The Boards met on Tuesday to begin a planned series of joint discussions on insurance contracts spanning twelve hours over the course of three days.
Unbundling of investment components (agenda papers 2E/83E-2F/83F)
The morning session was dedicated to unbundling. The Boards have discussed this topic extensively in the past. They previously moved away from the earlier proposals to unbundle non-interrelated components (ED) or explicit account balances (May 2011 meeting). In March 2012 meetings, they tentatively agreed on the principle of disaggregation instead of unbundling except in limited circumstances (intended to avoid intentional structuring) where unbundling would continue to apply resulting in a separate accounting of the component as if it was a separate contract.
The tentative decisions to date were
- to exclude from aggregate premiums recognised in comprehensive income the amounts the insurer is obligated to pay to policyholder regardless of insured event occurring and
- not to require unbundling on the balance sheet but instead require disclosure of a) the amounts payable on demand and b) the amount of insurance liability that represents the aggregated portions of premiums received excluded from the statement of comprehensive income.
However both Boards felt they wanted to bring back for consideration the issue as to whether unbundling was still appropriate in some situations where the elements are distinct and not interrelated.
The staffs were cautious not to unbundle elements which are in fact inter-related, as this would force measurement of these elements outside the insurance measurement model and create additional costs and complexities. To avoid such consequences, the staffs proposed the following guidance:
- If both the investment component and insurance component are distinct, an insurer shall unbundle the investment component and apply the applicable IFRS or US GAAP guidance in accounting for the investment component.
- Except as specified in the following paragraph, a component is distinct if the insurer or a third party regularly separately sells in the same market and jurisdiction contracts that are essentially equivalent to that component.
- Notwithstanding the requirements in the previous paragraph, an investment component or an insurance component in an insurance contract is not distinct and the insurer shall therefore account for the investment component together with the insurance component under the insurance contracts standard if the investment component is highly interrelated with the insurance component.
An indicator that an investment component is highly interrelated with an insurance component is a lack of possibility for one of the components to lapse or mature without the other component also lapsing or maturing.
The debate focused around two themes. Certain Board members were concerned that the proposed guidance was too narrow and investment elements that were distinct and could be sold separately would not be unbundled because of the words used in drafting.
One issue was whether the use of the word ‘both’ in criterion (a) requiring investment and insurance elements both to be distinct is necessary. Some felt that it is enough for the investment element alone to be distinct. The concern with criterion (b) was that even if there is not an equivalent insurance contract sold separately, that fact should not prevent the unbundling of a distinct investment element provided the two were not interrelated. Some suggested the removal of ‘in the same market or jurisdiction’ to avoid the added restriction. Others felt that if the insurance element was not sold separately, perhaps it is an indicator that there is some interdependency or cross-subsidy in the pricing of the elements and unbundling would not reflect that.
The other major theme was how to interpret lapsing features in criterion (c). One issue was where the withdrawal of the investment element would result in a lapse of the insurance policy. If the deposit can be withdrawn on demand and this would cause derecognition of the whole contract it would seem more faithful not to unbundle the associated put option. The staffs pointed out that bifurcating and recording on-demand elements at face value under IFRS 9 would result in a day one loss and the assumptions used for the insurance element would not be consistent with economic reality given that this treatment implies an insurance contract lapsing at the reporting date. Others focused on whether both criteria: the ability to be sold separately and to mature separately are needed or whether either condition, if met, is enough to unbundle provided the elements were not interrelated. It was noted that if the elements can mature separately, the amounts are still likely to be interrelated (e.g., the investment element has matured but the insurance element ‘tops up to the agreed value’). The element that has not matured is not really distinct in that case.
In the end, the staffs summarised the debate by noting that the Boards seem to have agree that an insurer shall unbundle an investment element if it is distinct. It is distinct if it is not interrelated. Indicators that it is interrelated are:
- One element cannot mature/lapse without the other
- Products are not sold separately in the same market and jurisdiction, or
- The value of one component depends on the value of the other.
The Boards approved the staffs summary as the final tentative decision subject to the need to draft an amended wording to better reflect the feedback summarised above (IASB approved with a majority of 12 and FASB was unanimous).
The Boards then considered again their previous decisions on unbundling from insurance contract of embedded derivatives, non-insurance obligations to deliver goods and services and investment components. The unbundling criteria for each of these types of elements are different due to their nature, different standards and accounting models applicable to them. The Boards confirmed their previous tentative decisions unanimously.
They then looked at whether it is possible to permit unbundling where it is not required. One member argued that if the unbundling of investment elements is not done due to operational and measurement difficulties but the entity is willing to do it they should not be prevented. In particular, insurers in Australia have been unbundling and are regarded as accounting leaders in this area. To prevent them from doing so in the future would penalise them unnecessarily.
Other members were concerned with comparability and argued that such information can be presented as additional non-GAAP information. The staffs further noted this is an issue of scope. The staffs reminded that the Boards have discussed unbundling at length to ensure contracts and components of contracts are appropriately handled within the scope of the appropriate standard. The concern with permitting unbundling where not required would trigger the need for additional guidance to be developed. In the absence of such guidance, it is possible that measurement model selected would be less preferable to the proposed insurance measurement model.
The Boards voted to prohibit unbundling where it is not required unanimously for FASB and near unanimously for IASB (1 member against).