Measurement of policyholder participation
The Boards discussed how to apply the principle that an insurance contract is measured using the expected present value of the fulfilment cash flows when those cash flows results from contractual participation features and the cash flows have a dependency from asset values held in participating funds. The two papers presented for this discussion included background information and the following recommendations to the Boards:
- The cash flows expected to result from the policyholder participation should be included in the insurance liability on the same basis as the measurement of the underlying items in which the policyholder participates;
- The measurement of the participating contract should reflect the asymmetric risk sharing between the insurer and the policyholder resulting from the minimum guarantee;
- The changes in the insurance contract liability shown in the statement of comprehensive income should be consistent with the presentation of the changes in the items from which the participating liability depends on; and
- The same measurement approach should apply to unit-linked ("UL") and participating contracts ("par").
During its presentation of the recommendation paper, the staff noted that the main difference between UL contracts and those with participating features is often associated with the nature of the asymmetric risk sharing between the insurer and the policyholders. UL contracts directly pass investment performance through to policyholders using an equivalent to a total return swap approach whereas par contracts frequently feature minimum guarantees as well as only sharing a percentage of the investment performance (for example 90%).
It was noted that the feedback received on the exposure draft ("ED") proposal for UL to amend the treatment of treasury share and owner occupied property was positive. Because of the existence of the same accounting mismatch for par business, respondents asked if the consequential amendments could be extended beyond assets backing UL contracts liabilities. The staff has identified some issues with this option, e.g. deferred tax assets cannot be measured at FV, thus proposing to amend the ED approach to reduce the accounting mismatch by measuring the liability using the same attribute as underlying item, i.e. if the underlying assets are measured at cost or they are not recognised (e.g. treasury shares), the measurement of the liability relating to this asset should also be measured in the same way. The paper gives an example of this proposal in paragraph 25.
The FASB noted that they would prefer to value the liability using the building block approach, i.e. project cash flows based on the contractual obligations of the insurer and use the fair value of the underlying items if that is what affects the benefits payable to the policyholder. They acknowledged that this creates an accounting mismatch in the situation where the underlying item is measured on a different basis or it is not recognised at all. They referred to this approach as a two step approach as you then deal with the mismatch in a second step which could produce some amendments to the accounting treatment of the assets. In conclusion FASB appeared more aligned with the ED proposals than with the new staff recommendations.
The IASB on the other hand generally supported the staff recommendation to measure the par contracts' liability on a basis consistent with the underlying items. This would eliminate the undesired accounting mismatch; the remaining source of volatility in the financial statements would come from the economic mismatch as markets change.
Some Board members asked for FV disclosure requirements as there would still remain claims against unrecorded FVs.
Following the IASB's discussions and its general agreement with the staff, the FASB confirmed their preference for measuring the liability under the building blocks approach without modifications i.e. that the cash flows should be defined based on what is promised to the policyholder. The decision on what to do with the potential accounting mismatch should be looked at as a second step.
As votes were taken the FASB unanimously rejected the staff recommendation whilst a large majority of the IASB members supported the staff recommendations.