Insurance Contracts

Date recorded:

Timetable and items to be excluded from the exposure draft

The Board noted the proposed timetable for the remaining deliberations leading to the publication of the exposure draft and subsequent outreach activities, re-deliberations, etc.

One consequence of the proposed timetable is that policyholder accounting, with the exception of the accounting for reinsurance (both by cedants and reinsurers), would not be addressed in the ED. At least one Board member challenged this decision, noting that while it made the timing awkward, the accounting by the insured might provide useful insights on contentious issues in insurers' accounting.

In particular, the Board member was concerned that the cash surrender value of a life insurance policy had been excluded from the measure of a liability in the insurer's financial statements, while it was almost certainly a relevant measurement attribute for the policyholder. In addition, it was likely that the Board would require recognition of an asset for future policy renewals on long-term contracts; however, the Board was highly unlikely to require recognition of a liability in the financial statements of the policyholder. In both cases, the lack of symmetry was a concern.

Another Board member was concerned that the Board had not learned the lessons of the Leases project, in which it had been heavily criticised for addressing only lessee accounting and leaving lessor accounting until a later date. The Board member was concerned that IAS 8 would lead policyholders to the IFRS on insurance contracts and infer, perhaps inappropriately, symmetrical accounting.

Other Board members were also surprised by the inclusion in the timetable of the use of other comprehensive income (and hence the possibility of recycling): this was the first time the Board had been warned that this issue was on the table.

The Chairman closed debate on these matters.

 

Measurement approach

The Board discussed the remaining measurement approaches (both of which would be modified to exclude day one profits):

  • measurement based on the approach being developed in the project to amend IAS 37 Provisions, Contingent Liabilities and Contingent Assets (the updated IAS 37 model).
  • a current fulfilment value that includes a composite margin.

The Board was evenly divided. Some favoured the fulfilment value approach, noting especially that the FASB had made a tentative conclusion in favour of this measurement approach. These Board members also saw a degree of consistency between the fulfilment model and the Board's conclusions on revenue recognition. Others thought that there was too much to be resolved in the 'updated IAS 37 approach' to enable them to support it.

Others specifically rejected the fulfilment value approach, in particular the analogy to the revenue recognition model. Those who supported the 'updated IAS 37 approach' noted that the approach remeasures the margin and was consistent with the building block approach put forward in the exposure draft. While the 'updated IAS 37 approach' had 'warts and blemishes', it was better than fulfilment value.

The Board voted 8 to 7 in favour of the 'updated IAS 37 approach'. This was a key vote because the margin, if it were to be maintained in a vote on the ED as a whole, would be insufficient to issue the ED. The Board concluded that procedurally it could continue, since it was the whole package that was the subject of balloting.

In any event, the ED would include a thorough discussion of the fulfilment value approach and the Invitation to Comment would seek views on the alternatives.

 

Subsequent release of residual and composite risk margins

This discussion began with the staff admitting that they were unable to present the Board a recommendation, since they were split among themselves. Some staff members believed that the attribute (driver) selected for release of residual and composite margins should result in recognising those margins in income in a systematic way that best depicts the insurer's performance under the contract. The other view was that the attribute in all cases should be the release from risk. Not surprisingly, the Board was finely balanced between both views.

The staff noted that:

  • The 'updated IAS 37 approach' includes a separate risk margin and that the residual margin should be released over the coverage period only because the risk margin under that approach is intended to capture the risk associated with the claims handling period.
  • The fulfilment value approach includes only a composite margin which should be released over a period that includes the claims handling period because the period used should reflect the risk associated with the settlement of claims.

The Board debated the issue in considerable detail, but in the end voted (8 to 7 again) to support the first alternative. The risk margin should be released based on a 'release from risk' notion, while the residual should be released on a passage of time basis. Board members noted that in the 'updated IAS 37 approach' the residual margin was essentially a plug, and that this item should be run off over the shortest possible period.

 

Initial recognition: Day One losses

The staff noted that, because of differences in the way in which insurance contracts were priced compared to the measurement models under consideration, a day one loss might arise in some situations. The Board confirmed that should such a loss arise, it should be recognised in profit or loss.

 

Relationship between the residual and composite margins and subsequent changes in estimates

The staff presented three possible approaches to addressing the subsequent changes in the residual and composite margins.

  • Approach A would result in subsequent changes in estimates being reported in profit and loss.
  • Approach B would adjust the margin for changes in cash flow, resulting in no impact on profit and loss.
  • Approach C, which the staff had found almost impossible to defend, would update the margin as a fixed proportion of cash flows, determined at exception.

The Board supported Approach A by a large majority. Many thought that Appoach B obscured too much information.

 

Discount rate

The Board agreed that the discount rate chosen should reflect the characteristics of the liability. It should not capture characteristics of assets held to back those liabilities if the liabilities do not share those characteristics. In addition, the Board agreed that it should not provide specific guidance on how to estimate a discount rate for insurance liabilities, beyond providing a cross-reference to the guidance for fair value measurement.

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