market inconsistency that were possible with risk adjustments rendered the information provided by an explicit risk margin not reliable for financial reporting.

The Boards discussed the issues presented, providing points for and against explicit risk margins, many of which had been considered in previous debates. Many members commented that it was difficult to dissent with the staff's view on risk margin as the question was not touching the issue that had divided them in previous discussions on this subject. A significant issue was identified in that the effective use of a risk margin in dependant on the estimate of the liability cash flows being prepared on an unbiased basis and some Board members were not convinced that this was always possible. The Boards decided that the staff should arrange an educational session on how risk margins are calculated in the market and the Boards will reconsider the issue at that point.

Day one gains and losses

The staff asked the Boards to consider whether an insurer should recognise day one gains, should be required to recognise day one losses, and whether the residual or composite margin could become negative on subsequent measurement.

There was no significant support for the recognition of day one gains amongst the Board members, and there was general agreement that day one losses should be recognised on day one. A small number of concerns were raised, and the Boards expressed a general feeling that margins should not become negative. A few Board members supported the possibility of recognising a negative residual margin, but only where the sum of the risk adjustment liability and the negative residual margins remained a net liability.

Margins

The staff presented an educational session to the Boards focusing on the implications of unlocking and remeasuring residual or composite margins. The staff also presented a number of examples of how various scenarios could play out under different unlocking and measurement assumptions. Although the Boards discussed this and raised a number of questions and comments, no decisions were made.

The Boards instructed the staff to prepare a paper for discussion based on the following guidance:

• use of floating margins (i.e. remeasuring the residual/composite margin for both favourable and unfavourable changes in non-financial assumptions);
• an onerous contract tests should be included; and
• only non-financial assumptions could be considered in the adjustment of the residual margin.

The Boards requested that the staff discuss these proposals with users prior to presentation to the Boards for decision.

Refresher on presentation models

The staff presented a short session to the Boards as a reminder of the issues arising from the presentation proposals set out in the ED / DP and which would need to be considered when making other decisions within the insurance project. The Boards noted the feedback from the comment letters requesting volume of business information being included in the statement of comprehensive income. No decisions were made, but the debate appeared to suggest that the Boards or their constituents cannot yet identify a clearly superior presentation format.

The Boards requested that the staff consider the work being performed by EFRAG on presentation which is expected to be presented to the IASB next week.

Discounting non-life contract liabilities and Locking the discount rate

The Boards did not consider these papers and have deferred them to the next meeting.

Discussion at the additional 1-2 March 2011 Joint IASB-FASB Meeting

Tuesday 1 March 2011

Papers 2A and 2B were originally planned for discussion in February, but were deferred to this month due to time constraints.

Locking in the discount rate (Paper 2A)

The staff presented a paper for the Boards' consideration on the use of locked in discount rates. The Exposure Draft / Discussion Paper ("ED/DP") originally proposed an unlocked discount rate and many preparers commented that, among other things, an unlocked rate did not faithfully represent the economics of many insurance contracts, would result in greater volatility and parallels were drawn between the treatment of other financial assets and liabilities and insurance contracts.

The staff considered these comments, but did not find merit in the arguments put forward and so they concluded and recommended to the Boards that the discount rate should remain unlocked.

With little discussion, the Boards unanimously agreed support for the staff recommendations.

Discounting non-life contract liabilities (Paper 2B)

The staff presented a paper to the Boards focusing on whether certain (i.e. short-duration) non-life insurance contracts should be exempted from discounting. This paper originates from concerns raised by respondents, primarily property / casualty insurers in the United States, that the application of discounting to short-term non-life insurance contracts would not faithfully represent those contracts.

Having assessed these concerns, the staff recommended that the Boards:

• exempt from discounting short-duration, short-tail claims where the settlement period is less than one year from the claim event;
• apply discounting to long-tail claims with a reasonably determinable payout pattern; and
• apply discounting to long-tail claims where the amount and timing of the cash flows may be uncertain.

The Boards spent a significant amount of time discussing the first staff proposal. Concerns were raised that this proposal would allow claims settled up to two years from contract inception to avoid discounting. It was noted that although the paper is only addressing non-life claims the current wording could also be read to include certain types of life insurance claims (for example short duration term insurance). Some Board members proposed reliance on the materiality concept used throughout IFRS, but this was opposed by other Board members who were concerned that the Boards had never actually defined the application of materiality, and that it would vary from jurisdiction to jurisdiction.

Overall, despite the significant debate, the Boards were unable to reach consensus on this issue and instructed the staff to investigate further and to bring this issue back as part of the consideration of the modified approach for short-duration contracts.

No disagreements were identified with the second staff proposal, but some Board members raised concerns that they couldn't see a difference between proposal two and proposal three. The staff advised the Boards that this separation arose from current practice for discounting of claims set out in proposal two and many concerns by respondents to the ED/DP on the discounting of uncertain claims. The staff concluded that they could not see any real circumstances in which proposal two and three would be different in practice. Overall, both Boards supported the staff recommendation for proposals two and three, but noted that some work may need to be done during the drafting phase.

Scope (Paper 2D)

The staff introduced a paper for the Boards to consider focused on resolving an issue identified from the ED/DP which affects the proposed scope of the insurance contracts standard. The paper did not consider financial guarantee contracts or financial instruments containing a discretionary participating feature. These two issues will be considered by the Boards later.

The main concern arising from the ED/DP was the treatment of fixed fee service contracts. Some respondents were concerned that the wording proposed by the ED/DP would result in the contracts that are clearly not insurance-related (e.g. fixed fee contracts for the provision of legal services) being included within the scope of the insurance contracts standard.

The staff proposed that the scope exclusion for fixed fee service contracts should be narrowed to apply only to those contracts that have the primary purpose of the provision of services and that would qualify for the modified approach for short-duration contracts.

The Boards engaged in a significant debate on this topic. Concerns were raised that the current wording proposed by the staff would result in non-insurers having to assess their contracts against the insurance contracts definition and to determine whether contracts (including those clearly not intended to provide insurance services) would fall within the scope of the modified approach for short duration contracts. A number of improvements were proposed (e.g. basing the decision on the substance of the product only and using unbundling to separate out the insurance components) but no universally acceptable solution could be agreed.

The Boards tentatively agreed with the idea of a scope exclusion for fixed fee service contracts that were primarily aimed at the provision of non-insurance services and instructed the staff to delete the reference to the modified approach to short duration contracts and consider the issue further. The Boards suggested that this issue should properly be considered as part of their consideration of the definition of an insurance contract.

The staff also asked the Boards to comment on the scope exclusions that were not tabled for specific discussion:

• Product warranties issued by a manufacturer, dealer or retailer;
• Employers' assets and liabilities under employee benefit plans and retirement benefit obligations reported by defined benefit retirement plans;
• Contractual rights or contractual obligations that are contingent on the future use of, or right to use, a nonfinancial item;
• Residual value guarantees provided by a manufacturer, dealer or retailer, as well as a lessee's residual value guarantee embedded in a finance lease;
• Contingent consideration payable or receivable in a business combination; and
• Direct insurance contracts that the entity holds (i.e. direct insurance contracts in which the entity is the policyholder).

Subject to the above discussion on the definition of an insurance contract, the boards agreed unanimously that these scope exclusions should remain as proposed in the ED/DP.

Wednesday 2 March 2011

Financial Guarantee Contracts (Paper 2E)

The Staff presented its views on the redeliberation of financial guarantee contracts based on previous discussions with the Boards. The Staff of both IASB and FASB have recommended that the Boards carry forward the existing approach on the scope allocation for financial guarantee contracts that is currently in place under IFRS 4 and IAS 39 within IFRS and several different pronouncements under US GAAP:

IASB recommendations

The Staff recommendation for IFRS was that:

• Financial guarantee contracts are scoped out of the IFRS for insurance contracts into the IFRS for financial instruments. However IFRS would:
• permit an issuer of a financial guarantee contract (as defined in IFRSs) to account for the contract as an insurance contract if it had previously asserted that it regards the contract as an insurance contract; and
• require an issuer to account for a financial guarantee contract (as defined in IFRSs) in accordance with the financial instruments standards in all other cases. Such contracts would be measured initially at fair value (typically equal to the consideration received), with subsequent amortisation of that amount, coupled with a test for credit losses under IAS 37.
• IFRS retains the current decision that does not provide an exception in the preparation of standalone financial statements for the treatment of intergroup guarantees from the accounting required for financial guarantee contracts.

FASB recommendations

The Staff recommends that the FASB should:

• Exclude from the scope of the insurance contracts project the accounting for financial guarantees. This would mean that the insurance contracts standard would carry forward the existing guidance such that:
• Financial guarantees currently within the scope of Topic 944 (formerly FAS 60) should be within the scope of the insurance contracts guidance
• Financial guarantees within the scope of Topic 815 (formerly FAS 133) and Topic 460 (formerly FIN 45) as well as financial guarantee insurance contracts within the scope of Topic 944 (formerly FAS 163) should not be within the scope of the insurance contracts guidance and should retain current accounting under those standards.
• Continue current practice under existing U.S. GAAP that provides an exception from recognition requirements for intergroup guarantees.

The Staff asked the Boards to ratify these assumptions. In general, there was full support from the IASB to each of the Staff recommendations.

FASB noted that they agreed with the IASB recommendation for the insurance project but suggested that the Boards should complete the insurance contracts project as planned, complete their deliberations on the impairment of financial assets project and then start a joint FASB/IASB project to develop a convergent treatment of financial guarantee contracts including those issued by members of the same group.

The Boards approved this approach and instructed their Staff to continue their work accordingly.

FASB intends to incorporate the outcomes of this exposure draft in the finalisation of the new US GAAP for insurance contracts. For the IASB this would likely result in possible amendments to both the new IFRS for insurance contract (the IASB aims at issuing it by 30 June 2011) and IFRS 9.

Field Testing Results (Paper 2F)

The Staff provided a paper to the Boards that highlighted the objectives of the field testing that started in September 2010 and was recently completed.

The Staff clarified that this was an extensive but still targeted field test that did not require a full restatement of participants' financial statements. It was developed with the expectation that participants did not need to invest significantly to adjust their systems, but rather give the best estimate of levels of effort.

Fifteen companies participated, 2 of which were unable to complete the testing in the time frame. The Staff will complete the full analysis of the field testing results during the course of March. However the paper asked the Boards what further information they would like to see as they complete the final discussions on the field testing results later this month. Staff indicated that they had not seen anything that has shown any of preliminary decisions reached so far need to be reopened and that Staff has already reflected the field testing results in each of the Board papers prepared so far. One FASB member requested a mechanism be developed such that all issues identified in the field testing reports are aggregated so that the Boards can be assured they have addressed each concern. The Staff indicated they would work within the parameters of the confidentiality of the field testing to produce this. The Staff were also asked to obtain information about the non-GAAP disclosures that would be presented pre- and post- implementation of the new IFRS with the objective of identifying where the insurance project may not be meeting the requirements of preparers and users.

Information Session on Uncertainty in the Measurement of Insurance Liabilities (Paper 2I)

The Staff presented their paper on Uncertainty in the Measurement of Insurance Liabilities to the Boards which addressed issues arisen during the discussions in the February meetings. The purpose was to address the Boards' concerns about the potential for double-counting of risk and other measurement items within the building block approach. The paper did not set out to prove the merits of the risk adjustment model, but rather to highlight the relationship between the building blocks. The Staff does not believe there is additional risk compared to other IFRSs of double-counting of these risks.

A few minor questions were asked, but overall the Boards were impressed with the Staff paper and noted that it addressed the concerns previously raised and identified the issues that would need to be discussed at the main March meetings.

Acquisition Costs (Paper 2G)

In the 2 February meeting, the Boards made a decision to include acquisition costs at the portfolio level departing from the contract level criterion included in the Exposure Draft. The Staff had divergent views on a recommendation regarding acquisition costs, and provided the Boards with a recommendation and an alternative view.

The Staff's recommendation was that acquisition costs to be included in cash flows are 1) related only to successful contract acquisitions; 2) limited to direct costs; 3) require application guidance.

The Staff's rationale for limiting acquisition costs to those related to successful contract acquisitions included the following arguments:

• Unsuccessful efforts do not have a future benefit
• Consistency with the Boards view in the Exposure Draft basis for conclusions that these costs can be clearly identified with contracts issued
• Consistency with other standards that these costs are determined at the contract level only for successful sales.

The other foundation of the Staff's recommendation is that these costs shall be direct costs only. The Staff developed a table in paragraph 30 of this paper that attempted to separate typical costs into incremental, direct and both direct and indirect costs.

The Alternative view, which was included in Appendix D, recommended that acquisition costs to be included in the expected cash flows should not be limited to costs for successful contract acquisitions and their identification should be the same as the criterion to identify fulfilment cash flows. Therefore, the alternative view introduced the concept of "directly attributable" costs which would include certain indirect costs (for example rent and other overheads for office accommodation used by acquisition activities) to be consistent with the previous tentative decision on the costs to fulfil an obligation on a portfolio of contracts.

There was significant discussion on this topic from both Boards, primarily focused on the successful effort recommendation and the meaning of "direct" or "directly attributable" costs.

The Boards were split on the question of whether to restrict acquisition costs to those related to successful efforts, with the FASB voted unanimously in favour of the Staff's recommendation of a successful efforts approach whilst the IASB voted 10:2 in favour of the Staff's Alternative view inclusive of costs arising from both successful and unsuccessful efforts.

Many IASB members indicated that the definition of acquisition costs should be consistent with that applicable for fulfilment cash flows as acquisition costs are a sub-set of those cash flows. The debate suggested that many IASB and FASB members consider that acquisition costs should include certain costs other than direct costs but no agreement on how such costs should be defined.

The Boards asked that the Staff draft language that better defines "directly attributable" for acquisition costs considering both the definition of fulfilment cash flows as tentatively agreed at the February meeting of the Boards and as well as "direct" costs as used in other IFRSs.

The Boards were in agreement that mandatory application guidance is necessary in the final standard to assist in defining these costs to be included in the expected cash flows and acquisition costs.

Information session on presentation (paper 2H)

This was carried forward to the main March meeting.

Discussion at the March 2011 IASB and IASB-FASB Meetings

Monday 14 March 2011

Alternative presentation models (paper 3A – education session)

The joint meeting on insurance this week started with an education session on presentation models. The Staff walked the Boards through a number of examples of statements of comprehensive income all aimed at reconciling the summarised margin approach proposed in the Exposure Draft with the key comment received from the comment letters that users of financial statements need a prominent volume information.

The Boards invited the Staff to continue their work and to validate the various alternative models with the representatives of the insurance stakeholder groups at the Insurance Working Group meeting on 24 March.

Alternative earning profiles for the composite margin (paper 3J – education session)

A second Staff-led education session focussed on the accounting approach for the composite margin release to profit. The Boards were reminded of the negative feedback received in the comment letters on the Exposure Draft proposals to use a formula driven approach to the release to profit of this liability and the Staff illustrated alternative methods including those that would require a risk based release. This approach could be analogous to the risk adjustment/residual margin approach favoured by the majority of IASB members in the Exposure Draft.

Practical expedient for the discount rate (paper 3G)

The Boards resumed their discussion on discount rate for non-participating contracts to consider whether a proxy rate (for example an interest rate of a high quality corporate bond) could be used under certain circumstances as a practical expedient to achieve the objectives tentatively agreed last month.

The majority of both Boards agreed with the Staff recommendation that such an expedient should not be introduced in the final IFRS because it would not allow the achievement of the stated objectives of a discount rate that reflects the characteristics of the insurance contract cash flows.

However the FASB members reserved their right to reconsider their decision when the scope of the new US accounting standard will be debated because the expedient may be useful if the scope requires a large number of non-financial institutions to be under the scope of the new standard for insurance contracts.

Tuesday 15 March 2011

Practical measurement of risk adjustment liabilities (papers 3B and 3C – education session)

The Boards received a third education session on Tuesday delivered by Joachim Oechslin, Chief Risk Officer at Munich Re. This session presented the case for a risk adjustment liability and illustrated the practical implications for its inclusion in an IFRS. Mr Oechslin explained the use of market-consistent valuation of insurance liabilities developed at Munich Re and the use that the company has made of these measures for a number of purposes including external market disclosure.

Mr. Oechslin explained the basis for Munich Re's calculation is a replicating portfolio that models the insurance liabilities cash flows. This calculation includes a risk margin that is determined using a cost of capital technique. The presentation highlighted that for this technique the key components that need to be defined for its consistent application are the level of confidence that the technique has to achieve (e.g. a 99.5 percentile confidence level); the time horizon over which the confidence level applies (e.g. the next twelve months) and the cost of capital rate.

A second education session on the same subject is planned for next week on 22 March.

A discount rate for participating contracts – the "Asset Liability Rate" (ALR) (papers 3E and 3H – education session)

A fourth and final education session for the Boards was delivered by Jean-Michel Pinton and Baptiste Brechot respectively Group Accounting Director and Actuary at CNP Assurances. Messrs. Pinton and Brechot co-presented with Eric Meistermann, a Deloitte partner who advised CNP Assurances in the development and testing of the results presented to the Boards. The ALR is a proposal to determine a discount rate for participating contracts. These are insurance and investment contracts where the benefits payable to the holder are dependent on the value of the assets backing the contracts' cash flows.

The ALR method determines the discount rate using a yield curve derived from the expected return of the assets held in the participating funds backing the insurance participating liabilities being measured.

The yield curve is not necessarily market consistent; instead it uses the same basis selected for accounting purposes for each of the asset classes that form the participating fund. The yield curve determined with reference to these assets accounting values is then adjusted with the deduction of a credit spread (in a "risk neutral" environment) and the addition of a liquidity premium to arrive at the ALR curve.

The presentation explained that the ALR method would give full account of the cash flows on options and guarantees and use a forward market consistent risk free rate to discount cash flows in excess of the asset durations.

Discount rate for participating contracts (paper 3F)

The Boards reached two important decisions on the discount rate for participating contracts:

1. To align the objectives for discount rates on participating contracts to those tentatively agreed last month for non-participating contracts; and
2. To include guidance in the final IFRS that explains how an insurer should reflect the dependency on asset values of participating contract cash flows

In reaching these unanimous decisions the Boards made reference to a Staff paper that was released in November 2010 where the cash flows of participating contracts were analysed across three sets of cash flows that:

• directly reflect asset values where the measure of the liability can be effectively and fully replicated by the use of the asset values;
• are independent of asset values thus identical to those in non-participating contracts; and
• indirectly reflect asset values as a result of being cash flows from embedded options and guarantees.

The Boards noted that this paper could be a valid basis for the development of the mandatory application guidance that would be included in the final IFRS.

Timing of initial Recognition of an insurance contract (paper 3I)

The Staff presented two alternative proposals

1. to reaffirm the principles in the ED and emphasise that insurers need not recognise insurance contracts before the start of coverage where the effect on the financial statements would not be material; and
2. that insurance contract assets and liabilities should initially be recognised when the coverage period begins, but to require the recognition of an onerous contract portfolio liability in the pre-coverage period if management becomes aware of an event that would cause a portfolio of contracts to become onerous in the pre-coverage period

Both Staff alternatives would require recognition of a liability for a contract portfolio that becomes onerous after an insurer becomes a party to the contracts but before the start of coverage. Some members in both Boards were not comfortable with the proposed emphasis on materiality in the first alternative and the complex processes that would be required for many insurers to monitor contracts prior to the start of the coverage period. One Board member questioned whether the alternative view would affect the contract boundary principle set out in the ED. The general view was that the contract boundary principle would not be affected. This point is expected to be considered further by the Staff.

The Boards decided tentatively that insurance contract assets and liabilities should initially be recognised when the coverage period begins, but to require the recognition of an onerous contract portfolio liability in the pre-coverage period if management becomes aware of an event that would cause a portfolio of contracts to become onerous in the pre-coverage period.

FASB members voted unanimously for this decision with a large majority of IASB members reaching the same decision.

Definition of an insurance contract (paper 3D)

The Exposure Draft proposes that a contract is not an insurance contract if it does not transfer significant insurance risk. This is in line with the current text of IFRS 4.

The Staff presented two alternative proposals

1. to reaffirm the additional conditions included in the Exposure Draft and not in the current text of IFRS 4 (consideration of time value of money in determining cash flows and the significance of additional benefits payable in certain scenarios and whether there is a possibility of loss by the insurer) to assess whether there is a significant transfer of insurance risk; and
2. to withdraw those additional conditions in assessing whether there is a significant transfer of insurance risk.

The Boards decided tentatively to confirm the following additional conditions not in IFRS 4 as proposed in the Exposure Draft that:

1. In determining whether it will pay significant additional benefits in a particular scenario, the insurer takes into effect of the time value of money; and
2. A contract does not transfer significant insurance risk if there is no scenario that has commercial substance in which the present value of the net cash outflows paid by the insure can exceed the present value of the premiums.

However, it was noted the Staff should draft additional guidance to address the situations where a reinsurer accepts substantially all the insurance risk inherent in the underlying policies but there may be only very limited likelihood that the reinsurer may suffer a loss as defined above on that reinsured portfolio of business.

FASB members voted unanimously for this decision with a large majority of IASB members voting for this decision.

Monday, 21 March 2011

Unbundling: Overall considerations (Paper 12F)

The staff presented a paper for the Boards' consideration and discussion on the background to unbundling, the objective for unbundling, what should be unbundled, and what the next steps should be for unbundling. This was not a paper for decision and the Boards' discussion was intended primarily to provide further guidance to the staff.

The Boards' members expressed multiple views, both for and against unbundling, and raised a number of concerns about the information provided by the staff. Concerns raised focused on whether the components would be measured or recognised differently were they not part of the insurance contract. In this situation, there was strong support for unbundling these components, but little consensus on how they would be identified or on how this could be implemented in practice. There was also concern amongst Board members that unbundling would likely require a significant application of judgement in identifying and measuring the components that would be unbundled.

The Boards discussions did not appear to indicate the presence of a significant trend towards a solution to the problem of unbundling, and given the nature of the concerns raised by the Board members we do not see any preliminary indications of a consensus between the different viewpoints.

Bifurcation of embedded derivatives (Paper 12G)

This paper focused on whether the Boards should carry forward current requirements for the separation of embedded derivatives from the host contracts. The paper did not discuss whether:

• investment components and obligations to deliver goods and services should be unbundled
• "riders", embedded derivatives that are limitations, or additional payments, to the sum assured, should be separated, or
• how to account for derivatives embedded within an investment contract with discretionary participating features.

These issues are intended to be discussed in separate papers at a future date.

The staff recommended that current practice (i.e. that embedded derivatives should be separated out) should be maintained. With fairly limited discussion, the Boards expressed strong support for this proposal (IASB: 13; FASB: 7).

Objective for an explicit risk adjustment (Paper 12D)

Without discussing any other issue, e.g. the practical implementation of a risk adjustment, the staff proposed a draft wording for the objective of an explicit risk adjustment. The objective was meant to address concerns raised by respondents to the ED/DP, and centred on the notion that the risk margin should be an amount that renders an insurer indifferent between retaining and transferring an insurance obligation. Unfortunately, the Boards deemed the proposed text confusing and many members raised the concern that this approach represented a return to an exit value model.

Criticism of the proposed wording resulted in a Board member putting forward an alternative proposal which simplified the approach the Boards had included in the ED/DP. A number of minor wording variations around this central proposal were discussed and the debate reached a consensus. The risk adjustment was defined as the compensation the insurer requires for bearing the risk of the uncertainty that the cash flows will exceed those expected. The Boards also agreed to include guidance that, in quantifying the positive risk adjustment, insurers should take into account the possibility that cash flows may also be less than expected.

Discounting for ultra long duration cash flows (Paper 12E)

The staff paper analysed the additional considerations for the discount rate in cases where the yield curve needs to extend beyond observable market interest rates because cash flows will be due/received beyond that time horizon to complete the recent tentative decisions on the selection of the discount rate and the prohibition to lock it in.

The staff recommended that the effects of changes in the discount rate for ultra long duration cash flows should be reflected in other comprehensive income and should reflect all changes in measurement attributable to the unobservable part of the yield curve an insurer would need to extrapolate.

The Boards were not receptive to this recommendation because it created an exception within the new accounting model principle to recognise all changes through profit or loss. Overall, the Boards concluded that this issue should be assessed at a later date when the re-deliberations on the overall accounting model were more advanced.

Tuesday, 22 March 2011

Explicit Risk Adjustment (education session)

The FASB and IASB observed two educational session presentations on explicit risk adjustments.

Presentation 1: Tony Coleman, Director, AMP Life Ltd & Chairman of Audit Committee

Mr. Coleman presented on Accounting for Insurance in Australia. He discussed a number of key features of the Australian standards and the insurance industry overall, with significant points summarised as follows:

Key features of the standard on nonlife insurance include:

• Use of unearned premium for pre-claim liabilities
• Discount insurance liabilities at risk-free interest rates
• Risk margins mandatory for outstanding claim liabilities
• Liability Adequacy Test applies with risk margins
• Mandatory disclose of Probability of Adequacy (PoA) of insurance liabilities with risk margins
• Mandatory disclosure of sensitivity of insurance liabilities to key assumptions e.g. inflation, claims severity, claim frequency
• Mandatory disclosure of claims development table
• All assets valued at market value, through Profit & Loss

Key Features for Life Insurance accounting include:

• Unbiased probability weighted expected cost of settling claims incurred
• Discounting for time value of money (at risk free rate with an allowance for illiquidity) to obtain present value
• Does not require explicit risk margins
• Uses residual margins with unlocked assumptions
• Difference between previously expected and current actual in year (including discount rate changes) flow through to P&L with residual margin adjusted for changes in non-financial market estimates/assumptions
• Residual margin can never be negative
• All assets valued at market, through Profit & loss

Risks within the risk margin include:

• Internal systemic – Risks internal to the liability valuation – whether the model is a good representation
• External systemic – Outside of insurer's control (judicial interpretations, economic risks, event risk, latent claim risk, recovery risk, claims management process risk, expense risk)
• Independent Risk – Inherent in the insurance process due to random statistical fluctuation

Since adopting the new standards, consistency and disclosure have improved. Market analysts (users) are very interested in liability disclosures and claim development tables.

Examples of required disclosures include:

• Change in value of insurance liabilities if:
• Inflation rate assumed increases/(decreases) by 10%
• Interest rate used increases/(decreases) by 1.0% per annum
• Average claims severity increases by 10%
• Average claims frequency increases/(decreases) by 10%
• Average term to maturity of outstanding claims increases/(decreases) by 10%
• Mr. Coleman also notes that various models that the FASB and IASB have been discussing should be reconcilable to the Australian model; however, disclosure is key.

Presentation 2: Mark Swallow and Leopoldo Camara, Swiss Re

Mr. Swallow and Mr. Camara discussed the Risk Adjustment in the context of their internal economic accounting framework called Economic Value Management (EVM). EVM is used by Swiss Re for: pricing of reinsurance/insurance business; asset liability management; internal/external performance reporting for all business; regulatory reporting under the Swiss Solvency Test. The EVM framework uses the cost of capital approach to calculate required returns. For underwriting activities, this includes an estimate of the frictional cost of the capital held for taking re/insurance risk.

The EVM framework:

• Splits performance of fund raising activities (underwriting) and fund investment activities (asset management)
• Recognises all profits on new business at inception, changes in estimates as they occur, and excludes future new business
• Values assets and liabilities on a market consistent basis
• Reflects best estimates
• Measures performance after capital costs (i.e., cost to shareholders for taking risk- the risk adjustment)
• Profit (after capital costs) is recognised upfront. Over the lifetime of the contract, frictional capital costs are released and recognised as income, as liabilities run off.
• Group capital costs consist of:
• Risk free return on capital representing shareholders base cost of capital
• Market risk premium (MRP) representing the shareholder's expected excess returns on market risk exposure, applicable to all business activities that generate systematic market risk
• Frictional capital costs (FCC) representing shareholders required compensation for agency costs, costs of potential financial distress and regulatory/illiquidity costs (required return on underwriting risk only)
• EVM Capital takes into account internal risk, regulatory, and rating capital requirements.

Mr. Swallow also stressed the importance of disclosure, noting there has to be flexibility in order for a company to run its business as it chooses (a more highly rated entity may pay less for capital; different insurers will adopt different risk appetites, which drives their risk capital).

Mr. Swallow also noted that under the EVM framework, profits are taken on Day 1 (acquisition costs are fully expensed upfront). Mr. Coleman noted the opposite is true in Australia where there is no upfront profit.

Contract Boundary

The Boards also re-deliberated certain criteria around setting the contract boundary. The Staff noted that most respondents agreed with the contract boundary provisions within the IASB's exposure draft and the FASB's discussion paper. However, some questioned whether the proposed contract boundary was “drawn in the right place” as it may affect the contract's eligibility for the modified approach for short-duration contracts. These concerns primarily stemmed from the health insurance sector but may extend to other sectors as well.

The discussion focused on:

• Whether a contract renewal should be treated as a new contract when the existing contract does not confer on the policyholder any substantive rights
• Whether this assessment should be made at the particular policy holder level or at the portfolio level (when pricing of the premiums does not include risks relating to future periods).

The Staff noted a distinction between those contracts that are priced for future risk (for example, a 10 year life insurance contract where the insured party pays $100/year, even though the actual cost may be $70 in year 1 versus $115 in year 10) and those that can be re-priced each year, even though it may be done at the portfolio level.

Some board members expressed concerns over unintended consequences not yet identified in providing a practical expedient, noting it may put too much business in the short-term bucket. Other board members supported the portfolio view, noting that if the insurer can re-price the contract, they can “get out of” the contract. Ultimately, both boards voted for the following:

• A contract renewal should be treated as a new contract when the existing contract does not confer on the policyholder any substantive rights
• This assessment should be made at the portfolio level but only if the pricing does not include risks related to future periods
• All renewal rights should be considered in determining the contract boundary, whether arising from contract, law, or regulation.

Discussion at the Additional 29 March 2011 IASB Meeting

Unlocking the margin

The staff held an education session with both Boards to discuss the topic of whether the residual or composite margin should be locked-in at inception or unlocked over the life of the contract. The staff asked the Boards for direction but no official decisions were made during this meeting.

Both the IASB and FASB proposals on insurance contracts would require the margin to be locked-in at inception and allocated to future periods. While the ED did not ask a specific question on unlocking the margin, many comment letter respondents disagreed with the requirement that the residual or composite margin should be fixed at inception.

Those who support unlocking the margin believe that the initial lock provides counterintuitive results as changes in estimates are recognised in profit or loss, even though the measurement of the liability includes a profit margin. They feel that it is not representationally faithful to recognise expense in one period only to reverse it in a later period. However, those not in favour of unlocking the margin believe that unlocking would defer the recognition of changes in estimates of the value of the insurance contract liability to periods after the period in which they occur

The staffs are considering recommending requiring unlocking the residual or composite margin to reflect estimated future changes and assumptions about non-financial inputs and to adjust the residual or composite margin prospectively for favourable and unfavourable changes. Additionally, the staff is considering recommending that if the measurement of the liability includes a risk adjustment, the boards should prohibit the residual margin plus the risk adjustment from becoming negative, and if the measurement of the liability does not include a risk adjustment, the Boards should prohibit the composite margin from becoming negative.

A majority of the IASB members generally supported where the staff was going with considering unlocking the margin, however several members on both Boards had concerns that they were introducing significant complexity into the model. Additionally, the FASB Chair expressed reservation about deferring items outside of profit and loss. She also questioned where the staff intended to go with the future discussion to occur around other comprehensive income and said the Boards needed to see the entire recommendation on both items to consider properly. The IASB Chair agreed. The FASB did not hold a tentative vote to determine whether their Board supported the direction of the staff.

The IASB staff also provided the Boards with a summary from the insurance working group's last meeting. The group discussed three topics during the meeting including 1) the discount rate, 2) presentation and 3) the residual margin. The group may hold another meeting in May 2011.

Discussion at the April 2011 IASB meeting

Taking stock (Paper 5/63)

The staff presented a brief paper to the Boards summarising the current status of the insurance project and the decisions taken to date. There was no significant discussion on the paper, and the most important issue arising is that June 2011 is now officially a 'working month' which will lead to the final ballot vote on the IFRS and resulting in its likely publication in July 2011.

Top down approaches to discount rates (Paper 5A/63A)

The staff presented a paper to the Boards addressing the application of the Boards' tentative decision on 17 February to permit both top-down and bottom-up approaches to determining the discount rate, with a focus on non-participating contracts.

The staff recommended that the Boards include application guidance in the final standard that:

• The top-down discount rate is not an asset rate, but should be determined to reflect the characteristics of the insurance contract liability
• An appropriate yield curve should be determined based on current market information. The yield curve can reflect the actual assets that the insurer holds, or be based on a reference (not replicating) portfolio which is determined to reflect the characteristics of the liability
• Where there are no observable market prices for points on the yield curve, the insurer should use an estimate consistent with the Boards' guidance on estimates – particularly the guidance on Level 3 financial instrument fair value guidance.

The staff confirmed that the IFRS will state that asset cash flows utilised for a top down discount rate valuation should be adjusted to reflect the characteristics cash flows of the liability. In particular, they should be adjusted for:

• Differences between the timing of the cash flows in the reference asset portfolio (or the insurer's own assets) and those of the liability to reflect the actual degree the durations match
• Risks inherent to the assets but which do not relate to the liability.

The staff also recommended that, as insurers using a top-down approach to determining the discount rate are likely to have found it impractical to apply a bottom-up approach, no further adjustments (e.g. liquidity / illiquidity) should be adjusted for.

The Boards' members asked a number of questions of the staff, largely focused on clarifying their understanding of the issues involved. A member suggested the use of a practical expedient for this process for non-insurance companies, but this did not receive significant support. The staff also clarified that the top-down discount rate is not an asset-based discount rate. It remains the discount rate reflective of the characteristics of the liability (in the same way that a bottom-up rate is not a risk-free discount rate) which has simply been determined on a different basis.

Overall the Boards' members supported the staff analysis and the conclusions they had reached without dissention. The staff should now finalise the analysis and prepare final wording for the standard on the valuation of discount rates for non participating insurance contracts.
 

Discussion at the special 27 April 2011 IASB meeting

The Boards discussed extensively a set of recommendations aimed at dealing with the subset of insurance contracts that the Exposure Draft (ED) defined as “short term insurance contracts” on the basis that they had a coverage period (i.e. the period during which an insurer stands ready to pay claims) of one year or less and did not contain features that made the cash flows vary significantly. The ED required that all the short term insurance contracts are accounted for using a modified approach prior to any claims being incurred. Beyond the coverage period the claim liability arising from the short term insurance contracts would be accounted for using the main building blocks model.

Eligibility requirements

The Staff noted that a number of comment letters were particularly critical of the ED because the proposed criterion based on coverage appeared to introduce a bright line and it was not principle-based.

To address this approach the Staff recommended that an insurer would be eligible to use the modified approach based on a new set of criteria which required that (a) the contract does not include a significant financing element and (b) the contract does not contain embedded options or other derivatives that significantly affect the variability of the cash flows, after unbundling any embedded derivatives. The latter criterion is substantially the same as in the ED and the first one being the innovation proposed by Staff.

The new criterion (a) was further explained when two additional criteria are met: (i) the time between the receipt of premium and the provision of coverage is insignificant, and (ii) the amount of premium charged is not substantially different if the policyholder paid at the beginning of the coverage period. Using a recent decision from the Revenue Recognition project, the Staff also recommended including a statement whereby a contract is not considered to have a significant financing element if the coverage period is one year or less. This was the original first criterion from the ED which now is used to underpin the attempt of a broader principle based criterion.

The joint discussion did not appear to generate a tentative decision on the recommendation other than a statement that the Boards intend to have a modified approach based on the unearned premium. Instead it appeared to have highlighted a number of differences that the Boards will have to deal with as they finalise this issue.

FASB noted their preference to treat the modified approach as a separate model from the building block approach rather than a proxy to achieve the same measurement objective of a current measurement of the contractual fulfilment. This departs from the position in the ED and may seem to have little practical impact on the discussion on the pre claim measurement of the short term contracts.

Most IASB members were uncomfortable with the “significant financing” criterion because it seemed to open the modified approach to a wider subset of contracts that they had anticipated. The IASB position remains on the concept that there is a single measurement model with a simplified approach that delivers substantially the same information when certain criteria are in place. The identification of these criteria should be the focus of the Staff work going forward.

Discounting of the pre claims obligation

The debate continued on another area where a number of comment letters offered recommendations to the ED proposals to apply an accretion interest expense on the unearned premium release to income.

The Staff recommendation suggested leaving the unearned premium liability undiscounted if the eligibility criteria are met.

The debate noted that the absence of a clear consensus on the detailed eligibility criteria had made the discussion on this point more difficult to progress at this meeting.

Some of the IASB members noted that the new standard will apply to markets where high inflation exists and thus the allowance of an undiscounted approach over a twelve month periods would need to be assessed carefully. They also noted that the reassessment of the “significant financing” criterion in light of this comment could offer the way forward on this issue.

Treatment of acquisition costs

The ED required the acquisition costs incurred for the contract to be treated as a component of the contractual cash flows. The same principle was retained for the modified approach and the Staff recommended this option to be taken to the final standard. However the recent decision in the Revenue Recognition standard to account for an asset when incremental costs are incurred for a contract with a customer that can generate sufficient revenue to recover them was taken into account and an alternative proposal tabled for discussion.

The IASB members were in favour (9 out of the 10 board members in attendance) of retaining the ED principle in line with the building blocks approach and to use a single definition of contract acquisition costs as recently approved (based on costs that directly relate to the contract acquisition activity – on a portfolio basis).

The FASB members instead challenged the proposals of the Staff and noted that there was an opportunity for the new insurance standard to be aligned with the Revenue Recognition project. The presentation of the acquisition costs as an asset would enhance the comparability with the other industries where the new requirement from the Revenue Recognition project would apply.

The chairs of the two Boards asked the Staff to bring also this issue back in the near future to seek a convergent outcome.

Premium allocation patterns and onerous contract test

The Staff reconfirmed the ED proposal for the release to income of the unearned premium liability and both Boards agreed with the recommendation. The final standard will require the liability to be released to income based on the passage of time over the coverage period subject to a test that another basis that utilises the expected timing of incurred benefits and claims is not significantly different.

The final session on this topic aimed at setting out the criteria for the testing that a portfolio of unexpired short term insurance contracts has become onerous.

The fundamental issue of the role of the risk adjustment liability returned to the fore with the Staff recommending a test based on the first two building blocks (expected cash flows and discount rate) and a number of IASB members highlighting that this would depart from the concept of the modified approach being a simplification of the main model. They argued that if the concept of the proxy prevails the liability test should be done against a full building block calculation not one that is curtailed of the component that captures the uncertainty which often is the cause of the onerous contract situation.

An additional reservation came from the fact that the unearned premium liability is undiscounted and the onerous test uses a discounted amount.

Eventually the Boards found some common ground on the agreement that the onerous contract test (to be defined) will be undertaken when the insurer judges that there are certain indicators that may suggest the insurance liability for the unexpired short term contracts is not sufficient. These indicators were presented as “qualitative factors” and included deteriorations in the loss ratio or the increase in the severity and/or frequency of the insured events.

Pending further work on the definition of the portfolio the Staff had not recommended the level at which the onerous contract should be performed and they will cover this issue in one of the future meetings.

Finally the decision as to whether to change the ED from requiring the use of the modified approach to one that allows it as an accounting policy choice was deferred to a future date when the other issues left unresolved at the end of this meeting would have been addressed satisfactorily.

Discussion at the special 5 May 2011 IASB-FASB meeting

The IASB and FASB held an extra meeting on 4 May to discuss the insurance project, specifically unbundling and participating contracts. The meeting was scheduled for 2.5 hours, but ran to 3 hours without covering participating contracts, which was postponed to the next meeting.

Background material on unbundling (Paper 1C / 66C)

The IASB Staff started by presenting supporting papers and background on unbundling, summarising some of the comments from respondents to the Exposure Draft (ED) on this subject. Among others, it was noted that the concept of "closely related" was thought to be difficult to interpret and apply and that requests for more guidance and examples were provided in the comment letters. The Staff reiterated the objective of unbundling being the measurement of non insurance components of an insurance contract where the requirements of another standard would provide more useful information than the building blocks approach. A non insurance component is one that is performed irrespectively of the occurrence of the insured event. No questions were asked in this paper.

Unbundling goods and services (Paper 1D / 66D)

The Staff presented three alternatives approaches. Of these, the Staff recommended approach C that goods and services should be unbundled from an insurance contract in accordance with the principles on identifying separate performance obligations developed for the revenue recognition project. Once separated, those goods and services would be measured in accordance with relevant requirements of IFRSs and US GAAP. The other alternatives presented were to:

1. Require unbundling of non-insurance services and goods only if they have been combined in a contract with the insurance coverage for reasons that have no commercial substance;
2. Require further unbundling of non-insurance services and goods (in addition to those combined for reasons that have no commercial substance in alternative A).

Although FASB members were generally in favour of the Staff's recommendation, there was much debate about the section which requires an entity to unbundle and account separately for a good or service as a separate performance obligation if "the pattern of transfer of the good or service is different from the pattern of transfer of other promised goods or services in the contract". This wording is taken from the revenue recognition project and the FASB argued that it does not transfer well to a liability measurement model as it would prevent unbundling in cases where the components are clearly unrelated, but the pattern is the same. The majority of the FASB therefore supported the Staff's recommendation only if this criterion is removed or substantially reconsidered.

The IASB were generally supportive of the Staff's recommendation. Some members argued that without guidance, it may be difficult to interpret the principles, and that if examples are provided, their status must be made clear. Most were of the view that the insurance standard should be consistent as much as possible with the revenue recognition standard and therefore, the "transfer pattern" criteria may need to be tested further. IASB noted that if it was necessary to modify the revenue recognition approach to fit the insurance standard, it could lead to confusion between the two approaches and requested that identical wording is kept in the two standards.

The Staff explained that the rationale for introducing the "transfer pattern" criteria was to keep all services in one unit of account if unbundling was done for presentation purposes only without impact on the net result. The IASB took a vote which resulted in a majority being in favour of the recommendation. The IASB asked the Staff to reflect on the various concerns raised and agreed to take this issue to the upcoming Insurance Working Group meeting (IWG), scheduled for 16 May.

Unbundling investment components (Paper 1E / 66E)

The paper considers the meaning of "investment component", the criteria that should be considered for separating the investment component from the insurance contract and whether it should be recognised and measured in accordance with the financial instrument requirements in IFRSs or US GAAP. Again, the Staff reiterated its aim to find a solution where benefits outweigh costs.

The Staff's recommendation is that "explicit account balances in insurance contracts that meet specified criteria should be unbundled. The specified criteria are adapted from those that are being developed for identifying separate performance obligations in the revenue recognition project. If the account balance meets the specified criteria, that component should be accounted for in accordance with the relevant requirements for financial instruments in IFRS / US GAAP."

The FASB initiated the discussions by expressing confusion over the explicit account balance definition and questioning whether a cash surrender value (CSV) would qualify as an explicit account balance. The Staff clarified that it sees a CSV as an integral part of the contract and would therefore consider it as an implicit account balance. Some FASB members were still not convinced by the Staff's explanation and, although they generally agreed with the recommendation, they asked for further clarification or rewording of the "explicit account balance".

The IASB briefly discussed and generally agreed with the Staff's recommendation, although they asked for the issue to be brought before the IWG at their upcoming meeting.

The two other elements in the Staff's recommendation, i.e. the criteria for unbundling and the measurement, were very briefly discussed by the IASB and they received general support. It was however requested that a wording clarification be made regarding the drivers that affect the insurance risk taken on by the insurer, which should be both the amounts paid in by the policyholder and the investment performance.

Although the FASB was also generally supportive of the Staff's recommendation, they were keen to word the criteria as efficiently as possible to avoid having to go through the evaluation process more than once, i.e. for account balances and for goods and services. Having said that, the FASB decided not to vote on these questions as it was felt they were subject to similar issues to those identified for the initial measurement of a financial instrument. Once again, it was agreed to bring this issue forward to the IWG meeting.

Discussion at the special 11-12 May 2011 IASB-FASB meeting

WEDNESDAY, 11 MAY 2011

Measurement of policyholder participation

The Boards discussed how to apply the principle that an insurance contract is measured using the expected present value of the fulfilment cash flows when those cash flows results from contractual participation features and the cash flows have a dependency from asset values held in participating funds. The two papers presented for this discussion included background information and the following recommendations to the Boards:

• The cash flows expected to result from the policyholder participation should be included in the insurance liability on the same basis as the measurement of the underlying items in which the policyholder participates;
• The measurement of the participating contract should reflect the asymmetric risk sharing between the insurer and the policyholder resulting from the minimum guarantee;
• The changes in the insurance contract liability shown in the statement of comprehensive income should be consistent with the presentation of the changes in the items from which the participating liability depends on; and
• The same measurement approach should apply to unit-linked ("UL") and participating contracts ("par").

During its presentation of the recommendation paper, the staff noted that the main difference between UL contracts and those with participating features is often associated with the nature of the asymmetric risk sharing between the insurer and the policyholders. UL contracts directly pass investment performance through to policyholders using an equivalent to a total return swap approach whereas par contracts frequently feature minimum guarantees as well as only sharing a percentage of the investment performance (for example 90%).

It was noted that the feedback received on the exposure draft ("ED") proposal for UL to amend the treatment of treasury share and owner occupied property was positive. Because of the existence of the same accounting mismatch for par business, respondents asked if the consequential amendments could be extended beyond assets backing UL contracts liabilities. The staff has identified some issues with this option, e.g. deferred tax assets cannot be measured at FV, thus proposing to amend the ED approach to reduce the accounting mismatch by measuring the liability using the same attribute as underlying item, i.e. if the underlying assets are measured at cost or they are not recognised (e.g. treasury shares), the measurement of the liability relating to this asset should also be measured in the same way. The paper gives an example of this proposal in paragraph 25.

The FASB noted that they would prefer to value the liability using the building block approach, i.e. project cash flows based on the contractual obligations of the insurer and use the fair value of the underlying items if that is what affects the benefits payable to the policyholder. They acknowledged that this creates an accounting mismatch in the situation where the underlying item is measured on a different basis or it is not recognised at all. They referred to this approach as a two step approach as you then deal with the mismatch in a second step which could produce some amendments to the accounting treatment of the assets. In conclusion FASB appeared more aligned with the ED proposals than with the new staff recommendations.

The IASB on the other hand generally supported the staff recommendation to measure the par contracts' liability on a basis consistent with the underlying items. This would eliminate the undesired accounting mismatch; the remaining source of volatility in the financial statements would come from the economic mismatch as markets change.

Some Board members asked for FV disclosure requirements as there would still remain claims against unrecorded FVs.

Following the IASB's discussions and its general agreement with the staff, the FASB confirmed their preference for measuring the liability under the building blocks approach without modifications i.e. that the cash flows should be defined based on what is promised to the policyholder. The decision on what to do with the potential accounting mismatch should be looked at as a second step.

As votes were taken the FASB unanimously rejected the staff recommendation whilst a large majority of the IASB members supported the staff recommendations.

THURSDAY, 12 MAY 2011

Accounting mismatch and volatility overview

The staff indicated that the majority of the papers to be presented were for discussion and that the results of these discussions would be taken into consideration, along with the discussions of the Insurance Working Group to be held on 16 May 2011, to determine the direction of the staff's work in this area. No decisions were asked at this meeting.

The staff further indicated that these discussions were held separately with the IASB and the FASB. In the staff's view, the individual Boards should consider this issue separately as a result of the differences in presentation, particularly on recycling and on the presentation of the assets backing the insurance contracts.

Reducing accounting mismatches in profit or loss through presentation

The staff analysed the sources of the accounting mismatches that arise when insurance assets and liabilities are measured on different bases. The staff recommended that an insurer should be permitted to recognise within other comprehensive income the differences arising between the original discount rates at contract inception and the current discount rate determined based on market interest rates observed at the reporting date. This option should be granted if that approach would eliminate or substantially reduce an accounting mismatch. The staff further recommended that the option should be applied by portfolio.

Some Board members felt that enough action had been taken to address volatility and that this proposal would be "a step too far". In particular, Board members mentioned:

• the proposals agreed by the IASB (but not the FASB) on 11 May for participating contracts; and
• the decision to use a top-down method to determine the discount rate.

In addition, Board members expressed concerns that this proposal could potentially conceal real economic mismatches or that it would only shift genuine accounting mismatches into other comprehensive income rather than addressing the cause of the mismatch. Other Board members raised concerns that if insurers were permitted to move volatility into other comprehensive income, then other industries would need to be treated the same way and other accounting standards would need to be modified to permit this.

Other Board members supported the staff recommendation. They raised the point that the Board has applied essentially a similar approach for pension accounting, and that the accounting standards should aim for a consistent approach to the treatment of variances and the use of OCI.

Implications of using OCI to reduce accounting mismatches in profit or loss

The staff noted this topic only applied if the Boards eventually supported the staff proposals regarding reducing accounting mismatches in profit or loss. The staff introduced the paper and made a number of observations, but no recommendations. Key issues discussed were:

• how to apply a locked in approach to insurance contracts with floating interest rates when the difference between the current discount rate and the locked-in rate is presented in OCI;
• whether an onerous contract test should be required where a locked-in discount rate is used; and
• how to show the effect of duration mismatches that may be concealed by the use of OCI.

The majority of Board members seemed reluctant to specify a preference before hearing the comments of the Insurance Working Group on these issues.

Among the Board members who expressed a view several were opposed to the direction of the staff observations for guarantees and for onerous contracts. They noted that this approach would allow changes in options and guarantees, representing true economic mismatches, to be recognised in OCI. Some Board members were also concerned that this use of OCI may necessitate revisions of other standards in order to maintain a level playing field across other industries as well as consistency within IFRS.

Assets backing insurance contract liabilities

The staff asked whether the IASB should change the requirements of IFRS 9 to present the gains and losses on financial assets backing insurance contract liabilities within other comprehensive income rather than in profit and loss (either changing general requirements of IFRS 4 or specifying different requirements for assets backing insurance contracts within the insurance standard). The staff presented the paper to the Board and recommended that IFRS 9 should not be changed.

Overall, the Board members were supportive of the staff recommendation, although no official vote was taken.

As they expressed their support for the staff recommendation Board members commented that they believe earnings management through realisation of gains should be avoided and this could be achieved effectively if the available-for-sale category was not reintroduced. Some members raised concerns that if previous papers should be implemented, it could lead to an uneven playing field across different industries and inconsistent treatment of similar transactions (with some going through profit and loss and others going through OCI) unless changes to IFRS 9 were made. That said, they still supported the staff recommendation.

Other Board members were concerned that if the use of OCI proposed in Paper 6B was rejected, the mismatch between asset valuations and liability valuations would remain, and would necessitate revisions to the measurement rules for the assets backing the insurance contracts in order to address volatility. In particular, these members were opposed to implementing separate measurement rules (either within IFRS 9 or as an override of IFRS 9 within IFRS 4) for the assets backing insurance contracts.

Discussion at the May 2011 IASB meeting

The joint Boards discussion on margins (risk adjustment and residual margin vs. the composite margin) spanned the two sessions on 17 and 18 May with an attempt to resolve the divergence between the two Boards. The Boards also had planned to discuss reinsurance and cross-cutting disclosure issues but these have not been debated yet.

The majority of the discussions on 17 May focused on Paper 3A (for risk adjustment) and Paper 3F (for composite margin). These discussions resulted in a general consensus amongst the Board members that the results (if not the presentation) of the two models was largely similar and that there were probably only a few areas or circumstances where significant differences would remain. In an effort to achieve convergence, the Boards directed the staffs to prepare a number of examples for discussion on 18 May. These examples were presented to the Boards on 18 May as Paper 3K.

Ultimately, after reviewing the examples prepared by the staffs, the IASB voted strongly for (only two opposed to) retaining an explicit risk adjustment, while FASB voted equally strongly (five for) the composite margin. Board members expressed dissatisfaction with this result and indicated a preference for a single standard to be developed and suggested that the topic could be reconsidered after later meetings (e.g. finalisation of the proposed treatment for the residual margin) had provided additional clarity on the exact extent of divergence.

The staff also provided a brief summary of the IWG meeting held on 16 May 2011, with no significant questions asked by the Board members.

Risk Adjustment (Paper 3A)

The staff introduced the paper, discussing the history of the insurance project with a focus on the origins and development of the risk adjustment model and presenting arguments for and against the use of a risk adjustment.

Board members noted that one of the primary differences between the risk adjustment model and the composite model as described appears to be the objective of the margins. In the risk adjustment model, the margin measures the variability of the cash flows. In the composite margin model, the entire margin represents deferred profit that should not be recognised until the service of standing ready to meet claims has been performed.

This issue was not adequately resolved, and went on to colour much of the discussion over the two days. In addition, the staff pointed out a distinct geographical distinction between those two approaches based largely on current industry practice in each geographical region. During the discussions, some Board members raised concerns that the standard being developed should be based on improving current practice, rather than aiming to maintain it, so the drivers of the final decision should be based on conceptual correctness and practical applicability rather than current practice or the amount of education required in a jurisdiction.

Although some Board members objected to the level of subjectivity the risk adjustment approach might allow, other members pointed out that as long as the level of subjectivity was disclosed it would provide valuable information regarding the risk levels of the entity's liabilities. No specific disclosures were mentioned, but references to the subjectivity and disclosures relating to level 3 financial instruments and IAS 37 were mentioned.

Finally, a Board member commented on the remeasurement differences between the two models, noting that the lack of remeasurement in the composite margin model was likely to conceal developments in risk and is therefore less transparent than a risk adjustment model.

Composite Margins (Paper 3F)

Although Papers 3E, 3F and 3G were referred to, the majority of the staff's presentation revolved around Paper 3F on realisation of the composite margin. As before, the staff introduced the paper describing the development of the composite margin model and presenting arguments for and against the use of this model.

Several of the issues raised during the discussion on the risk adjustment model were raised again. In particular, concerns about the transparency of the composite margin and whether the objective of liability measurement was truly being met, with the composite margin model being compared with a revenue recognition approach rather than focusing on liability measurement.

Board members also argued backwards and forwards about which model was "simpler" to implement, measure and apply, and whether that simplicity resulted in transparent and decision-useful information.

Ultimately, very few new arguments were raised and the Boards concluded that the results arising from the two models may well be very close in a significant number of cases. The Boards therefore instructed the staff to review this consideration and prepare examples for discussion.

Model Comparison (Paper 3K)

The staff prepared the examples that the Boards had requested, and presented them to the Boards during the 18 May discussion. The staff noted that the FASB staff disliked the model used as it did not appear to be in line with their proposed objective for the composite margin, lending further weight to the argument that this issue will not be resolved unless the Boards can agree on the objective of the margins, either for the IASB's approach to account for uncertainty via risk adjustments or the FASB's approach to defer and subsequently allocate profit based via a composite margin.

A significant amount of time was spent discussing and understanding the examples presented, and reconsidering the arguments raised during the previous days discussions.

At the end of this intense debate a fundamental disagreement between the two Boards appeared to remain on the purpose of the margins, with the IASB arguing that the risk adjustment represents a measure of the uncertainty in the cash flows of the liability, while the FASB argued that the uncertainty was already captured in the probability weighted average cash flows.

The IASB argued convincingly that a contract with a 50% chance of a £100 loss and a 50% chance of a £0 loss has a fundamentally different risk profile than a contract that had a 100% chance of a £50 loss, even though they both have a weighted average cash flow value of £50. The IASB were, however, unable to persuade the FASB of the relevance and reliability of an accounting model that recognises and discloses some measure of that variability.

Eventually, the Boards' Chairmen indicated that a decision (even if tentative) was required and called the vote. The IASB voted clearly in favour of the risk adjustment model, while the FASB voted strongly for retaining the composite margin model.

As noted above, the Board members indicated dissatisfaction with this result and indicated that this topic should be reconsidered to achieve a convergent decision once additional elements of the model had been discussed and finalised.

Discussion at the special 31 May-2 June 2011 IASB-FASB meeting

Reinsurance (Paper 3A/69A)

The FASB and IASB met for more than two and a half hours to discuss the topic of reinsurance which was originally scheduled to be discussed on 16 May. A reinsurance contract is an insurance contract that an insurer purchases to transfer insurance risk to another insurance company. The paper presented eight staff recommendations which were mostly agreed upon by the Boards. The Staff recommendations were developed considering feedback received from constituents that more details are required on the subject of reinsurance than what was included in the Exposure Draft / Discussion Paper (ED/DP).

Definition of significant risk transfer

The first Staff's recommendation was to add new application guidance to the significant risk transfer test. The guidance states that a reinsurance contract is deemed to meet the definition: "If substantially all of the insurance risk relating to the reinsured portions of the underlying insurance contracts has been assumed by the reinsurer".

Board members from both the IASB and FASB were uncomfortable with the words "substantially all" and, although they tentatively agreed with the principle behind the new guidance, they asked the Staff to refine the wording. Some Board members suggested using similar wording to those in paragraph 35 of the paper - "if the economic benefit to the reinsurer for its respective portion of the underlying policies is virtually the same as the ceding company's economic benefit, then the reinsurer has assumed substantially all the insurance risk related to the reinsurer policies". The Staff also explained that the guidance is effectively a short cut, and that if the "substantially all" condition is not met, the reinsurer would have to perform the full significant risk transfer test.

Both Boards tentatively agreed with the Staff's recommendation, assuming the wording is changed in line with that in paragraph 35 of the paper.

Interdependent contracts

The second proposal from the Staff is for the guidance to be clarified such that an "insurer shall assess the significance of insurance risk contract by contract and that, contracts entered into simultaneously with a single counterparty for the same risk, or contracts that are otherwise interdependent, shall be considered a single contract". Both Boards tentatively agreed with the Staff's recommendation without much debate.

Recognition of reinsurance contract

The Staff recommended that "when the amount recoverable from the reinsurer for a loss on an underlying insurance contract is independent of the losses and recoverable on other underlying insurance contracts, the cedant should recognise a reinsurance asset when the underlying contract is recognised, otherwise the cedant should recognise a reinsurance asset when the reinsurance coverage begins". Although the Boards tentatively agreed with the principle proposed, they asked the Staff to clarify the wording as many found it confusing. The Staff clarified that this guidance should deal with non-coterminous contract covers when the reinsurance contract reinsures a class of insurance contract which may include also contracts that will be issued in future. In these cases if the reinsurance policy is on an aggregate loss basis, a reinsurance asset would be recognised at the effective date of the reinsurance policy. The reinsurance asset would be remeasured to take into account the new reinsurance contracts issued when they are initially recognised.

Ceded risk adjustment

The Staff recommendation is for the "ceded portion of the risk adjustment to represent the risk being removed from the use of reinsurance". In the Staff view, an insurer should arrive at the same answer whether it calculates the ceded risk adjustment based on the gross or net basis and it does not propose to specify the method that should be used to calculate it. The IASB tentatively agreed with the recommendation. The FASB did not discuss this topic given their preference for a composite margin.

Treatment of gains and losses

The Staff recommended a significant change from the ED/DP approach proposing that gains on purchase of reinsurance contracts are not recognised on day one. FASB unanimously supported this recommendation whilst a minority of four members of IASB out of the fifteen present voted against it.

The basis for this approach is that the cedant has not been relieved of the obligation it has reinsured (i.e. the reinsurance does not cause derecognition of the insurance liability) and that it could cancel or commute the reinsurance contract at a later stage. For these reasons, the measurement of the reinsurance assets using the building block approach noted above is reduced by any positive difference from that calculation. In other words, the initial recognition of the reinsurance assets is not greater than any upfront premium paid to the reinsurer to purchase the contract. Both Boards approved this change from the ED/DP and asked to include in the final IFRS that an additional reason to not allow the cedant to recognise a gain on reinsurance purchased is the subjectivity in the measure and the ultimate obligation the cedant has reinsured.

The Staff also recommended a change to the ED/DP when reinsurance protection is purchased by the cedant at a loss on day one (i.e. the building block calculation produces a net negative probability weighted present value inclusive of a risk adjustment asset). The Staff proposed that the ED/DP approach that when the reinsurance contract covers pre-claims liabilities a loss should not be taken to profit or loss immediately and it should instead be amortised over the coverage period as a component of the reinsurance asset. However, this treatment would not be permitted for reinsurance of post-claims liabilities (e.g. retrospective reinsurance) where a negative building block net result would have to be recognised immediately through profit or loss.

Although the FASB members found the language used unclear and over-complicated, they generally agreed with the Staff's recommendation. A very large minority of seven out of fifteen IASB members voted against deferring the loss over the coverage period and expressed a preference for immediate loss recognition also for reinsurance purchased to cover pre-claims liabilities.

Cession of residual / composite margin on underlying insurance contracts

The Staff proposal was that on initial recognition of the reinsurance contract the "cedant shall estimate the present value of the fulfilment cash flow for the reinsurance contract, including the ceded premium and without reference to the residual/composite margin on the underlying contracts, in the same manner as the corresponding part of the present value of the fulfilment cash flows for the underlying insurance contracts". Although one IASB member disagreed, both Boards tentatively agreed with this recommendation without much debate.

Ceding commissions

The Staff recommended that the "ceding commissions and expense allowances from the reinsurance contract be included in the expected cash flows of the measurement of the liability to the extent that the cedant has included their direct costs in the expected cash flows. Any excess amount should be recorded as a reduction in the ceded premium." There was confusion among Board members on this topic as it was not clear to them whether this was a question of measurement or presentation. The Staff clarified this is related to presentation and the Boards asked the Staff to bring back this discussion when they address presentation in a wider context.

Credit risk of reinsurer

The recommendation from the Staff was that "the cedant record an allowance for the risk of non performance by the reinsurer when estimating the present value of the fulfilment cash flows when the current information and events suggest the cedant will be unable to collect all amounts due according to the contractual terms of the reinsurance contract." The FASB were unanimously in favour of the Staff's recommendation. The IASB on the other hand preferred to rely on the general impairment model that is available in the current literature in IAS 39. This will be reviewed in light of the new impairment model for financial assets once it is finalised.

Discussion at the June 2011 IASB Meeting

MONDAY, 13 JUNE 2011

Whether to unlock the residual margin (Paper 3B)

The staff introduced the paper, discussing the ED, the comments and responses to the ED and the results of the field testing. The IASB staff recommended that the residual margin should not be locked in from inception, and should be adjusted for changes in the estimated cash flows. The FASB staff did not support this proposal as they had concerns that unlocking the residual margin risks concealing movements and noted the current US GAAP methodology.

IASB members raised concerns that the proposal to unlock the residual margin necessitates a redefinition of what the residual margin is meant to be. Originally, the residual margin represented the difference between premium and the insurance liability which cannot be recognised on day one. Some considered it to be the "expected profit" on the contract. The staff concluded that their proposal is an attempt to make the residual margin represent the unearned profit remaining on the contract. Board members raised concerns about this approach, as the insurance contracts project was focused on liability measurement, not profit recognition.

Additional concerns were raised that this approach could conceal movements on the face of the balance sheet and profit and loss, rendering the financial statements less transparent. Unlocking could also potentially break the link between assets and liabilities, resulting in additional accounting mismatches.

Members also raised concerns that unlocking could increase the complexity of the new standard even further and noted comparisons to the corridor approach that was applied to pensions accounting.

Supporters of the staff proposal noted that, even though they agreed with the staff proposal, additional work would need to be done in order to make this proposal workable.

At the vote, the IASB members voted marginally in support (8 vs. 7) for the staff proposal. The FASB members did not appear to vote formally, but the majority of the members did not seem to support this proposal.

How to unlock the residual margin (Paper 3C)

Continuing from the discussion in paper 3B, the staff turned the discussion to how the residual margin would be unlocked and raised a number of questions for the Boards consideration.

Q1: 'Consume' or 'float'

The first topic raised by the staff was whether the residual margin should be "floated" (i.e. adjusted for positive and negative changes) or "consumed" (i.e. adjusted only for negative changes). The staff recommended that the residual margin should be floated, and that no limits should be applied to the adjustments.

Board members raised a number of concerns about the practicality of this approach and the potential complexities involved in implementing it. Staff responded that companies were already doing something similar under Australian GAAP. Comments were also made that, having decided to support the unlocking of the residual margin, the decision to support floating over consuming the residual margin was a more logical conclusion

The IASB then voted (11 vs. 4) to support the staff recommendation to float the residual margin and to impose no limitations to the adjustments made. The FASB, unsupportive of unlocking the margin, elected not to vote on this topic.

Q2: What changes should adjust the margin & Q3: Changes in discount rates

The next topic considered was which changes should be reflected in the residual margin, with the staff recommending that:

• all changes in the estimates of the cash flows should be recognised in the adjustment to the residual margin; and
• insurers are permitted, but not required, to recognise the adjustments arising from changes in the discount rate in profit and loss when recognising the adjustment in the residual margin would result in an accounting mismatch.

The IASB discussed any limitations in the residual margin, with the IASB voting (12 vs. 3) to not limit increases in the residual margin. The IASB then discussed whether changes in discount rate should be recognised as an adjustment to the residual margin or in profit or loss in the period of the change to the extent that these changes create an accounting mismatch. No decision was made, as Board members commented on the complexities that would arise, with some commenting that the issue was not fully understood and that they would prefer to defer the decision until more work had been done.

Q4: Changes in risk adjustment

The first item being assessed was the changes in the risk adjustment. The staff recommended that all changes to the risk adjustment should always be recognised in profit and loss.

Boards' members commented that this approach was inconsistent with previous staff recommendations to recalibrate the prospective remeasurement of the building blocks against the residual margin. Several members indicated at this point that they were reconsidering their votes to previous recommendations.

However, the IASB still voted 9 vs. 6 to support the staff recommendation.

Q5: Adjust prospectively or retrospectively

The staff recommended that changes to the residual margin should be made only on a prospective basis. With fairly minimal discussion, the IASB voted (10 vs. 5) to support the staff recommendation.

In conclusion, these decision suggest that the future IFRS will have a recalibration approach that takes into account the prospective remeasurement of the probability weighted cash flows (building block 1) but excludes those arising from the risk adjustment (building block 3). It would also appear to suggest that prospective changes in the discount rate (building block 2) would not be taken against the residual margin given the narrow rejection of the recommendation to link recalibration with accounting mismatch. This last decision could mean that insurers with assets at amortised cost would be exposed to the accounting mismatch arising from the fluctuation of their discount rate used to measure their insurance liabilities. This has been described as the "cost-current" mismatch (from the fact that the assets are at cost and the liabilities are on a current basis) or liability driven mismatch.

Allocation of the residual margin (Paper 3D)

The staff presented their paper to the Boards and recommended that:

• the residual margin should not be negative
• the residual margin should be allocated over the coverage period on a systematic basis using a pattern reflective of the transfer of the services provided
• the residual margin should be determined on a level that aggregates similar contracts.

A Board member queried whether a change in the earning pattern would be considered a change in accounting policy, to which the staff responded affirmatively.

Some members raised concerns that if the residual margin was meant to represent the unearned profitability on the insurance contract (as indicated in papers and decisions earlier in the day), earning of the full amount over the coverage period was inconsistent. Other members were concerned that this topic had implications for day one gains and onerous contracts that had not been adequately explored.

No opposition was raised to the proposal that the residual margin should not be negative.

The IASB voted (9 vs. 6) in support of the proposal to recognise the residual margin over the coverage period. This means that for post-claims liabilities insurers would not have any residual margin for the recalibration to be performed against prospective changes of cash flows.

No decision was taken on the third recommendation, as the Boards felt that decisions on the definition of a portfolio should be taken prior to considering this issue.

Acquisition costs revisited (Paper 3E)

The staff presented the paper to the Boards and highlighted the current position as well as the divergent opinion previously expressed by the two Boards. The staff also asked the question of whether the Boards wanted to retain the tentative decisions previously taken or to follow some other approach to acquisition costs (e.g. based on an approach consistent with the Boards' tentative decisions on leases or revenue recognition).

Principally, the Boards' debate focused on the unit of account (i.e. at what level acquisition costs should be measured) and on whether the acquisition costs to assemble a portfolio, however defined, should include the costs associated with unsuccessful attempts to issue a contract.

Some Board members commented that all acquisition costs incurred in assembling the portfolio are considered by the insurance company and priced into the consideration charged for issuing new contracts thus confirming the logic of including all acquisition costs. Other members rebutted this argument on the basis that a) the portfolio includes only the product of successful efforts, and b) no other industry is permitted to defer acquisition costs on unsuccessful efforts to sell a contract with a customer even though they also price their contracts accordingly, even if all acquisition costs are necessary to assemble a portfolio the justification to have a different approach for insurance contracts appears to be controversial.

The Boards voted (IASB – 14 vs. 1; FASB – unanimous) that only direct acquisition costs should be included within the insurance contract cash flows and remained divergent (IASB – 6 vs. 9; FASB – unanimous) on the proposal to include only costs associated with successful sale activity.

WEDNESDAY, 15 JUNE 2011

Presentation of insurance contracts in the statement of comprehensive income

The FASB Staff introduced the paper explaining that, in developing the current recommendation, consideration had been given to the feedback received from the Boards and the feedback from the outreach on the alternatives presented at a previous meeting. It was also noted that this paper does not cover the statement of financial position (balance sheet), the presentation of purchased reinsurance, nor that of unbundled deposit components.

Volume of insurance contracts sold

According to what the Staff has heard from users and preparers of financial statements, most want to see both volume and margin information. The Staff recommendation to accommodate this request considered three alternative presentation examples with the first one being preferred by the Staff. In developing the alternative examples, the Staff considered three approaches for the premium recognition criteria for the presentation:

• due – consistent with the cash flow estimates in the liability;
• written – consistent with initial liability measurement; or
• earned – consistent with the release of the margins.

The Staff recommended that, for contracts measured using the building block approach, the premium due be presented in the statement of comprehensive income, with no indication that it is revenue. Although several of the Board members expressed a strong preference for using premium earned, which is what they believe users of accounts are used to see, the Staff explained that this approach does not fit with several insurance contracts, in particular those with long term coverage.

The approach recommended separates the underwriting margin between the margin from contracts measured using the modified approach, where the premium earned is presented, and the margin from contracts measured using the building blocks, where the premium due is presented instead.

Presentation of insurance contracts income and expenses

Together with the volume information, the statement of comprehensive income will also show as separate items changes in assumptions, release of the margins, investment income and changes in discount rates. The Boards expressed their agreement that the Staff recommendation is a step forward compared to the ED. However, the Boards’ preference appeared evenly split between the two illustrations that were not part of the Staff recommendation. Those favouring example 2 liked that it offered a dual statement presenting separately the contracts measured using the modified approach and those measured using the building block approach, and showing the detail of expected versus actual cash flows for the latter. These Board members argued it was easier to see the profit drivers and how the building blocks developed. It was noted though that the wording should be simplified to remove some of the insurance jargon. A final advantage of this presentation would seem to be the clarity on revenue presentation as, in example 3, premiums are presented on one line leading to an implicit association to a revenue line despite the earlier agreement that volume information should not have this connotation.

On the other hand, those in support of using example 3 noted that it resembles more the traditional statement of comprehensive income, showing premiums due, claims and expenses incurred, release of margins and changes in margins and assumptions. Those in favour of example 3 also argued that it may have most appeal to the industry as it is closer to what they are used to. From a standard setting perspective it would seem to offer a clearer way to set minimum requirements and allow preparers to put additional information in the notes. Such an approach would also have the benefit of avoiding the development of a statement specific to the insurance industry that users would find difficult to understand. The information in the footnotes would still be important and the IFRS should contain specific requirements to allow a consistent disclosure of key performance indicators.

The IASB was split equally between examples 2 and 3 with seven members voting for each, whilst a majority of five members of the FASB against two were in favour of example 2.

Discussion at July 2011 IASB Meeting

THURSDAY, 21 JULY 2011 (IASB-FASB)

Short term insurance contracts

The staff introduced the discussion topic, the modified approach for short term insurance contracts, and provided a summary of the relevant decisions made to date as well as the outreach that had been undertaken. In particular, the staff discussed the feedback on the ED proposals and the Insurance Working Group feedback on the post-ED discussions to date.

The staff proposed two approaches, with the IASB and FASB staffs each supporting different approaches. The IASB staff proposed a "one-model" approach, under which the simplified model for the pre-claims accounting phase of a short term contract is based on the revenue recognition project and serves as a proxy for the building block approach which is then used for the post-claims accounting phase of these contracts. The FASB staff proposed a "two-model" approach, under which the simplified model and the building blocks approach are separate accounting models and short term and long term insurance contracts are different types of contract.

With minor exceptions (principally in the eligibility criteria), the two approaches are expected to have largely similar practical results. The staff noted that it is likely that approximately 90% of the contracts eligible for the simplified under one approach would also be eligible under the other approach. The Boards were, however, unable to reconcile the "one-model" and "two-model" concepts with their understanding of the insurance project overall direction so far and whether specific contract examples would meet the eligibility criteria under the two approaches. The allocated time was largely spent debating whether a one-model approach or a two-model approach should be used and whether that approach was justified by the economics of the underlying transactions.

No decisions were reached and none of the other topics in the Papers were considered. It is emblematic of the current level of progress on this project that one member commented that the Boards had "wasted one and a half hours talking in circles". The Boards directed the staff to prepare additional information for the next meeting. This additional work is primarily a review of insurance contract types to identify those contracts that are likely to meet the eligibility criteria for one approach but not the other so that the Boards could then consider whether changes should be made to the eligibility criteria proposed by the staff in today's meeting.

Discussion at September 2011 IASB Meeting

Disclosure

Aggregation and disaggregation principle

The Boards resumed their discussion on insurance contracts after the summer break with a number of Staff recommendations on the disclosure principles and guidance applicable to insurance contracts.

The first topic was the principle of meaningful aggregation and disaggregation included in paragraph 81 of the ED where it was stated that an insurer shall aggregate or disaggregate information so that information that is useful is not obscured by either the inclusion of a large amount of insignificant detail or the aggregation of items that have different characteristics.

The staff recommended that for the disclosures of insurance contracts:

• The final standard should only include the aggregation and disaggregation principle of disclosures in paragraph 81 of the ED on the grounds that this would be consistent with other projects such as Revenue and Leases. However the Staff recommended that the final standard should not prohibit an insurer from aggregating amounts across reportable segments.
• Finally they recommended that minimum disaggregation levels—if necessary—should be addressed for the individual disclosure requirements.

After a lively debate where the proposals were analysed in detail the Boards agreed with the Staff recommendations.

Methods, inputs and changes from previous periods

The Boards discussed the methods, inputs and changes from previous periods. As part of this discussion, the Staff recommended:

a)	To retain the ED requirement that an insurer discloses separately the effect of each material change in inputs and methods, together with an explanation of the reason for the change, including the type of contracts affected.
b)	To change the disclosure on discount rates in line with previous Boards’ guidance and to require that for contracts in which the cash flows do not depend on the performance of specified assets an insurer would disclose the yield curve (or range of yield curves) used.
c)	To remove the ED requirement to disclose a “measurement uncertainty” analysis for the inputs that have a material effect on the measurement of insurance contracts.

Proposals a) and b) were approved whilst c) caused a great deal of discussion which resulted in another divergent decision between the two Boards.

The IASB members decided that it would be better to align the IFRS on insurance to the requirements of IFRS 13 where the disclosures of measurement uncertainty have been developed. FASB members instead preferred to retain the proposals of the ED and they rejected the Staff recommendation.

Nature and extent of risk arising from insurance contracts

The Boards discussed the nature and extent of risk arising from insurance contracts. As part of this discussion, the Staff recommended:

a)	to tighten the ED requirements in favour of a more consistent disclosure of liquidity risk such that the maturity analysis be based only on expected maturities (expected net undiscounted cash outflows resulting from recognised insurance liabilities). The option to disclose an analysis based on the remaining contractual maturities would be removed from the final IFRS;
b)	to specify the minimum time bands for the maturity analysis in line with those of the leases project where, at the minimum, the table includes the expected net cash outflows for each of the first five years and a net total for the remaining and
c)	not to require further prescriptive liquidity disclosures such as:
	i.	information on the ability of policyholders to request/demand their funds.
	ii.	distribution of liquidity needs between different entities within the consolidated group.

Some IASB members commented that a broader guidance in line with the FASB decisions at their meeting on 7 September would be preferable given that liquidity risk is affected by the composition of the entire balance sheet and not only the expected maturity of certain liabilities.

The IASB eventually supported the Staff recommendations whilst the FASB preferred to extend its decisions on financial risk disclosures to issuers of insurance contracts. These decisions include two key requirements:

Risk adjustment: Objective and confidence level disclosure

Risk adjustment objective

The Staff recommended that the IFRS states that the objective of the risk adjustment should be "compensation the insurer requires for bearing the uncertainty inherent in the cash flows that arise as the insurer fulfils the insurance contract".

The IASB approved this recommendation.

The Staff also recommended that the application guidance on the risk adjustment objective should clarify that:

a)	the risk adjustment measures the compensation the insurer would require to make it indifferent between
	i.	fulfilling the insurance contract liability, and
	ii.	fulfilling an obligation to pay an amount equal to the expected present value of the cash flows that will arise from the insurance contract
b)	in estimating the risk adjustment, the insurer should consider both favourable and unfavourable outcomes in a way that reflects its degree of aversion
c)	a risk adverse insurer would place more weight on unfavourable outcomes than on favourable ones.

Some IASB members thought the ‘than on favourable ones’ language in recommendation c) above should be removed because of the ambiguity it carries. However the IASB agreed with all of the Staff proposals.

In addition the IASB decided to retain the confidence level equivalent disclosure that had been proposed in paragraph 90(b)(i) of the ED. Eleven IASB members supported this decision.

The basis for the rejection included a number of specific considerations all of which displayed a common discomfort of the IASB members to introduce disclosures that would have brought back into the new IFRS elements of the current exit value approach that had been abandoned in favour of the current fulfilment value model.

Risk adjustment: Techniques and inputs

Removal of the limitation of techniques

The Staff recommend eliminating the limitation of the permitted techniques for quantifying the risk adjustment and that an insurer should apply a valuation that simply meets the objective of the risk adjustment.

The desirable characteristics that a risk adjustment technique should satisfy in order to meet the notions that the Board intended to convey with the risk adjustment objective are: (a) risks with low frequency and high severity will result in higher risk adjustments than risks with high frequency and low severity, (b) for similar risks, contracts with a longer duration will result in higher risk adjustments than those of a shorter duration, (c) risks with a wide probability distribution will result in higher risk adjustments than those risks with a narrower distribution, (d) the less that is known about the current estimate and its trend, the higher the risk adjustment shall be and (e) to the extent that emerging experience reduces uncertainty, risk adjustments will decrease and vice versa.

IASB members approved the Staff recommendation and reaffirmed the characteristics as drafted in the ED. However some IASB members noted that these characteristics did not include anything in relation to the level of diversification of a portfolio, since a large correlation of the individual risks increases a portfolios risk, and vice versa.

Finally the IASB decided to retain as examples the three techniques mandated in the ED (Confidence levels, CTE and Cost of Capital), together with the related application guidance.

Discussion at October 2011 IASB Meeting

The session was extensive and it began an hour earlier than scheduled and ended one hour later.

The Boards considered a verbal summary of the investors' outreach that took place during the last few months. The Staff summarised it saying that there were two broad themes emerging from the outreach. Based on their understanding investors wanted to see:

• More evidence of the Boards' intention to listen to their views and concerns. However the Staff also noted they received conflicting views and requests from investors; and
• An accounting standard that reports economic volatility, volume information and provides them with insights into the effects of measurement judgements as well as when these judgements are changed, in particular when dependent on changes in interest rates.

Scope – Fixed fee service contracts

The FASB Staff led the discussion on this item reminding the Boards that last March they tentatively agreed to exclude certain types of fixed fee contracts from the definition of insurance.

Staff recommended that fixed fee contracts that provide service as the primary purpose should be excluded from the scope of the insurance contract standard if they exhibit all of the following characteristics:

1. contracts are not priced based on an assessment of the risk associated with the individual customer,
2. contracts typically compensate customers by providing a benefit in kind rather than by paying cash, and
3. the type of risk transferred relates mostly to 'over utilisation' of services.

The discussion considered specific arrangements to be in the grey area including windscreen replacement, roadside repair, warranty and health as the Boards worked to ensure they understood where specific contracts would fall out of scope.

Overall, there was broad support from the Boards despite some open questions on certain contracts such as warranty or health related contracts. The Staff recommendation was unanimously approved by both Boards, subject to redrafting certain language and inclusion of application guidance or examples.

Presentation – Statement of comprehensive income (SoCI)

The Staff reminded the Boards that in the June meeting, there were presentation alternatives for which the Boards expressed interest in more information. The Staff outlined with illustrative examples the alternatives to the recommended presentation highlighting what information would be required to be on the face and in the notes and how the recommendation applies to the Building Blocks Approach (BBA) and the Premium Allocation Approach (PAA). The Staff noted that they concluded that a separate presentation of BBA and PAA items is useful.

The Staff asked whether the Boards agree that the insurer should disclose:

1. the underwriting margin from the contracts accounted for with the BBA;
2. certain specific components of the BBA underwriting margin as listed in the Staff proposal;
3. the underwriting margin from the contracts accounted for with the PAA; and
4. certain specific components of the PAA underwriting margin as listed in the Staff proposal

In addition, the Staff asked with which of the recommendations below the Boards agree with and which line items should be presented as a minimum on the face of the SoCI.

The recommendations were:

Recommendation A – Disclose the underwriting margin either in total or segregated between the BBA and the PAA contracts with a requirement to present premium earned income and claims expenses for the PAA contracts and a requirement to present premiums due for the contracts under the BBA; or

Recommendation B – Mandate only the BBA underwriting margin in the SoCI leaving the PAA and the BBA premiums due items as required disclosure notes with an option to include them on the face of the SoCI as an accounting policy election.

The Staff noted that volume information under Recommendation A is on the face whilst Recommendation B would allow for that information to be in the disclosure notes and it would result in an approach that would produce a similar SoCI for pure insurers as well as conglomerates with insurance operations. Recommendation A would always operate under the usual materiality principle.

Recommendation C (suggested in an addendum by one of the IASB members) – Combine BBA and PAA in separate columns that refer to the underlying business models (i.e. life and non-life for lack of better definition at this point) with only two items mandated on face: the sum of premium earned and premium due, the latter adjusted for the changes in the BBA liability, and the underwriting margin line. The proponent IASB member noted that this approach makes information more comparable outside the insurance sector.

The Staff noted that they felt Recommendation C was complex, that changes in the liability also contain the impact of claims and benefits and that the premium figure for the BBA portion of that line item would be a derived number rather than a real premium amount.

The IASB member proposing Recommendation C illustrated with examples why he did not believe that figure should be deemed a derived amount and that he could see its relevance to investors.

A lively albeit inconclusive debate followed where we noted in particular that the Boards only agreed that the recommendations could be seen in a different light if there was a more extensive unbundling of deposit components.

All acknowledged that users wish to see volume information (e.g. premiums) and the underwriting margin. It was also noted that insurers could be required to only apply the IAS 1principles to address the need to include particular items on the face of the SoCI. With these considerations, that do not appear to represent tentative decisions, the Boards asked the Staff to bring back this matter using examples that explore Recommendation C and that illustrate the differing entity types.

The Boards did not address the remaining questions from the Staff paper.

Presentation – Statement of financial position (SoFP)

The Staff asked whether, for the BBA contracts, the Boards agree that insurers should disaggregate the following components, either in the SoFP or in the notes (in this case the amounts must reconcile to the SoFP):

1. Expected futures cash flows
2. Risk adjustment (IASB)
3. Residual margin (IASB)
4. the single margin, where relevant (FASB)
5. the effect of discounting?

The Boards unanimously agreed with this recommendation. However, in response to a proposal from one of the FASB members to consider whether acquisition costs could also be separately presented in the SoFP as an asset they agreed to have the Staff pursue this further at a future meeting.

The Staff then asked whether, for those contracts measured under the PAA, the Boards would agree that the liability for unexpired coverage (i.e. that based on the unearned premium method) should be disclosed separately from the liability for incurred claims (always based on the BBA).

The Boards agreed with this recommendation unanimously.

The Boards then decided that for the PAA an insurer would recognise as a receivable any uncollected premium due to secure the short duration coverage irrespective of the fact that the policyholder has a right to cancel the policy and forfeit the payment of those premiums not yet due. The receivable would be an asset outside the scope of the insurance contracts standard. The vote was unanimous from FASB and majority-based from the IASB (9 against 6).

The Staff had proposed that only the unconditional right to receive a premium is accounted for as an asset with the conditional premiums deducted from the unearned premium liability. The Boards overruled them on the grounds that this would be a departure from the existing practice that seems to have support from many users.

It should be noted that with this decision an insurer would account for the unearned premium liability based on the way the policyholder agrees to pay the premium (i.e. all upfront or by instalments over the coverage period). In the event of a significant conditional premium payment the accounting of the receivable under the financial instruments standard would recognise a lower asset than in the event of an upfront payment. This is due to the initial fair valuation of the asset which would take into account the probability of certain cash flows not being collected. As a result the unearned premium liability would also be lower to reflect the fact that it may expire earlier following the cancellation of the "stand ready" obligation that a non-payment of a future premium would trigger.

The majority of the Boards then approved the Staff recommendation that the PAA liability would be presented separately from the BBA liabilities. This required two IASB votes because they initially perceived this as implicitly requiring a vote for a two-model approach which they reject. However when the IASB Staff reassured the IASB that this was not the case and 10 IASB members approved the proposal with only 5 still voting against it.

One last item on the SoFP discussion was the agreement to account for portfolios that under the BBA may be assets separately from portfolios that are liabilities. On the grounds that there will be a future debate on the presentation of acquisition costs deemed part of the contractual cash flows the FASB unanimously supported the proposal with 13 IASB members voting in favour and only 2 against it.

Eligibility criteria for the PAA

The last item for discussion at this meeting was a matter that the Staff brought back after having been unsuccessfully discussed at two previous joint meetings with July being the most recent instance of this ongoing stalemate. Unfortunately also this third attempt was fruitless and the Staff will be preparing a new attempt in the coming months.

Parallel to this discussion and increasing its overall importance in the Boards' efforts to converge is the underlying disagreement between the Boards on an accounting standard for insurance contracts that uses a single or two measurement models or, in other words, whether the PAA is a simplification of the BBA or an accounting model on its own.

IASB strongly believes that there should be a single model with a simplification allowed when the PAA delivers materially the same results as the BBA. FASB instead believes that a separate model based on the PAA should be codified in the final standard.

At this meeting the Staff suggested to consider the PAA as the measurement for any type of insurance contract and develop criteria for when an insurer would not be permitted to use it. This new approach, which was further refined with an addendum paper released the night before the joint meeting, would require an insurer to use the BBA when either of the following applies:

1. The BBA provides more relevant information than the PAA, relative to the cost; or
2. It is difficult to allocate the premium for the contract in a reliable and a rational manner.

For both criteria the Staff had also produced application guidance which triggered a lively but ultimately inconclusive debate around its outcomes.

The Boards gave general support for what the Staff was trying to achieve but concern over the application guidance being ambiguous and resulting in the accounting of contracts under the PAA that both Boards would instead expect to be measured with the BBA ended in a request to redraft the guidance that supports these criteria. The Boards also asked for examples of contracts that are in the PAA or in the BBA based on these future revised criteria.

Discussion at the November 2011 IASB Meeting

TUESDAY, 15 NOVEMBER 2011

The IASB met on the 15 November for an educational session on residual margin. During the two hour long meeting, the IASB staff presented the papers and asked the Board their views on certain questions without formally asking for decisions to be taken. Although the FASB staff joined by teleconference, it did not participate in the discussions as FASB prefers the route of a single composite margin.

The first paper, "Which changes in estimate adjust the residual margin?", discusses the changes in estimate that would adjust an unlocked residual margin, assuming that the tentative decision of unlocking the margin to reflect changes in cash flows still holds. The staff asked the IASB its views on whether all the changes in estimates used to measure the insurance contract liability should adjust the residual margin and if not, which changes should / should not.

After quite a lengthy discussion, there was a clear preference among the Board members for unlocking only non-financial estimates (i.e., any changes relating to the discount rate and the risk adjustment should not be taken through the residual margin (assuming the tentative decision to unlock remains)). It was however made clear to the staff that many questions still remain unanswered and that developing concrete examples would make the discussions much more productive.

The second paper, "Residual margin — two approaches", contrasts the approaches of locking in the residual margin at inception, as per the exposure draft, and the approach of adjusting the residual margin to reflect some or all changes in estimates. After summarising the paper, the staff asked the IASB what approach it favoured. Views were split; approximately half of those members who spoke up had a preference for unlocking the margin whereas the other half preferred to retain the approach from the exposure draft. We noted that similar arguments were raised to support both views; in particular, the degree of complexity was raised as a negative feature of the other approach by both camps. IASB staff appeared to provide support to the unlocking camp when they pointed out that locking the residual margin is not as simple as it may appear and that respondents to the exposure draft were indeed concerned about the practical implications of locking in the residual margin.

The other papers on allocation of residual margin and interest accretion were not discussed. Another session on insurance is taking place on 16 November and will address disaggregation of explicit account balances.

WEDNESDAY, 16 NOVEMBER 2011

The IASB and FASB met to discuss the disaggregation of explicit account balances. This topic has previously been referred to as the unbundling of non-insurance components.

Prior to opening the debate on this issue, the IASB staff summarised the feedback received from the Insurance Working Group (IWG) received on 24 October 2011, when two representatives of the insurance industry presented their proposals for an other comprehensive income (OCI) solution for insurance accounting. The staff reported that IWG members expressed a preference for assets and liabilities to be measured on a consistent basis - either on a current or cost basis ("current-current" or "cost-cost" approaches). The "current-current" approach seemed to be favoured if something along the lines of the OCI solutions proposed is included in the final IFRS to reduce volatility from accounting mismatches. The staff acknowledged that in spite of the significant support observed among the IWG members, a number of questions on the OCI solutions remain unanswered; in particular on the subject of liability adequacy testing and residual margin unlocking.

Moving to the paper on the explicit account balances accounting, the staff highlighted its recommendation that an account balance was explicit if it was an accumulation of the monetary amount, credited with an explicit return. They also clarified that they would distinguish between unbundling and disaggregating non-insurance components. The disaggregation of an explicit account balance would be for presentation purposes only and the insurer would measure the cash flows of the explicit account balance together with all the other cash flows from the insurance contract under the building blocks approach. Subsequent to the completion of the measurement, it would present any explicit account balance separately. The staff asked their first two questions:

1. Do the Boards agree that all explicit account balances should be presented separately from the insurance contract liability?
2. Do the Boards agree with the following criteria for identifying explicit account balances?
   A contract has an explicit account balance if both of the following conditions are present:
   1. The balance is an accumulation of the monetary amount of transactions between the policyholder and the insurer.
   2. The balance is credited with an explicit return. A return is explicit if it is determined by applying either of the following to the balance: (1) a contractual formula in which the insurer may have the ability to reset the return rate during the life of the contract or (2) an allocation determined directly by the performance of specified assets.

The FASB chair asked for a vote on the first question noting that they would need to assume that the staff proposal would be a de minimis in terms of disaggregation of account balances and conceding that members may wish to expand it. Both Boards agreed; however, some said that other items would need to be considered and explored further. The Boards decided to avoid the second question because of the underlying issues around what should be included and how it should be measured and preferred to consider the staff's other questions. The staff then put forth the next three questions:

1. Do the Boards agree that all explicit account balances and the related assets should be recognised in an insurer's financial statements and that they should not be offset against each other?
2. Do the Boards agree that an insurer shall measure explicit account balances and services associated with the explicit account balances, if any, together with the other components of insurance contracts?
3. Do the Boards agree that explicit account balances should be presented separately from the insurance contracts liability on the face of the statement of financial position (rather than the notes) in an amount equal to the sum of:
   1. the explicit account balance, and
   2. an accrual for all fees and returns though the reporting date?

The staff reiterated that explicit account balances would not be unbundled with a separate measurement from the insurance component of the contract. Instead they would be measured together with the other components of an insurance contract's cash flows. However their disaggregation from the insurance contract carrying amount would result in a separate presentation from it on the face of the statement of financial position. Such an approach would not require the explicit account balances to be discounted. Following inconclusive discussions among Board members, the IASB staff attempted to survey the Boards with some basic questions. When asked if the Board members believe the whole contract should be measured using the building blocks (excluding embedded derivatives, etc. and other items already unbundled), 9 IASB members said they did with 6 members preferring unbundling to disaggregation. However, the IASB members were unanimous that at least disaggregation would be needed in the final IFRS. Finally, the same majority of 9 indicated that they would be comfortable to restrict the disaggregation requirements to explicit account balances only as defined in the staff paper. The other members were prepared to go further in disaggregating deposit components. When asked similar questions, only two FASB members believed that the whole contract should be measured using the building blocks.

The IASB chairman declared that no tentative decisions could be recorded at the end of the session and asked the staff to explore other approaches. He also asked for more concise and thorough papers stating that the length of the paper discussed at this session coupled with the number of questions that remained and needed to be addressed may have been a factor affecting the quality of the debate.

Discussion at the December 2011 IASB Meeting

THURSDAY, 15 DECEMBER 2011

Policyholder participation

With the exception of Marc Siegel for FASB and Ian Macintosh for the IASB all members of the Boards attended the session on insurance contracts where four individual issues were deliberated.

The first paper did not ask for a decision but reported on the FASB meeting of 30 November. At that meeting FASB agreed a simplified method for the measurement of certain cash flows of insurance contracts with non-discretionary and performance–linked participating features. These cash flows are determined by reference to assets and liabilities that are the underlying of the non-discretionary performance –linked participating feature. These cash flows will be measured at the insurer’s current obligation adjusted to eliminate accounting mismatches that reflect timing differences between the current obligation and the USGAAP/IFRS value of the underlying items the cash flows are linked to. These differences should reverse within the time horizon set by the boundary of the insurance contract

This wording is subtly different to the May 2011 IASB decision to measure the relevant component of the insurance participating contract liability at the IFRS value of the relevant underlying assets and liabilities.

It was noted that although the wording of the FASB decision differs from the previous IASB decision the effect of this FASB decision is that FASB have now converged so as to be equivalent with the IASB decision taken in May 2011. Under both Boards’ proposals the participating contract insurance liability would be adjusted to mirror the measurement and presentation of the underlying items to the performance of which it is linked. The Staff and Boards will further consider whether they can agree on an identical wording that can be used to set out both decisions.

It was reported that FASB also agreed to converge with the earlier IASB decision that any changes in the relevant component of the insurance contract liability should be presented in the same way within the SoCI (i.e. consistently within net income or OCI) as the relevant underlying assets and liabilities.

Measurement of options and guarantees embedded in insurance contracts

The Staff paper noted that although (as noted above) a mirroring approach has been agreed for certain non-discretionary performance-linked participating features, it is necessary to consider separately any embedded options and guarantees.

The paper noted that embedded options and guarantees could be valued either by including guaranteed cash flows in the scenarios where the guarantee takes effect or directly determining a market-consistent value for the option and guarantee. In other words in those scenarios where the embedded derivative has effect the cash flows of the derivative and not of the underlying item should be considered in measurement of the insurance liability. Staff recommended that for all insurance contracts (including participating contracts):

"all options and guarantees embedded in insurance contracts that are not separately accounted under the financial instrument standard as a derivative instrument should be measured using a current, market-consistent expected value approach"

After some discussion as to whether further clarification was needed on the selection of the discount rate, the Board members present unanimously supported this Staff recommendation.

Cash flows that existing contracts require to be paid to future policyholders

The paper relates to participating contracts where the insurer is required to declare a distribution of the assets within participating funds the insurer holds to its policyholders when the insurer and where undistributed amounts to policyholders who have lapsed, surrendered or matured their policies are carried forward for future distributions and cannot be attributed to the insurer’s own equity. When policies expire they forfeit the policyholders’ benefits not yet distributed and these benefits are spread between the remaining and any new policyholders that would purchase a new contract issued from the same participating fund. In rare cases where there are few policyholders remaining and the undistributed surplus is quite large the entity maybe able to apply to the insurance regulators to affect a payout to someone other than policyholders but this requires a change of the contractual terms.

The Staff paper concluded that there is a present obligation arising from a current contract and that it represents a liability even though the identity of future policyholders is not known. The contract boundary is not breached as the liabilities relate to a current contract not a future contract. . Staff recommended that:

"...when measuring an obligation created by a contract that depends partly on the performance of assets and liabilities of the insurer, an insurer should include in the measurement of the insurance contract liability all such payments that result from that contract, whether payable to current or future policyholders."

It was noted by various Board members that in some circumstances insurers may obtain judicial and/or regulatory approval to vary the contract terms so that part of the contract obligation may be payable to shareholders but the consensus was that any such potential variation of contract terms could be dealt with by specific disclosure should it arise. With one abstention the Board members present otherwise unanimously supported this Staff recommendation.

Discounting of insurance liabilities for incurred claims (board paper 7H/77H)

Before the discussion on this paper Hans Hoogervorst noted that IASB had received a memo from the Hub Global Insurance Group which requested the Boards to withdraw this paper – citing there had not been proper due process. Mr Hoogervorst confirmed that the Boards would not withdraw to the paper and would respond to the Hub Global Insurance Group noting that the Boards disagreed with many of the points raised in the memo.

The Boards discussed the first part of this paper in which the Staff asked the Boards to:

"reconfirm their earlier decision to require the discounting of the liability for incurred claims when the effect would be material."

The paper noted the views of those respondents to the ED that are opposed to discounting. Board members noted their support for a general principle that requires discounting where its effect would be material. It was noted that the time value of money is an essential component of an insurer’s business and pricing models and that as the time value of money is implicit in asset valuation, measuring liabilities on an undiscounted basis would introduce accounting mismatch.

The Staff paper also included the results of the Staff model which looked at the impact of discounting the incurred insurance claim liability on the net income and total surplus based on US non-life insurance regulatory filings for the period 2005-2010. The results showed a significant effect due to discounting which varied over the period.

It was noted that all undiscounted liability information currently included in the financial statements would continue to be available within the financial statements including the 10 year development table on an undiscounted basis.

The final accounting standard will require the disclosure of the yield curve used to determine the effect of discounting and a maturities table showing the expected settlement pattern.

The Board members present unanimously supported this Staff recommendation.

Two members noted that consideration should be given to an exception from the discounting requirement for certain very material one-off exposures. Such exposures often have considerable uncertainty over the timing of settlement, limited relevant prior experience of such exposures and the absence of a group of such exposures, resulting in considerable difficulty in determining an appropriate settlement pattern for such one-off exposures against which to apply discounting. Consideration of this question was deferred until Friday.

A further point raised and deferred for consideration to Friday is whether the materiality of discounting is considered at contract inception or on an ongoing basis as claims are incurred and settled.

The remainder of paper 7H/77H concerning application guidance on materiality for discounting and a possible practical expedient to exclude certain contracts from the discounting requirement will be considered on Friday.

FRIDAY, 16 DECEMBER 2011

With the exception of Daryl Buck from the FASB all members of the Boards attended the three hour session on insurance contracts where the following issues were deliberated:

• Discounting of insurance liabilities for incurred claims
• Unit of account
• Onerous contracts

Discounting of insurance liabilities for incurred claims (board paper 7H/77H) (continued)

The meeting considered the second and third proposals in the Discounting paper – proposal one having been considered the previous day.

The second proposal in the Staff paper was

"... that no specific guidance was required on determining when the effect of discounting of the liability for incurred claims would be immaterial"

It was noted that there is a general principle in IFRS and US GAAP that the requirements of accounting standards are not applied to immaterial items. The members of both Boards present agreed unanimously to the Staff proposal.

The third Staff proposal was

".. that for contracts to which the insurer applies the premium allocation approach, not to require discounting of incurred claims that are expected to be paid within 12 months of the claim occurrence date"

After noting that this determination would be made on the basis of a portfolio of contracts, Staff confirmed their intention to have application guidance that would require discounting of all cash flows within those portfolios that were expected to be paid after 12 months, unless the effect was immaterial.

The recommendation would require an insurer to determine at each reporting date whether the 12 months expedient is applicable. For those liabilities with a settlement period beyond 12 months from the claim occurrence date discounting would always be applied, unless immaterial.

Staff noted that the shortcut on immaterial discounting for claims settled over a short period only applies only to portfolios of contracts to which the insurer applies the premium allocation approach. This practical expedient is not proposed for contracts where the building blocks approach is applied where only the general materiality principle applies. This recommendation is so designed because the main beneficiaries of the practical expedient will be insurers applying the premium allocation approach who may find that all of their business falls within the characteristics described for the application of the practical expedient.

The members of both Boards agreed unanimously with the Staff proposal.

Unit of account (board papers 7A/77A, 7B /77B, 7C/77C and 7/I/77I)

Paper 7I/77I was made available to observers just before the meeting and diagrammatically illustrates the Staff proposal to group contracts in a portfolio if they share similar risks, have similar expectations of profitability and are managed together.

The risk margin is the component of the measurement model that is calculated based on this unit of account.

The most important news to highlight from this set of papers is that the Staff of the two Boards decided to recommend a departure from the proposals contained in the ED and suggested that the risk adjustment liability is reduced for any diversification across portfolios that exist within the same reporting entity (covered in paper 7C/77C). The ED had introduced the concept of pooling of risks but limited it to the portfolio as defined with an explicit prohibition to allow cross-portfolio diversification to be taken into account in the setting of the insurance liabilities.

The Staff proposed that the diversification within the same entity once computed is allocated to each individual portfolio and the residual margin is then increased accordingly to prevent the recognition of accounting profit. Staff recommended that an insurer determines components within a portfolio to classify different elements of the overall residual margin liability of that portfolio and applies to each of these components the appropriate earning model that would release the residual margin component to profit. These components would also be used for the unlocking of the residual margin.

Contracts are grouped together in these components or sub-portfolios if they have similar inception dates, a similar contract boundary (economic duration) and similar expected patterns of release of the residual or single margin.

Staff noted that the definition of residual margin sub-portfolios is important because it determines the extent to which day 1 losses are offset against positive residual margins rather than expensed on day 1.

Many members from both Boards commented that they were uncomfortable with the "similar profitability" criterion in the portfolio definition as it may require many separate portfolios due to varying levels of profitability. Others noted that the profitability criterion would prevent profitable and unprofitable contracts being offset within a portfolio. Staff responded that their intention was that the criterion would only require separating portfolios where profitability was significantly different.

Several members commented that the proposals were over-engineered and that there should only be one concept of portfolio and insurers should develop appropriate entity–specific methods to earn residual margin over the life of their contracts.

After considerable discussion it was agreed that the Staff would be asked to delete the sub-portfolio proposal and revise the portfolio definition so that it focussed on the criteria of similar risks, similar duration and pattern of release of margin. For the premium allocation approach the second criteria would be a similar pattern of release from risk or a similar pattern for the provision of services.

Based on this tentative decision contracts would not require to be managed together or have similar estimated profitability in order to be grouped into a portfolio.

When the Boards were taken through paper 7C/77C the Staff explained that the calculation of the risk adjustment although allocated to each portfolio would take into account the benefit of diversification across portfolios up to the level of the reporting entity.

In order to achieve this aim Staff proposed:

"... not to prescribe the unit of account for determining the risk adjustment but instead to specify the principle that the risk adjustment should measure the compensation the insurer requires for bearing the uncertainty inherent in the cash flows that arise as the insurer fulfils the insurance contracts"

After much discussion as to whether prescribing a unit of account greater than the portfolio may lead to possible double counting of the effect of diversification and Staff noting that there will be guidance to explain that entity-wide diversification should be taken into account in determining the risk adjustment the Staff recommendation was agreed unanimously by the IASB. FASB is not supportive of a risk adjustment liability and did not vote on this paper.

Onerous contracts (board paper 7D/77D)

An onerous contract test is required under the building blocks approach and premium allocation approach during the pre-coverage period (as insurance contracts are only to be recognised in the financial statements when coverage starts) and additionally for the premium allocation approach during the coverage period given that the premium is allocated and not remeasured.

The Staff made three recommendations covering

• What is an onerous contract?
• When should an onerous contract test be carried out initially and subsequently?
• Should the basis of measuring an onerous contract be consistent with the measurement of the liability for incurred claims?

During the discussion it became clear that Staff and the members of both Boards had not had chance to consider these proposals in the light of the earlier agreement that for the premium allocation approach discounting would not be required where a claim was expected to be settled within 12 months of the occurrence. It was therefore agreed that this paper would be considered at a later date.

Discussion at the January 2012 IASB Meeting

This session was initially scheduled to be a joint session with FASB to reach joint tentative decisions on the papers presented. However following the discussion of the same set of papers in a FASB-only education session on 18 January the agenda has been amended and this session was demoted to an IASB-only education session. The agenda included the following items:

• The Board's progress on the project so far;
• Agenda paper 2A: Premium Allocation Approach (PAA) Eligibility Criteria
• Agenda paper 2B: PAA Mechanics

The Board was not asked to make any decisions at this point.

The Staff noted that the IASB has substantially completed the work needed relating to the measurement of an insurance contract and that several decisions are in line with the FASB. However there are some areas where the Boards have reached different conclusions and in the coming months whilst completing discussions on the remaining topics the Board will assess whether any differences between them can be reconciled prior to the publication of the respective due process documents.

Paper 2A, PAA: Eligibility Criteria

The IASB discussed some proposed principles-based eligibility criteria for the premium allocation approach. The proposals suggested that insurers should apply the building block approach rather than the premium allocation approach if, at the contract inception date, either of the following conditions is met:

• It is likely that, during the period before a claim is incurred, there will be a significant change in the expectations of the net cash flows required to fulfil the contract that would not be captured by the onerous contract test ('expected cash flows criterion'); or
• Significant judgement is required to determine the amount of premium to be recognised in each reporting period, for example if there is significant uncertainty about the length of the coverage period ('allocation of premium criterion').

The Staff noted that the Boards have discussed the eligibility criteria on previous occasions and at most recent in October meeting. Paper 2A proposes principles-based eligibility criteria for the PAA that were developed from that October meeting. The Staff reported that it had done targeted outreach and contract "testing", noting that when participants had reached different conclusions on the eligibility of certain contracts, this was the result of subjectivity and judgment needed. They also noted that only a relatively small set of different circumstances produced different conclusions.

Extensive debate ensued with IASB members appearing in agreement with the intent but noted that it was overly complex and did not address the issue of whether PAA is a proxy or a separate model. It was noted that this was the 4th time the Boards were discussing this item and, at least, there continues to be agreement on the big picture. In general, the IASB members noted their belief that there is one model for insurance contracts, and that default is the Building Blocks Approach (BBA). The PAA is merely a proxy or practical expedient to applying the full BBA. In terms of what qualifies a contract to utilise the PAA, almost everyone agreed that a 12 month duration test is a good practical expedient. The remaining question is the need to develop additional application guidance to determine which contracts longer than 12 months falls into the PAA.

The Staff indicated they would bring the PAA criteria back in February, inclusive of a supplement to Paper 2A to have a 12 month practical expedient, and then criteria that would address the issue: "would the PAA serve a high quality proxy for the BBA". The IASB Chair noted this will be the fifth time this subject is discussed.

Paper 2B, PAA: Mechanics

The Staff introduced