The Boards were presented with a concise presentation of the accounting for insurance contracts with a comparison of the effects of applying the 'allocation of the original transaction price' approach, 'explicit building blocks' approach and applying the revenue recognition model to insurance contracts.
The Boards discussed the effects of application of the revenue recognition model to insurance contracts based on a numerical example. Even though some Board members saw some merit in applying that model, most Board members found it unappealing as the results were seen as not understandable for the effects of pooling, especially for insurance contracts with more 'moving parts'. Some Board members would like to discuss an alternative application of revenue recognition model to insurance contracts. The staff clarified that it went over a number of possible applications, but the results were similar in broad terms to those presented in the example.
The Boards also discussed the explicit building blocks approach. Some Board members were concerned with the possible effects on smoothing of revenues. The following discussion of this model focused on risk margins that should compensate for the inherent risk characteristics of the contracts. Some Board members were concerned with the application of this approach to contracts with multiple performance obligations and possible need for disaggregation of the margin that would lead to increased complexity.
The Boards discussed the measurement objective of the insurance contracts. One Board member expressed his frustration with the whole Insurance Contracts project as he believed that the insurance industry was similar to other financial services industries and basic accounting models should apply to it, with some necessary modifications or additional (application) guidance. Some Board members expressed their already well articulated opposition to the separate risk margin component in the measurement objective. They believed that the risk characteristics of insurance contact were already embedded in the inflows and outflows of the contract, and the proposed measurement objective confused the inflows and outflows. Other Board members disagreed. They understood the risk margin component of the measurement objective as the expression of the risk embedded in the insurance contract and as a compensation for additional capital held that reflected this riskiness.
After a significant discussion both Board narrowly agreed that a reporting entity should measure an insurance contract equal to its current estimate of the amount to fulfil the present obligation created by that contract by using a building blocks approach.
The Boards also agreed that a reporting entity should estimate that cost using present value techniques that consider:
- the unbiased, probability-weighted average of future cash flows;
- the time value of money;
- a risk adjustment for the effects of uncertainty about the amount and timing of future cash flows; and
- an amount to eliminate any positive day one difference.
The Boards continued their discussion with assessing how to determine the risk adjustment (point 3 in the discussion above). The Boards considered three possible definitions of the risk margin notion:
- the price of risk a market participant would require when taking over the obligations from the insurer;
- the price an insurer would require to induce it assume the risk from the policyholder or another party;
- the amount an insurer would rationally pay to be relieved of the risk.