At the 27 February 2012 meeting, the IASB and the FASB discussed jointly the following topics related to insurance contracts:
- Premium allocation approach
- Measurement of liabilities for infrequently high-severity events
- Unbundling of goods and services
- Onerous contracts
This was a particularly long joint session attended by fourteen IASB members and all of the seven FASB members.
Premium allocation approach
At the February 2012 meeting the IASB and FASB continued their discussion on the premium allocation approach ("PAA"). The Boards discussed the criteria that will allow an entity to apply the PAA and also some mechanical issues around the PAA.
Eligibility criteria for the premium allocation approach – Papers 3E, 3F, 3H and 3I
The IASB believes that a single accounting model should be applied to all insurance contracts. However, in some situations the costs of applying the full building blocks approach ("BBA") may outweigh the benefits. Consequently, they support developing a simplified accounting approach determined by the principle that measurement under the PAA is likely to be a reasonable approximation to the BBA liability and supplemented by application guidance. On the other hand, FASB do not consider the PAA liability will generally be an approximation to the BBA liability and prefer to focus on eligibility criteria noting that many FASB board members believe there are two models to account for insurance contracts.
Both IASB and FASB Staff agreed that applying the PAA to contracts that have a coverage period of one year or less is considered to be a reasonable practical expedient to applying the PAA.
The IASB Staff proposed that:
- Contracts should be eligible for the PAA if that approach would produce measurements that are a reasonable approximation to those that would be produced by the BBA.
- A contract should be deemed to meet the conditions in (a) without further work if the coverage period is one year or less.
- Contracts would not produce measurements that are a reasonable approximation to those that would be produced by the BBA if, at the contract inception date, either of the following conditions are met:
- It is likely that, during the period before a claim is incurred, there will be a significant change in the expectations of net cash flows required to fulfil the contract; or
- Significant judgement is required to allocate the premium to the insurer’s performance obligations in each reporting period. This may be the case if, for example, significant uncertainty exists about:
- The premium that would reflect the exposure and risk the insurer has for each reporting period; or
- The length of the coverage period.
- An insurer should be permitted but not required to apply the PAA to contracts that are eligible for that approach.
The discussion noted that for many contracts particularly those providing coverage against infrequent high severity events (such as short term catastrophe or earthquake policies) it is likely that there will be significant changes in the expected cash flows under the contract before a claim is incurred. The Boards intend that such contracts should meet the eligibility criteria for the PAA and Staff were requested to reconsider this wording.
Subject to the comment above and some refinement of the wording, the IASB agreed unanimously with the Staff proposal for the PAA eligibility principle and application guidance supplemented by the practical expedient.
The IASB also agreed with 13 in favour that use of the PAA should be permitted but not required where the eligibility criteria, including the practical expedient, are met.
The FASB rejected by 6 to 1 the principle that contracts should be eligible for the PAA if that approach would produce measurements that are a reasonable approximation to those that would be produced by the BBA. Their reasoning is that in many instances there will be material differences in measurement.
Subject to the same drafting points noted by the IASB but without the reasonable approximation principle, the FASB accepted by 4 to 3 the proposed eligibility criteria supplemented by application guidance and also accepted by 4 to 3 the practical expedient that a contract should be deemed to meet the eligibility criteria without further work if the coverage period is one year or less.
The FASB rejected by 6 to 1 the proposal accepted by the IASB to permit but not require use of the PAA where the eligibility criteria, including the practical expedient, are met. Instead FASB require the PAA to be used where the eligibility criteria are met.
Premium allocation approach mechanics – time value of money and remaining coverage – Papers 3E and 3G
At their January 2012 educational meetings the Boards discussed matters related to mechanics of applying the PAA. More specifically, whether to adjust the liability for remaining coverage for the time value of money. At this meeting both Boards were asked to make a decision. However, the IASB Staff and the FASB Staff made different recommendations.
The IASB Staff recommended that the PAA liability should be discounted and interest accretion should be required in the measurement of the liability for remaining coverage for contracts that have a significant financing component. As a practical expedient, insurers need not apply discounting or interest accretion if at contract inception the insurer expects that the time between payment of substantially all of the premium and the insurer’s corresponding obligation to provide coverage will be one year or less.
The FASB Staff proposed the measurement of the liability for the remaining coverage period should not be discounted and interest should not be accreted on the liability.
It was noted that the practical expedient as currently set out in the revenue recognition project is slightly inconsistent with that accepted for the insurance standard but that the practical expedient in the revenue recognition project is expected to be revised to be in line with the insurance standard.
Both Boards accepted unanimously the IASB Staff recommendation including the practical expedient as outlined above.
Premium allocation approach mechanics – acquisition costs measurement – Papers 3E and 3G
The Staff proposed the following two pairs of alternatives treatment for acquisition costs:
1A) the measurement of acquisition costs should include directly attributable costs (for the FASB, limited to successful acquisition efforts only); consistent with the decisions made under the BBA; and
1B) Insurers should be permitted to expense directly attributable costs that are not incremental.
2A) the measurement of acquisition costs should include only incremental costs, and
2B) Insurers should be permitted to expense all acquisition costs if the contract coverage period is one year or less (consistent with the revenue recognition project).
Board members did not support having different acquisition costs measurement requirements for the BBA and the PAA. However, Board members wished to allow insurers a practical expedient for the PAA consistent with the revenue recognition project of expensing all acquisition costs, not just non-incremental acquisition costs. Therefore the Boards rejected the Staff proposals and instead favoured a third alternative comprising component 1A and 2B of the original Staff proposals: the FASB were unanimous and the IASB had a majority of 12.
Premium allocation approach mechanics – acquisition costs presentation and amortisation – Papers 3E and 3G
The Staff presented two proposals under which acquisition costs should be
A. recognised as an asset (and thus the liability for remaining coverage would be gross of acquisition costs), and
B. amortized consistent with the Boards’ tentative decisions on reducing the liability for remaining coverage (over the coverage period on the basis of time, but on the basis of the expected timing of incurred claims and benefits if that pattern differs significantly from the passage of time)
Members of both Boards noted that proposal A presents acquisition costs differently between the PAA and the BBA. There was a suggestion that the earlier BBA decision that acquisition costs are part of the cash flows under an insurance contract may need further consideration.
The Boards did not vote on the Staff proposals. Instead all Board members indicated nearly unanimous support for the Staff to consider further a proposal made by a FASB member that acquisition costs should be netted against the liability for the remaining coverage under the PAA or netted against the residual or single margin under the BBA rather than disclosed as an asset under PAA as proposed by the Staff in proposal A above.
Based on this discussion, Staff has been directed to prepare a comprehensive paper on acquisition cost measurement and presentation under both the BBA and the PAA. Staff proposal B was not discussed.
Measurement of liabilities for infrequent high-severity events – Paper 3C
The paper noted that the expected value proposals in the Insurance Contracts IASB Exposure Draft and FASB Discussion Paper (the ED/DP) differ from the current incurred loss model used by insurers. Under the ED/DP liabilities are measured at the expected value at the balance sheet without taking into account information only available subsequent to the balance sheet date regardless of whether a loss is incurred. Although a claims liability is not measured for losses under the PAA before they are incurred, the expected value principle still applies with regard to subsequent information and subsequent events.
The Board discussed whether, and if so how, to modify the requirements of the insurance standard in measuring liabilities for infrequent high-severity events. The estimates of the expected cash flows for such liabilities can be very volatile, especially immediately before and after a loss is incurred, and the uncertainties affecting the reliability of the estimates at the balance sheet date are sometimes resolved by subsequent information.
The Staff noted that, as proposed in the ED/DP, insurers should measure all insurance contract liabilities taking into account estimates of expected cash flows at the balance sheet date. However, the Staff proposed that if the effects on the financial statements are material, insurers should update cash flow estimates made at the balance sheet date for events that occur, and information that becomes available, after the balance sheet date but before the financial statements are issued when the following conditions are met:
- An infrequent, high-severity event, such as a catastrophe is impeding as of the balance sheet date, but has not yet occurred;
- Where the expected losses related to the event in (a) are based on information that is subject to substantial deviation prior to the event occurring; and
- There is only a relative short period between when the insurer first projects loss estimates related to the event and when the event occurs.
Staff also made alternative proposals as to whether, or not, insurers should recognise an onerous contract liability at the balance sheet date if the onerous contract liability is already known to have reversed in the post balance sheet period as a result of subsequent events.
Both Boards unanimously rejected the Staff proposals and decided that all insurance contract liabilities, including onerous contract liabilities and liabilities recognised under the PAA, should be recognised on the basis of information available at the reporting date using current subsequent event guidance under IFRS and US GAAP. Guidance will be added to the insurance standard to explain that the occurrence or not of an event that was impending at the balance sheet date would not constitute an adjusting post balance sheet event.
The Boards agreed that subsequent non-adjusting events or information affecting the insurance liability estimated at the balance sheet date are events that should be disclosed in accordance with post balance sheet guidance under IFRS and US GAAP.
Unbundling goods and services
At the May 2011 joint meeting, the IASB and FASB tentatively decided that obligations to deliver goods and services should be unbundled from an insurance contract in accordance with the guidance for identifying separate performance obligations in the revenue recognition project and that unbundled goods and services should be accounted for in accordance with whichever guidance is relevant based on the characteristics of the unbundled components.
Unbundling criteria – Paper 3D
At this meeting, the Boards discussed how to incorporate the criteria for identifying separate performance obligations from the revenue recognition project into the insurance contracts project so that they can be used to unbundle these components from a host insurance contracts. The unbundling of asset management services included in account driven insurance contracts will be considered at a subsequent meeting.
The discussion noted that the criteria derived from the revenue recognition proposals (paragraph 29 of the Revenue Recognition recent exposure draft) may not be essential for insurance but it was agreed that they should be retained.
The Staff produced examples illustrating different contractual structures to bundle health insurance and claims management services which may have different unbundling results in spite of producing very similar economic effects. For example, in a group health insurance contract the inclusion of an aggregate excess or a self insured layer may have very similar overall economic effect but it would produce different unbundling results because of the purpose for which the insurer provides claims management services.
The Boards agreed unanimously with the Staff proposals to remove or revise specific language from the criteria used for separating performance obligations in the revenue recognition project so that the guidance is applicable to insurance contracts without unintended consequences.
Onerous contracts – Papers 3A and 3B
During the December 2011 meeting the Boards tentatively decided that:
- An insurance contract is onerous if the expected present value of the future cash outflows from that contract exceeds:
- The expected present value of the future cash inflows from the contract (for the pre-coverage period)
- The carrying amount of the liability for the remaining coverage (for the PAA only)
- Insurers should perform an onerous contract test when facts and circumstances indicate that the contract might be onerous
- Onerous contracts identified in the pre-coverage period should be measured on a basis consistent with the measurement of the liability recognised at the start of the coverage period. Similarly, onerous contracts identified under the PAA should be measured on a basis consistent with the measurement of the liability for claims incurred (i.e. the BBA)
At the February meeting the Boards continued their discussion on onerous contracts and reached the following decisions.
Onerous contracts – remeasurement frequency
Staff recommendation that the remeasurement of the liability for onerous contracts that have been identified should be updated at the end of each reporting period was agreed unanimously by both Boards.
Onerous contracts – identification and measurement
Only the IASB members participated in these decisions because they relate to the risk adjustment – onerous contracts under the FASB single margin approach were not considered.
The majority of IASB members (9 members against 5) tentatively decided that the risk adjustment should be included in the test to identify onerous contracts and that the risk adjustment should be included in the measurement of onerous contracts liabilities.
Onerous contracts and discounting
At the December 2011 meeting the Boards noted that there might be unintended consequences arising from the interaction between the following tentative decisions:
- That an insurance contract is onerous if the expected present value of the future cash outflow from the contract exceeds the carrying amount of the liability for remaining coverage;
- Not to require discounting of the liability for incurred claims when they are expected to be paid within 1 year from the incurred date; and
- To measure onerous contracts on the same basis as the liability for incurred claims.
In relation to pre-claims liabilities under the PAA where claims incurred liabilities are expected to use the no discounting concession the Staff proposed to
- Identify onerous contracts on a discounted basis but measure onerous contracts on an undiscounted basis; or
- Identify and measure onerous contracts on a discounted basis
Both Staff recommendations were rejected unanimously by the Boards. Instead the Boards unanimously agreed to identify and measure onerous contracts for the PAA pre-claim liability on the same basis chosen for the associated claims liability – therefore insurer will use a discounted basis for identification and measurement if the practical expedient not to discount liabilities is not applied and use a undiscounted basis for identification and measurement of onerous contracts if the practical expedient is elected for the claims liability measurement.
The Boards agreed that there remain three final items to be decided upon on the issue of onerous contracts and that the Staff should bring them to one of the future joint meetings:
- Onerous contract identification and measurement under the single margin approach
- Unit of account for onerous contract identification and measurement
- Remaining coverage liability for onerous contract accounting under the PAA when the PAA practical expedient not to apply discounting in determining the remaining coverage liability is applied but claims liabilities are discounted