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Insurance contracts

Date recorded:

Education session — FASB single margin amortisation

The Staff presented the FASB decisions to release the single margin under the BBA over the period of run-off of risk and thus in many cases over a period in excess of the coverage period and possibly up to final settlement of claims depending on whether significant risk continues up to final settlement.

The presentation also illustrated that as the run-off of risk changes the amortisation pattern for the single margin would be changed prospectively without restating the brought forward single margin or affecting any previous release of the single margin.

There was considerable discussion of the difference in treatment by FASB of the single margin under the BBA and PAA as FASB have decided to implicitly amortise the entire single margin over the coverage period under the PAA. In contrast the IASB include an explicit remeasured risk margin throughout the life of the contract under both the PAA and the BBA.

Staff recommended reconsidering the decision to release the whole unamortised single margin when a contract become onerous given that a minor change in estimates may trigger an onerous contract and a substantial release of single margin.

Finally it was noted that the FASB proposals for a single margin released on reduction in risk over the coverage and settlement period may produce outcomes for many contracts that are not dissimilar to the IASB proposals for a residual margin released over the coverage period and an explicit risk margin that is released via remeasurement throughout the life of the contract.

Education session — Use of OCI for certain changes in measurement of insurance contract liabilities

The Staff prepared five papers but the education session did not specifically address the mechanics set out in paper 2C/82C or the detailed example in paper 2E/82E. No decisions were called for at this education session. The Staff expect to present proposals for a decision–making session in May 2012.

Background to proposals for use of OCI

Staff noted that the draft proposals have been formulated on the assumption that IASB and FASB asset accounting rules will be revised to allow the use of FVTOCI for certain assets although the scope and detail of these amendments to the asst rules have still to be determined and are due to be debated further in May 2012.

Staff noted that the proposals seek to address volatility and accounting mismatch in the performance statement but do not address balance sheet volatility which is considered a lower priority in most feedback received by the Staff.

Staff noted that the boards have rejected the use of a locked (at inception) discount rate for measuring insurance contract liabilities.

Staff noted that if insurers included all investments at FVTPL then both investment and insurance liability volatility due to interest rate changes would appear in P&L but feedback indicates that insurers wish to have the option to take both asset and insurance contract measurement volatility due to changes in market interest rates to OCI and not include in P&L significant items that largely compensate one another in the short term and distract from presentation of core business performance.

There was significant discussion of whether the volatility is due to an accounting mismatch (different valuation bases or recognition timing) or to an economic mismatch (e.g. duration mismatch). Members also noted that short term changes in interest rates affect discounted cash flow measurement but unwind over time and do not affect the actual liability settlement.

The proposals for use of OCI

The draft proposals outlined are for the reporting of changes in insurance liability measurement arising from changes in the discount rate after contract inception in OCI rather than in P&L.

Staff noted that the cumulative balance in OCI would be the effect on measurement of the current insurance portfolio due to changes in discount rate after inception. Amounts in OCI would automatically be recycled as insurance contracts are derecognised.

Staff analysis showed that US insurers, for example, typically hold approximately 70% to 75% of their assets in a form that may meet the new criteria when developed for FVTOCI reporting.

The asset rules are expected to require recycling from OCI on sale and many members noted that asset sales may not necessarily correspond to insurance liability settlements and thus there may be opportunities for earnings management by timing of asset realisation and reduced effectiveness of the proposals in the matching of the effects of interest rate changes on measurement of assets and insurance liabilities in OCI.

Staff acknowledged that further work is required on recycling proposals.

Members expressed mixed views on the proposals for using OCI rather than P&L and were especially concerned at the possibility of masking economic volatility and the complexity of some aspects of the proposals.

The need to consider asset and insurance liability proposals as a combined package was also noted by several board members.

In response to suggestions from a member that insurers should be required to present OCI and net income as a combined performance statement the chairman noted that the recent IASB decisions on reporting OCI and net income with an option for one or two separate statements would not be changed for insurers.

Use of OCI – other cash flows

Staff explained that other assumptions may also be sensitive to changes in interest rates and raised the question of whether measurement changes arising from such assumptions should also be reported in OCI.

Although the relationship between various assumptions was noted (e.g. lapses, surrenders and interest rates) the general view appeared to be that this proposal would be a step too far and would be overly complex leading to a lack of clarity on what the balance in OCI would represent

Use of OCI – require or permit

Staff proposed requiring the use of OCI unless the use of P&L avoids accounting mismatch.

Board members noted that this would require insurers to allocate assets to contracts in order to determine whether there would be a mismatch from using OCI.

Board members noted that this decision would depend on the details of the likely changes to asset rules.

Use of OCI – unit of account

Staff rejected the entity as too wide of a unit of account as well as the contract or the product as a too small unit. They had mixed views, some suggesting using contract portfolios other recommending the allocation of contracts based on the asset portfolios.

Board members noted the complexity and reallocation required as contracts mature and assets are sold but did not have a full discussion at this point.

Use of OCI – frequency of election

Staff proposed that if the OCI decision is made by portfolio it should be made for new portfolios and only be changed if there is a fundamental change in the investment strategy for that portfolio, which is likely to be rare.

Staff proposed that if the OCI decision is made by group of contracts it should be made at contract inception and be irrevocable with any new accounting mismatch arising dealt with by election for new contracts only.

Board members noted the Staff proposals but did not discuss them at this point.

Use of OCI – Loss recognition test

FASB Staff proposed recycling from OCI where the cumulative balance in OCI exceeds the remaining single/residual margin plus investment return on assets allocated against the relevant insurance liabilities. IASB Staff did not propose a loss recognition test.

Members expressed concern at the complexity of these calculations and the requirement for insurers to allocate assets against all insurance liabilities for this test. One member also noted that seeking to fine-tune the recycling from OCI could encourage users to ignore balances remaining in OCI.

Overall response to the OCI proposals

It was acknowledged that the basic proposal to report changes in insurance liability measurement arising from changes in the discount rate after contract inception in OCI rather than in P&L would be a pragmatic response to eliminating some accounting mismatch volatility from the P&L. However, there was significant concern at the potential complexity of many aspects of the proposals and that they would not address all causes of accounting mismatch and may, in some circumstances, mask economic volatility.

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