• 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 February 2010 IASB-FASB Joint Meeting
• Discussed at March 2010 IASB-FASB Joint Meeting

Timetable

• Click for IASB Project Timetable

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.

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.