The Boards, at this joint session, discussed use of other comprehensive income (OCI) and acquisition costs (ACs) and agenda papers scheduled to be discussed for the meeting included the following:
- Agenda Paper 2B/83B: Acquisition Costs – the Story so Far
- Agenda Paper 2C/83C: Acquisition Costs in the Building Block Approach (BBA)
- Agenda Paper 2D/83D: Acquisition Costs in the Premium Allocation Approach (PAA)
- Agenda Paper 2G/83G: Summary of Questions and Staff Recommendations for using OCI for Insurance Contracts
- Agenda Paper 2H/83H: Background on the use of OCI
- Agenda Paper 2I/83I: Use of OCI for presenting the effect on the insurance contract liability arising from changes in specified assumptions
- Agenda Paper 2J/83J: Use of OCI to present specified changes in the insurance contract liability
- Agenda Paper 2K/83K: Loss Recognition Test
- Agenda Paper 2L/83L: Examples to Illustrate the use of OCI for presenting specified changes in the insurance liability
- Agenda Paper 2M/83M: Additional Background on the use of OCI
Agenda paper 2A had not been issued for this meeting.
The OCI solution
The FASB staff led the discussion referring the Board members to agenda papers 2G/83G which contains a summary of all questions for the Boards, the detailed paper 2I/83I addressing the first three questions, and additional background papers and illustrative examples (2H/83H, 2L/83L and 2M/83M) all summarising details related to the “Use of OCI for Insurance Contracts”.
The staffs noted there are three main objectives in developing the recommendations for the use of OCI: (1) reduce short-term volatility, (2) reflect results from the insurer’s core operations and (3) reduce accounting mismatches created between measurement of the insurance liabilities and the assets backing those liabilities.
The staffs acknowledged some mismatches will still exists in OCI, but noted that users expressed more comfort with these mismatches in OCI rather than profit or loss. The staffs also acknowledged the other side of argument, noting that use of OCI is very complex and further, that under either approach, both statements would need to be used in evaluating results.
The first staff recommendation was on presenting Changes in the Insurance Liability in OCI. The staffs recommend that changes in the insurance liability arising from changes in discount rate should be presented in OCI (question 1).
The discussion was lengthy and essentially resulted in two issues being debated. The first: What is the amount that should be captured – the change in the current discount rate to the original discount rate (as proposed by the staffs) or the change from period to period (similar to pension accounting)? The second: Once you have separated this amount, where do you want to present it – within OCI or within profit and loss?
While there was intense debate around this first issue, both Boards generally agreed with the use of OCI as a means to limit the volatility associated with accounting mismatches despite some minor objections.
The most significant discussion was around the second issue and what amount should be presented in OCI. One IASB Board member walked through various examples using the staff illustrations where he believed asset sales and duration mismatches in assets and liabilities resulted in financial results that were less transparent and misleading and as such did not meet the objectives outlined by the staffs – a result not of the decision to use OCI but of the staffs’ proposal on what amount to capture. Others believed the proposal, although not perfect, was better than current accounting and was necessary in light of previous decisions made on accounting for the assets and fulfilment value liabilities. In either view, the discussions seemed to solidify consensus in the need for an OCI solution to be included as a continuous statement within the statement of comprehensive income and to be discussed separately.
The vote on question 1 was unanimous for FASB and with a majority of 10 for IASB to support use of OCI as recommended by their staffs.
Continuing in Agenda Paper 2I/83I, the staffs now addressed question 2 and whether changes included in OCI should include changes in the discount rate only or also changes in interest sensitive cash flows (CFs).
The staffs highlighted that there are certain assumptions (namely interest rate guarantees, options and lapse assumptions) which are impacted by changes in the level of market interest rates. The staffs noted some of the advantages of including the effect of the interest sensitive CFs in profit or loss (e.g., it is easier to understand and it is consistent with other cash flows) and the reasons to include in OCI instead (e.g., it is consistent with the previous decision and less complex for insurers).
The staff recommendation on recording the impact of changes in interest sensitive assumptions was split with FASB staff recommending that changes in the insurance liability that arise from changes in the interest sensitive assumptions should be recorded in OCI whilst the IASB staff recommended profit or loss.
There was limited discussion on this topic although several Board members (both in FASB and IASB) pointed out the decision to record to profit and loss actually was a decision to record these as net against the residual margin for the IASB given previous decisions on unlocking.
The vote on question 2 saw only two FASB members supporting their staff for an OCI approach and five agreeing with the IASB staff to account for these in profit or loss. All but one IASB member supported their staff for a profit or loss treatment with 1 abstention on the basis that it was not truly to profit and loss given the effect on the unlocking of the margin.
Continuing in Agenda Paper 2I/83I, the staffs now addressed whether changes included in OCI should be permitted or required, the unit of account for the election and the ability to make changes once elected (questions 3, 4 and 5).
The staffs discussed the advantages and disadvantages of “permit versus require” and the unit of account noting that the complexity of the OCI solution coupled with the fact that some mismatches would ultimately arise under any scenario.
The staff recommendation on the issue as to whether to permit or require was that changes in the insurance liability arising from changes in discount rates should be required to be presented in OCI unless presenting those changes in profit or loss would eliminate or significantly reduce an accounting mismatch (question 3).
The staff recommendation on question 4 (Unit of Account) was split with the FASB staff recommending that this is done on portfolio basis whilst the IASB staff recommended to account for it based on the insurer’s asset mix.
Finally the staffs recommended that the decision to present changes in the insurance liability in OCI or profit or loss should be: (a) irrevocable if the unit of account is an allocation of individual contracts or (b) changes if the fundamental strategy for the portfolio were to change resulting in a new accounting mismatch (expected to be rare) (question 5).
Initial discussions stemmed from whether the default position proposed in question 3 should be OCI (as recommended by staffs) or profit or loss and the need to understand the unit of account to make the decision. The Boards discussed the relative mix of assets typically held by insurers and the mechanics under each scenario which resulted in a quick turn of the discussion.
The Boards noted the complexity of the OCI solution almost mandated that the default position be OCI as recommended by the staffs. The recommendation to require rather than permit was considered necessary to retain transparency and comparability. The Boards agreed there was a need to separately discuss performance linked contracts (including those that are contractually linked and those that are subject to guarantees and linked investment returns) which were already in the line to be considered as a result of these decisions in one of the future joint Board sessions.
When the Boards were asked whether they supported a modification to the staff recommendation under question 3 with all changes required to be presented in OCI but without any possibility to move the changes from OCI to profit or loss even when this created accounting mismatch, the FASB expressed a majority of 5 vs. 2 and the IASB majority of 8 vs. 6 in support of this tentative decision. Based on that decision, the other matters were not addressed. However the Boards also voted that insurance contract liabilities from performance linked contracts will be handled separately.
The staffs then discussed the mechanics of the OCI solution as presented in Agenda Paper 2J/83J. The staffs presented three alternatives (as well as the advantages and disadvantages) in determining the interest rate that should be used for the OCI solution. The staffs considered (a) interest equal to the expected long term return on the assets, (b) interest equal to the current rate at the beginning of the reporting period or (c) interest at the rate locked in at inception of the contract. The staffs noted in using the current rate such that interest expense is based upon the rate at the start of the reporting period, it will fail to meet the OCI objectives. The staffs noted it introduces a new accounting mismatch in net income if assets are recorded at FV-OCI or amortised cost and further that the amounts recorded in OCI would not naturally reverse.
The staffs then considered two alternatives for how OCI could be used to reflect the changes in the discount rate:
- Alternative A: Present interest expense in net income calculated using the discount rate locked in at inception. Present in OCI, other changes in the insurance liability arising from changes in the discount rate. Under this alternative, the amount included in accumulated other comprehensive income (AOCI) is the difference between the present value of remaining CFs discounted at the current rate and the present value of remaining CFs discounted at the locked in rate.
- Alternative B: Present in net income, interest expense calculated using the current discount rate plus an amount shown as transferred to/from OCI such that total interest expense in net income is equal to interest calculated using the discount rate locked in at inception. Under this alternative, the amount included in AOCI is the difference between the present value of remaining CFs discounted at the current rate and the PV of remaining CFs discounted at the initial rate.
The staffs recommend that insurers present in: (a) Profit or loss, interest expense using the discount rate locked in at inception of the contract and (b) OCI, changes in the liability arising from changes in the discount rate as set out in alternative A above (question 1).
The staffs also recommend that insurers present interest expense in the profit or loss in respect of changes in the expected cash flows based on the discount rate locked in at inception of the insurance contract (question 2).
The discussion here was limited and a continuation of some of the items highlighted in the opening debate around what should be reported in OCI. Some believed the rate at inception was not the appropriate rate, but most generally felt this was the only acceptable solution.
The vote on question 1 was a unanimous support to the staffs from FASB and a majority support from IASB (9 vs. 5). On question 2, the staff recommendation was supported by FASB with a majority of 6 vs. 1 and by IASB with a majority of 12 vs. 2.
The staffs concluded the OCI solution marathon by introducing agenda paper 2K/83K “Loss Recognition”. Based on the Boards’ previous decisions, they noted that the purpose of the loss recognition test was to accelerate the accounting through profit or loss of gains/losses accumulated within OCI when circumstances dictate it. Interest expense from insurance liabilities would be recognised in profit or loss based on the inception discount rate with the effects of interest rate changes on the measurement of the liability included in AOCI. The staffs highlighted there may be instances after initial recognition of the insurance contract liability where the contract is expected to have a loss such that it would require acceleration of the amounts retained within OCI.
The staff recommendation was split again with the FASB staff recommending a loss recognition test whilst the IASB staff did not recommend a loss recognition test.
The discussion here was brief and generally all agreed that they would never have an adequacy test on a financial liability and that this was no different. FASB voted this with a majority of 6 against use of loss recognition test whilst the IASB majority counted 13 votes.
The staffs discussed acquisition costs and reviewed some of the historical decisions made and comments received, noting that the Boards have moved from a presentation of the income statement on a summarised margin basis toward a presentation that expresses volume information and accordingly wanted to confirm the accounting for acquisition costs against these preferences. Separately, the staffs noted that the Boards have decided to allow an asset for customer sales in revenue recognition and that some have argued the insurance project should consider a possible alignment with that decision.
The staffs presented three alternatives for presenting the portion of premiums that the insurer charges to enable it to recover acquisition costs:
- Alternative A: Recognises the right to recover ACs as an asset.
- Alternative B: Include ACs in the CFs used to determine the margin and which would require an insurer recognise a reduction in the margin when ACs are incurred, with no effect on the statement of comprehensive income. The ACs would be shown net against the residual/single margin and allocated to profit or loss the same way as the margin. Changes in the insurance contract liability arising from the ACs would be shown with the release of margin and not as changes in the CFs. [Alternative B is a variant of the FASB’s view in developing their 2010 DP]
- Alternative C – Include ACs in the CFs used to determine the margin and which would require an insurer to recognise a reduction in the margin and would require the insurer to expense ACs and recognise income equal to, and offsetting, those costs when ACs are incurred. Changes in the insurance contract liability arising from the ACs would be shown the same way as changes in the CFs. [Alternative C is consistent with the IASB’s view in developing the 2010 ED]
The staff recommendation was to reject Alternative A and the recognition a Deferred Acquisition Cost Asset (question 1).
In addition, for ACs in the Building Block Approach, the staffs did not put forward a recommendation and instead asked whether the Boards think that an insurer should:
- recognise a reduction in the margin when the ACs are incurred, with no effect in the statement of comprehensive income. The ACs would be shown net against the residual/single margin and allocated to profit or loss using the allocation pattern previously determined for the single/residual margin (Alternative B) or
- account for the cash flows relating to the recovery of ACs in the same way as the other cash flows that are expected to arise in fulfilling the contract, and recognise premium income equal to, and offsetting, those costs when the acquisition costs are incurred (Alternative C)?
The discussion here was brief as the Board quickly decided that absent a decision on volume information presented for premiums, the only decision they could answer was Question 1 and whether ACs should be treated as an asset. On that questions, the Boards spent much time articulating views on whether the ACs were fulfilment costs or if they should be outside of the model. The Boards briefly reconsidered expensing the costs and the simplicity of establishing an asset but it was clear that many of the same historical and philosophical differences remain.
The IASB majority of 10 vs. 2 supported the staff recommendation to reject an asset recognition basis for ACs.
The FASB Chair elected instead to ask the questions differently and asked first who supported each of the following:
- Alternative C – FASB unanimously rejected it
- Alternative A (which considered deferred acquisition cost asset or expense as incurred to be debated further) – FASB unanimously supported it
- Alternative B (as a compromise) – FASB expressed only a majority of 4 against 3 members.
Based on these votes it would seem that the FASB may now disagree with the IASB on ACs accounting and it would contemplate an asset recognition basis for recoverable ACs which the FASB staff would now need to develop further.