• 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

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.