Insurance contracts — Education session
This session was initially scheduled to be a joint session with FASB to reach joint tentative decisions on the papers presented. However following the discussion of the same set of papers in a FASB-only education session on 18 January the agenda has been amended and this session was demoted to an IASB-only education session.
The agenda included the following items:
- The Board's progress on the project so far
- Agenda paper 2A: Premium Allocation Approach (PAA) eligibility criteria
- Agenda paper 2B: PAA Mechanics
The Board was not asked to make any decisions at this point.
The Staff noted that the IASB has substantially completed the work needed relating to the measurement of an insurance contract and that several decisions are in line with the FASB. However there are some areas where the Boards have reached different conclusions and in the coming months whilst completing discussions on the remaining topics the Board will assess whether any differences between them can be reconciled prior to the publication of the respective due process documents.
Premium Allocation Approach (PAA) – Eligibility criteria (Paper 2A)
The IASB discussed some proposed principles-based eligibility criteria for the premium allocation approach. The proposals suggested that insurers should apply the building block approach rather than the premium allocation approach if, at the contract inception date, either of the following conditions is met:
- It is likely that, during the period before a claim is incurred, there will be a significant change in the expectations of the net cash flows required to fulfil the contract that would not be captured by the onerous contract test ('expected cash flows criterion'); or
- Significant judgement is required to determine the amount of premium to be recognised in each reporting period, for example if there is significant uncertainty about the length of the coverage period ('allocation of premium criterion').
The Staff noted that the Boards have discussed the eligibility criteria on previous occasions and at most recent in October meeting. Paper 2A proposes principles-based eligibility criteria for the PAA that were developed from that October meeting. The Staff reported that it had done targeted outreach and contract "testing", noting that when participants had reached different conclusions on the eligibility of certain contracts, this was the result of subjectivity and judgment needed. They also noted that only a relatively small set of different circumstances produced different conclusions.
Extensive debate ensued with IASB members appearing in agreement with the intent but noted that it was overly complex and did not address the issue of whether PAA is a proxy or a separate model. It was noted that this was the 4th time the Boards were discussing this item and, at least, there continues to be agreement on the big picture. In general, the IASB members noted their belief that there is one model for insurance contracts, and that default is the Building Blocks Approach (BBA). The PAA is merely a proxy or practical expedient to applying the full BBA. In terms of what qualifies a contract to utilise the PAA, almost everyone agreed that a 12 month duration test is a good practical expedient. The remaining question is the need to develop additional application guidance to determine which contracts longer than 12 months falls into the PAA.
The Staff indicated they would bring the PAA criteria back in February, inclusive of a supplement to Paper 2A to have a 12 month practical expedient, and then criteria that would address the issue: "would the PAA serve a high quality proxy for the BBA". The IASB Chair noted this will be the fifth time this subject is discussed.
Premium Allocation Approach (PAA) – Mechanics (Paper 2B)
The Staff introduced Paper 2B and whether the PAA proposed in the ED could be simplified by considering (a) the requirement to discount the liability for remaining coverage and accrete interest, and (b) the treatment of acquisition costs.
The Staff highlighted the advantages of alignment with the revenue recognition ED and disadvantages of being operationally difficult. The Staff proposed the following two alternatives:
- Alternative A: Do the Boards agree that the measurement of the liability for remaining coverage should not be discounted and interest should not be accreted on the liability?
- Alternative B: Do the Boards agree that: (1) Discounting and interest accretion should be required in the measurement of the liability for remaining coverage for contracts that have a significant financing component? And, (2) as a practical expedient, insurers need not apply discounting (or interest accretion) if the coverage period of the contracts is less than one year?
Generally the discussions seemed to favour the view that discounting and interest accretion should be required in the measurement of the liability for contracts' remaining coverage when a significant financing component is present (this is consistent with the proposals in the revenue recognition ED).
As part of the discussions on mechanical issues, the IASB also discussed the treatment of acquisition cost.
The Staff noted that some believe that the measurement of acquisition costs in the PAA should include directly attributable costs and that insurers should be permitted to expense directly attributable costs that are not incremental. However, others believe that the measurement of acquisition costs in the PAA should be consistent with the proposals in the revenue recognition ED (i.e. only incremental costs will not be expensed as incurred). Finally, the Staff noted that acquisition costs should be recognised as an asset and should be amortised in a manner consistent with the tentative decision on reducing the liability for the remaining coverage.
The outcome of the discussion was a desire to maintain an alignment between BBA and PAA. Ultimately, almost everyone agreed that acquisition costs are part of the cash flows of the insurance contract and do not represent a separate asset.