With the exception of Marc Siegel for FASB and Ian Macintosh for the IASB all members of the Boards attended the session on insurance contracts where four individual issues were deliberated.
The first paper did not ask for a decision but reported on the FASB meeting of 30 November. At that meeting FASB agreed a simplified method for the measurement of certain cash flows of insurance contracts with non-discretionary and performance–linked participating features. These cash flows are determined by reference to assets and liabilities that are the underlying of the non-discretionary performance –linked participating feature. These cash flows will be measured at the insurer’s current obligation adjusted to eliminate accounting mismatches that reflect timing differences between the current obligation and the USGAAP/IFRS value of the underlying items the cash flows are linked to. These differences should reverse within the time horizon set by the boundary of the insurance contract
This wording is subtly different to the May 2011 IASB decision to measure the relevant component of the insurance participating contract liability at the IFRS value of the relevant underlying assets and liabilities.
It was noted that although the wording of the FASB decision differs from the previous IASB decision the effect of this FASB decision is that FASB have now converged so as to be equivalent with the IASB decision taken in May 2011. Under both Boards’ proposals the participating contract insurance liability would be adjusted to mirror the measurement and presentation of the underlying items to the performance of which it is linked. The Staff and Boards will further consider whether they can agree on an identical wording that can be used to set out both decisions.
It was reported that FASB also agreed to converge with the earlier IASB decision that any changes in the relevant component of the insurance contract liability should be presented in the same way within the SoCI (i.e. consistently within net income or OCI) as the relevant underlying assets and liabilities.
Measurement of options and guarantees embedded in insurance contracts
The Staff paper noted that although (as noted above) a mirroring approach has been agreed for certain non-discretionary performance-linked participating features, it is necessary to consider separately any embedded options and guarantees.
The paper noted that embedded options and guarantees could be valued either by including guaranteed cash flows in the scenarios where the guarantee takes effect or directly determining a market-consistent value for the option and guarantee. In other words in those scenarios where the embedded derivative has effect the cash flows of the derivative and not of the underlying item should be considered in measurement of the insurance liability. Staff recommended that for all insurance contracts (including participating contracts):
"all options and guarantees embedded in insurance contracts that are not separately accounted under the financial instrument standard as a derivative instrument should be measured using a current, market-consistent expected value approach"
After some discussion as to whether further clarification was needed on the selection of the discount rate, the Board members present unanimously supported this Staff recommendation.
Cash flows that existing contracts require to be paid to future policyholders
The paper relates to participating contracts where the insurer is required to declare a distribution of the assets within participating funds the insurer holds to its policyholders when the insurer and where undistributed amounts to policyholders who have lapsed, surrendered or matured their policies are carried forward for future distributions and cannot be attributed to the insurer’s own equity. When policies expire they forfeit the policyholders’ benefits not yet distributed and these benefits are spread between the remaining and any new policyholders that would purchase a new contract issued from the same participating fund. In rare cases where there are few policyholders remaining and the undistributed surplus is quite large the entity maybe able to apply to the insurance regulators to affect a payout to someone other than policyholders but this requires a change of the contractual terms.
The Staff paper concluded that there is a present obligation arising from a current contract and that it represents a liability even though the identity of future policyholders is not known. The contract boundary is not breached as the liabilities relate to a current contract not a future contract. . Staff recommended that:
"...when measuring an obligation created by a contract that depends partly on the performance of assets and liabilities of the insurer, an insurer should include in the measurement of the insurance contract liability all such payments that result from that contract, whether payable to current or future policyholders."
It was noted by various Board members that in some circumstances insurers may obtain judicial and/or regulatory approval to vary the contract terms so that part of the contract obligation may be payable to shareholders but the consensus was that any such potential variation of contract terms could be dealt with by specific disclosure should it arise. With one abstention the Board members present otherwise unanimously supported this Staff recommendation.
Discounting of insurance liabilities for incurred claims (board paper 7H/77H)
Before the discussion on this paper Hans Hoogervorst noted that IASB had received a memo from the Hub Global Insurance Group which requested the Boards to withdraw this paper – citing there had not been proper due process. Mr Hoogervorst confirmed that the Boards would not withdraw to the paper and would respond to the Hub Global Insurance Group noting that the Boards disagreed with many of the points raised in the memo.
The Boards discussed the first part of this paper in which the Staff asked the Boards to:
"reconfirm their earlier decision to require the discounting of the liability for incurred claims when the effect would be material."
The paper noted the views of those respondents to the ED that are opposed to discounting. Board members noted their support for a general principle that requires discounting where its effect would be material. It was noted that the time value of money is an essential component of an insurer’s business and pricing models and that as the time value of money is implicit in asset valuation, measuring liabilities on an undiscounted basis would introduce accounting mismatch.
The Staff paper also included the results of the Staff model which looked at the impact of discounting the incurred insurance claim liability on the net income and total surplus based on US non-life insurance regulatory filings for the period 2005-2010. The results showed a significant effect due to discounting which varied over the period.
It was noted that all undiscounted liability information currently included in the financial statements would continue to be available within the financial statements including the 10 year development table on an undiscounted basis.
The final accounting standard will require the disclosure of the yield curve used to determine the effect of discounting and a maturities table showing the expected settlement pattern.
The Board members present unanimously supported this Staff recommendation.
Two members noted that consideration should be given to an exception from the discounting requirement for certain very material one-off exposures. Such exposures often have considerable uncertainty over the timing of settlement, limited relevant prior experience of such exposures and the absence of a group of such exposures, resulting in considerable difficulty in determining an appropriate settlement pattern for such one-off exposures against which to apply discounting. Consideration of this question was deferred until Friday.
A further point raised and deferred for consideration to Friday is whether the materiality of discounting is considered at contract inception or on an ongoing basis as claims are incurred and settled.
The remainder of paper 7H/77H concerning application guidance on materiality for discounting and a possible practical expedient to exclude certain contracts from the discounting requirement will be considered on Friday.