In April 2009, the IASB had a preliminary discussion on future insurance contract premium receipts (that is, policyholder behaviour and the related issue of contract boundaries). This session discussed a staff analysis and their recommendations on this topic.
Accounting for future premiums that depend on options
The staff noted that in many long-term insurance arrangements, the insured has the right to continuing cover provided it continues to pay the contact premium. The insurer has effectively written an option for the policyholder. The option compels the insurer to accept the policyholder's premiums (as determined by the insurance contract) and continue the insurance coverage. The insurer has a premium for the current year and a series of written options into the future years. The staff had identified three approaches to accounting for renewal options, which they thought were consistent with the approaches the Revenue Recognition team explored in its paper on Contract Boundaries:
- Ignore the option.
- Measure the option.
- Look through the option (ie treating cash flow subject to renewal and cancellation options as part of the existing contract).
The Board debated a staff recommendation that the measurement of an insurance contract should include the expected (that is, probability-weighted) cash flows (future premiums and other cash flows resulting from those premiums, for example, benefits and claims) resulting from that contract, including those cash flows whose amount or timing depends on whether policyholders exercise options (such as renewal and cancellation options) in existing contracts. Put otherwise, the measurement of an insurance contract should look through renewal and cancellation options.
Some Board members were unhappy about how the staff had analysed the issue. Some thought that the 'option' that the insured had to renew the insurance contract was the same as an option as understood in the Revenue Recognition Discussion Paper-others thought that it was. Some Board members would prefer measuring the renewal option at initial recognition, rather than looking through, as the staff proposed.
Another Board member rephrased what he thought the staff was trying to express: that the initial recognition of an insurance contract needed to identify what the Insurer was receiving and for what it had been received. He suggested that on initial recognition, the insurer had received the premium for (i) the first years' cover; and (ii) the right to renew at the same premium next year. This Board member did not want to establish a general principle of always looking through renewal options and asked the staff to be cautious about how it expressed the principle.
Another Board member thought that looking through the option would allow you to get to an expected value measure: it includes some time value, but whether it was the 'right one' was debatable. This Board member was not opposed to looking through the option, but again was concerned about how the principle was expressed. In particular, in his view, the future premiums were not contractual, since the insured has no obligation to pay the premium in the future. Thus, the cash flows are not contractual.
Ultimately, the Board accepted the staff recommendation, but with significant concerns about how it was expressed and articulated. The staff will return with more refined proposals at a subsequent meeting.