Business combinations and portfolio transfers

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

a. if the consideration received exceeds the expected cash flows, the insurer should treat the difference as the [residual margin] [composite margin] (depending on the model eventually agreed by the Boards) at that date;

b. if the expected cash flows exceed the consideration received, the insurer should recognise that difference in profit or loss at that date.

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

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

a. if the fair value of the contracts exceeds the expected present value of the cash flows [plus the risk adjustment, in the model that uses such an adjustment], the insurer should treat the difference as the [residual margin] [composite margin] at that date;

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

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

Transition

Application of transitional models to insurance accounting and measurement related issues

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

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

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

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

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

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

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

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

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

Treatment on transition date of intangibles arising from a business combination

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

Treatment on transition date of deferred acquisition costs

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

Transition disclosure

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

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

Application of IFRS 9 and reclassification of financial assets

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

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

The Board reviewed (briefly) whether it had complied with the due process steps [as required in the IASB Due Process Handbook based on the steps listed in paragraphs 110-111 ('Comply or explain' approach) of the Handbook] in the leases project. In particular, the Board considered whether the Board had responded sufficiently with respect to the criticism that the leasing model included in the Discussion Paper DP/2009/1 Leases was incomplete because the lessor accounting was not sufficiently developed.

The Board noted that comments received from constituents on DP/2009/1 about lessor accounting had helped the Board to develop approaches to lessor accounting; that before issuing an exposure draft on leases, the Board was conducting significant outreach activities about the project to seek inputs from various constituents, including the lessor industry; and the Board would, during the exposure period and subsequent redeliberations, continue those discussions as they develop a final standard.

The Board concluded that all mandatory due process steps required by the IASB Due Process Handbook for this phase of the project had been performed. In addition, sufficient non-mandatory activities had been undertaken for this stage of the project.

Disclosures - investment companies (IASB only)

The IASB debated whether to require investment companies to make a disclosure similar to that which is currently required by US GAAP: a financial highlights schedule. This schedule presents per share investment income or loss, realised and unrealised gains and losses per share, distributions to shareholders, purchase premiums, redemption fees, payments by affiliates, expense and net investment income ratios, total return, and capital commitments.

The staff admitted that the US GAAP requirements are incorporated in US GAAP by way of AICPA guidance, which in turn interprets the 1940 Investment Companies Act. A Board member noted that he was not enthusiastic about the proposal, but would support it in the spirit of convergence.

Other Board members spoke in favour of the proposal, noting that North American analysts see the financial highlights schedule as 'more important' than earnings per share information provided in the financial statements.

After a brief debate, the Board agreed that an investment company should disclose a financial highlights schedule. The schedule would present per share investment income or loss; realised and unrealised gains and losses per share; distributions to shareholders; purchase premiums; redemption fees; payments by affiliates; expense and net investment income rations; total return; and capital commitments.